A global infrastructure resource May 2015

NexusA global infrastructure resource

May 2015

Financial institutionsEnergyInfrastructure, mining and commoditiesTransportTechnology and innovationLife sciences and healthcare

Norton Rose Fulbright

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Contents

Foreword 04

Introduction 05

A new solution for funding infrastructure: institutional investors and project finance 06

Tax planning, tax avoidance and the OECD: the impact of OECD proposals for global infrastructure projects 14

Resolving China’s infrastructure disputes: five points to note for parties 18

Building bridges: in search of solutions for Africa’s infrastructure gap 24

The European Commission’s investment plan for Europe 32

The circular economy revolution: the future of waste processing for Europe 44

The Latin American infrastructure pipeline 50

Export Credit Agencies and energy in Asia Pacific: a changing role? 58

Project Sukuk: Islamic finance solutions for funding infrastructure 66

Breaking the resource curse: an opportunity for investment in Africa’s process sector 72

Sharing mining infrastructure 82

Contacts 94

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04 Norton Rose Fulbright – May 2015

Foreword

Sir John Armitt Author of The Armitt Review: an independent review of long term infrastructure planning

I am delighted to provide a foreword for the first edition of Nexus, Norton Rose Fulbright’s new publication on the global infrastructure sector. In recent years there has been much discussion concerning the need to invest in infrastructure around the world.

In developed markets a key driver is continuing population growth, particularly in urban areas. As cities expand, their infrastructure requirements increase exponentially. Maintaining an infrastructure network which is able to function effectively across all sectors (in particular transport, energy and social infrastructure) is critical to their ongoing success. In emerging markets, the lack of infrastructure represents one of the greatest obstacles to sustainable growth. Overcoming this obstacle is a matter of global justice, as well as an economic imperative.

The expenditure required to meet these needs is estimated to be in excess of US$50 trillion over the next 10 to 15 years. This represents a colossal challenge in both financial and technical terms.

There will be no ‘one size fits all’ solution in addressing this challenge. Not only are the infrastructure requirements and development processes in developed countries different to those in less developed states, but there are unique social, economic and environmental factors in each country. These factors dictate both the rate of development and the form it will take.

Despite this diversity, there are certain common challenges which arise around the world. A key message of this publication is that experience and ideas can be transferred and adapted to find workable solutions to meet these challenges.

Of particular concern is the source of funding. While there is considerable finance available from the private sector for new projects, attracting this investment while markets are focused on returns, against a shifting regulatory backdrop, is challenging. Ultimately the bill for public investment must be borne by the public, through taxation revenues, bank or pension fund investment or at the fare box. Therefore, if we

accept, as most countries in both developed and emerging markets now do, that private sector investment is a necessary component of infrastructure development, appropriate risk allocation between parties is vital.

Furthermore, the projects world is by its nature inclined towards clearly identifiable obligations and risk profiles. This presents significant difficulties when considering infrastructure requirements over a 25-30 year timeframe, particularly when global uncertainties are taken into account.

Equally pressing is the need to develop in an environmentally sustainable fashion, while retaining economic viability. Put simply, renewable energy must become cheaper to become a genuine alternative on a global scale. Environmental issues are also key in the processing and waste sectors.

Finally, global skills shortages are an ongoing concern. Investment in apprenticeships, engineering and other technical professions is crucial if we are to keep up with the rate of development required.

While the challenges are significant, so too is the rate at which new ideas and approaches are being developed. As the world becomes more sophisticated and more complex, the pace at which knowledge is exchanged is ever-increasing. This in turn accelerates the rate of growth, and enables new technologies and approaches to pass rapidly from one region or industry sector to the next.

It is likely that the next wave of development will be based on a mixture of public and private involvement. However, the role of governments in the setting and sustaining of policy remains crucial. Without strategic, consistent, economically and environmentally sustainable and commercially pragmatic infrastructure policy there can be no long-term solutions in meeting the need for infrastructure.

This publication demonstrates the scope of opportunities available in today’s infrastructure market, and sets out some of the ideas and solutions being developed to harness them.

Introduction

Norton Rose Fulbright – May 2015 05

Introduction

We are delighted to welcome you to the first edition of Nexus, our insight and commentary on the global infrastructure sector.Infrastructure is the nexus for so many of the world’s ambitions and demands. Unlocking future economic growth, creating jobs and sustaining income streams for each of our own retirements, infrastructure offers opportunity, change and risk. This is evident from the topics we explore in this inaugural edition which covers: • A new solution in funding infrastructure: the role of institutional investors in the future of

project finance

• The new OECD proposals on tax planning and their likely impact for global infrastructure projects

• Practical techniques for resolving China’s outbound infrastructure disputes

• The development pipelines and some innovative funding solutions for infrastructure in Latin America and Africa

• The recent release of the European Commission’s investment plan for Europe, and what it means for infrastructure development in Europe

• Islamic or Sukuk financing of infrastructure

• Waste and the circular economy ‘revolution’ – what does this mean for the future of waste processing in Europe?

• The changing role of ECA financing in the development of energy projects

• Breaking the resource curse – what export restrictions on raw materials in Africa mean for investing in Africa’s process sector

• Sharing mining infrastructure – the challenges and opportunities for shared use of infrastructure in the African mining sector

Such is the depth and breadth of the industry, that in designing this publication the challenge was not finding sufficient content but deciding what to leave out. Consequently this will be the first of many editions. I would like to thank Sir John Armitt, author of the Independent Armitt Review of Infrastructure for his contribution of the foreword for this our inaugural edition. Sir John emphasises the need for ‘strategic, consistent, economically and environmentally sustainable and commercially pragmatic infrastructure policy’ and this publication is in part, our contribution to the debate that underpins such policies.

We hope you find this resource useful, and always welcome thoughts on how we can improve on it in the future.

Nick MerrittGlobal head of infrastructure, mining and commoditiesTel +65 6309 [email protected]

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A new solution for funding infrastructure: institutional investors and project financeby David Carter and Bevan Peachey, London

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A new solution for funding infrastructure: institutional investors and project finance


In the recent past it has been difficult for institutional investors to participate directly in project finance (PF) or public private partnership (PPP) structures. A handful of recent transactions show these difficulties are now being overcome. The need for infrastructure investment around the globe far outstrips the funds available from retrenching banks – historically the only organisations able to fund new infrastructure without direct recourse to the balance sheets of governments or major corporates.

Part 1

Part 1 of this article will consider the context in which banks have traditionally funded new infrastructure, and the barriers which have (in most countries) prevented major institutional investors from seriously participating. In essence there are two problems:

1 The cumbersome decision making process inherent in the traditional bond and funding structures through which institutional investors typically invest, when juxtaposed against the need to make constant decisions through a project’s construction phase (the Decision Making Problem).

2 The low risk appetite/capacity of the institutional investors (the Credit Rating Problem).

Part 2

Part 2 will examine one solution to the Decision Making Problem. This is based on enabling bondholding institutional investors to make decisions in a manner comparable to bank lenders, and the appropriate restructuring of the usual funder and intercreditor decision making and approval mechanics.


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Part 1

The need for institutional investors in PFI/PPP

The funding gap – a problem The global need for infrastructure greatly exceeds funds readily available for equivalent investment. For governments across the developed and developing world, infrastructure spending represents one of the most potent barriers to sustained economic growth. The World Bank has estimated that the funding gap in emerging markets is US$1-1.5 trillion per year1. In London alone, the Greater London Authority has estimated that the annual funding gap is GB£4.46 billion per annum2.

This gap exists at two levels:

Level 1An inadequate pipeline of government-backed infrastructure projects.

Level 2A lack of debt available to finance the government pipeline.

As global economies recover from the financial crisis, governments are increasingly addressing the Level 1 gap – witness the P3 boom in the US and the increase in projects mooted in the UK. Sooner or later, the gap at Level 1 must close.

Traditionally, only banks have been able to provide consistent funding at Level 2. They have the organisational expertise (together with their technical and legal advisers) to structure project risks so that their organisations can bear them. They also have the experience needed to supervise projects in construction, monitoring borrowers, considering waivers and consents on a case by case basis, restructuring projects when necessary. Investing independence means they have been able to price for and accept sometimes considerable project risk.

In part, the long term global need for infrastructure has simply outgrown the capital available from banks. In part, the banks’ ability to provide debt has declined as the global need for investment has increased. The credit crunch hit project finance lenders hard, particularly in Europe, wiping some out and forcing others to drastically slim down their

1 http://www.cccep.ac.uk/Publications/Policy/docs/PP-infrastructure-for-development-meeting-the-challenge.pdf

2 https://www.london.gov.uk/sites/default/files/London per cent20Infrastructure per cent20Plan per cent202050 per cent20 per centE2 per cent80 per cent93 per cent20consultation per cent20document.pdf

operations. As the deal flow slowed, investment teams sometimes lost the critical mass needed to survive and disbanded. Basel III will make it increasingly difficult and expensive for surviving project finance bank lenders to offer debt on the twenty, thirty or forty year tenor over which PF/PPP facilities are often repaid.

Institutional investors – a solution and an opportunityAs it has become clear that banks’ balance sheets will not be able to support the need to finance infrastructure, attention has increasingly turned to institutional investors.

The sums held by institutional investors – principally insurers, pensions funds and sovereign wealth funds – approach the funding gap in scale. An OECD paper has estimated the total global infrastructure funding required from 2010 to 2030 to be US$50 trillion. The same paper estimated the total sums held by pension funds, insurance companies and mutual funds to be in excess of US$65 trillion3. The pricing, ticket sizes and tenor institutional investors can offer borrowers can also make them more attractive than traditional bank funders.4

Seen from the institutional investors’ perspective, there are several factors pushing them to take up PF/PPP debt:

• The investment profiles of the institutional investors are, in some respects, particularly well-suited to PF/PPP debt. They are usually seeking long term, low risk, fixed income products to match the nature of their insurance, pension and sovereign liabilities.5 For insurers, this is complimented by incentives to match the tenor of funding sources and liabilities under Solvency II.

• Although the lack of a transparent index or public market makes direct comparison difficult, infrastructure is widely seen as a well performing asset class over the long term. Even for investors whose priorities lie elsewhere, the diversification benefits of unlisted infrastructure may prompt moves into an area which is currently underinvested by most institutional investors.6

3 http://www.oecd.org/futures/infrastructureto2030/48634596.pdf

4 The pioneering bond deals which closed in Europe in 2014 were based on open competition, in which bond solutions were chosen on pricing grounds.

5 Infrastructure bonds can also carry inflation protection, though this approach is exceptional.

6 See Private Real Estate Markets and Investments edited by H. Kent Baker, Peter Chinloy.



• Historically low interest rates make the returns available to those prepared to take a short period of construction risk particularly attractive.

• Major institutional investors are facing political pressure to invest directly into infrastructure.

Given these incentives, why is there so little participation by the institutional investors in the PF/PPP markets?

Two problems

The Decision Making ProblemPF and PPP are based on effective transfer of risk away from a special purpose vehicle project company (ProjectCo), which has an initial liability to build a project. Sophisticated bank lenders have preferred to be able to regulate and supervise this risk transfer and project progress. This process requires frequent decision making. In contrast to the bank position, tax exempt retail bond purchasers in the US have accepted lower levels of control, and trusted to the day one allocation of risk and obligation as assessed by credit rating agencies. Indeed, traditional bondholding structures would make it difficult for these bond purchasers to make frequent and rapid decisions in the style of banks. If sophisticated institutional investors are to invest in PF structures they will face a choice. When negotiating upfront financing arrangements with sponsors, they can either:

• focus on key entrenched rights, placing a correspondingly increased level of emphasis on the robustness of day one risk allocation (a solution which is emerging in North America)

• restructure the decision making procedures and roles, so that the bondholding institutional investors (or other co-funders) enjoy decision making control similar to the controls historically enjoyed by banks (a solution which may be emerging in Europe).

Making either approach ‘fundable’ presents various structural challenges, distinct from those raised in conventional bank-led PF. The solutions to these challenges remain experimental, and are rapidly evolving.

It should also be noted that in the past, few institutional investors have been able to match the deal team expertise enjoyed by PF banks, who closed numerous PPPs throughout the 1990s and 2000s. This in turn affects the strategies institutional investors might prefer (or be able) to deploy to overcome the decision making problem.

The Credit Rating ProblemMajor institutional investors are often only able to provide debt if the relevant debt instrument or counterparty exceeds a certain credit rating.

There are usually two reasons for this position:

• Regulatory concerns: Solvency II incentivises insurers to take highly rated debt. Regulations often prohibit pension funds from investments below investment grade.

• Institutional concerns: investors themselves often have internal rating restrictions, and given their liabilities, a focus on certainty of return.

In a PF transaction, bonds are issued by the ProjectCo, or a sister SPV issuing company (able to issue listed bonds without breaching the control and confidentiality provisions binding ProjectCo). Historically, bonds issued by a ProjectCo would not achieve the credit rating required to allow them to attract major institutional investors.

To overcome this issue, various SPV credit enhancement solutions have been pioneered which allow project bonds to be issued at an improved rating. These have been state or multilateral backed in recent years.

Why focus on Project Finance?

Project Finance debt is expensive. Given the tightly defined risk profile lenders fund on, it has also been criticised in the past for lack of flexibility in the infrastructure it procures. These disadvantages are weighed against the high gearing ratio the model supports and the lack of upfront cost for authorities. Whether publicly or privately procured, there is an argument that a PF structure allows the infrastructure procurer to purchase ‘more’ infrastructure than they could otherwise afford.

The simple fact remains that while there are other infrastructure finance models, PF continues to form the basis on which most infrastructure is procured by the state, throughout the OECD, and in many developing economies. The robust nature of risk transfer to construction contractors and long term government guaranteed returns, also means the structure can be suited to direct investment by institutional investors in greenfield infrastructure.


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Part 2

Helping institutional investors make project decisions

Appointing decision makersThough challenging, it is possible to structure institutional investor debt so that it enjoys the same level of project control bank lenders would typically expect.

Bonds, through which institutional investors usually invest, are typically passive instruments. The purchaser holds the bond and expects in most cases payment of a coupon, without the need to take further action. This is particularly the case with listed bonds, in which the investor pool may be changing, and the only contact with the issuer is through the bond/indenture trustee. The trustee, though it co-ordinates votes for decision making by the bondholders, usually does no more than enforce their static rights.

To the extent bondholders invest through day one purchase of listed bonds, passivity is hardwired into the instruments through which the institutional investors hold their debt.

To the extent the bonds or notes are not listed, the passive approach reflected in traditional bond structures has historically been reflected by their purchasers. These purchasers do not generally expect to exercise active rights akin to bank holders of PF debt.

Generally, project decisions exist at two levels:

Category ABroadly procedural decisions (for instance approval of metrics and assumptions in financial models, approving budgets, approval of ProjectCo decisions under subcontracts where the funders’ reserved discretion to withhold approval can only be exercised ‘reasonably’).

Category BBroadly commercial decisions (for instance calling an event of default, approval of key ProjectCo actions under construction or operating subcontracts).

The structures which enable bondholder decision making focus on a combination of categorising decisions and delegating project decisions.

Decision support – the Monitoring AdviserProject bonds issued to institutional investors before the financial crisis were typically structured around monoline

insurers. These organisations sought to solve both the Decision Making Problem and the Credit Rating Problem, by guaranteeing the ProjectCo’s debt, and assisting with the decision making process. When the credit crunch hit, the monolines balance sheets were unable to support all of the project (and other debt) guarantees they had written. The monoline market effectively collapsed.7

Largely staffed by former monoline employees, successor organisations have emerged in the shape of Monitoring Advisers (MAs). MAs take no credit risk, but provide an administrative aid to the bondholders, particularly with Category A decisions.

For the MA role to function, all potential creditor decisions are assigned a level on the spectrum between Category A and Category B. There are usually three to five basic levels, but in a bespoke PF transaction the exact structuring of these will be at the discretion of the parties. The mechanics assigning a decision to a level can also be nuanced – for instance decisions may shift between levels, depending on the financial health of the underlying project.

Unlike on bank transactions, each ProjectCo request for a creditor decision is then structured as a proposal, which receives a yes or no answer. The ProjectCo designates the level it thinks the proposal falls under, and delivers it to the MA.

The MA confirms the decision-making category of the request – an important oversight function, preventing the ProjectCo or other creditors (whose approval rights may vary with each level) from gaming the system. It then passes a recommendation to bondholders, either to accept or reject the proposal.

Importantly, before the proposal is delivered, the MA actively liaises with ProjectCo to ensure proposals are workable – ideally, only those likely to receive a ‘yes’ will be formally delivered.

Each level will come with a specified decision-making period – the length of which is likely to be a point of close negotiation between sponsors and funders. Depending on the level of reliance bondholders are willing to place on the MA, failure of bondholders to vote within specified times can lead to Category A recommendations being automatically accepted. Alternatively, bondholders can vote to overrule the

7 One provider, Assured Guaranty, continues to offer wrapped products on a smaller scale than previously.



recommendation. The level of reliance bondholders are comfortable with placing on the monitoring adviser will often depend on the efficiency of the underlying bondholder voting.

Decision making – the majority bondholder representativeAn emerging approach to efficient underlying bondholder voting is the appointment of a majority bondholder representative (MBR). This idea reached its most advanced refinement to date under the Aberdeen Western Peripheral Route/Balmedie-Tipperty road project (Aberdeen Roads) PPP project, which closed in Scotland in December 2014.

The basic concept is simple: the bondholders elect an MBR to make majority (or supermajority) decisions on their behalf. The MBR usually requires election by the same majority as the voting block it is entitled to control – so, if it is entitled to make decisions for bondholders where a 50 per cent vote would otherwise be required, it must be elected by 50 per cent of bondholders. This can be refined with tiered levels of MBR appointment, so that if elected by a supermajority, it can make supermajority decisions.

The MBR approach requires a high degree of coherence, or at least consensus, amongst the bondholders. It should be noted, however, that this consensus can effectively be built at two levels – amongst the bondholders themselves, and by investment through managed funds (meaning a third party institutional investor effectively delegates consensus reaching powers to that managed fund).

For both sponsors and investors there are advantages to an MBR appointment:

• Sponsors receive the comfort of a single point relationship.

• Investors are able to assume positions akin to those developed by bank PF funders.

There remain some differences in the positions an MBR can assume, compared to bank lenders:

• If the bonds are tradable, or there is a sufficiently diverse investor base, it is natural that there be a right to remove the MBR at some point in the future. This means the intercreditor and decision making provisions of the financing still need to function in the absence of an MBR.

• There may be certain decisions which bondholders are not prepared to delegate to an MBR. Bank PF structures will typically give individual creditors certain entrenched rights, so this is not entirely novel. Reaching non-MBR

decisions will usually fall back on conventional unwieldy voting mechanics, but most of them concern the structure of the bonds themselves, so remain workable in the context of the project. We note that in the past we have seen ‘all senior creditor’ decisions deferred to MBR decision makers.

• There may be certain commercial positions an MBR could not adopt with the same ease as a bank, or even at all. This usually derives from the underlying relationship of the MBR with the bondholders, or even potential bondholders. For instance, ‘snooze-you-lose’ provisions are often accepted by banks. These state, in broad terms, that non-responsive creditors are deemed to have approved ProjectCo proposals, or are not counted in votes. If an MBR fails to respond to a proposal, institutional investors will typically argue it is unfair for the underlying investors (potentially, on a listed bond, a member of the public) to lose the right to have their interests represented. Sponsors will argue in response that they are relying on rapid decision making by the MBR, and without ‘snooze-you-lose’ it is hard for them to justify this reliance.

• Though the MBR can provide single point negotiation and decision making, it remains a front for a range of investors, who may have subtly different concerns or regulatory constraints. The problems these create are almost always technical and can be structured around by the lawyers, but they create another layer of complexity.

An obvious constraint on the MBR structure is the need for an institutional investor to have project finance deal team expertise, and the capacity to make ongoing decisions. Though this is relatively rare amongst institutional investors, there are now teams who do have this experience and are active in the market. As institutional investors become more active in the market, this experience is likely to spread.

Co-investment with banksOnce supported by MA and MBR appointments, institutional investor co-investment with banks as ‘intercreditor equals’ becomes a genuine possibility. From a purely economic perspective, banks continue to be competitive and flexible providers of short term debt – the liquidity ratio burden of Basel III being greater the longer the debt tenor. Institutional investors are often attracted by the long tenor of infrastructure debt, so an arrangement where the bank debt amortises ahead of bond debt suits both investor classes. This builds on the advanced Canadian model, in which bank construction facilities are repaid ahead of the bond from completion payments. The same rules can be applied to prepayment.


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Compatibility with bank debt also makes it easier for active multilateral debt providers to co-fund. Given how active multilaterals such as the European Investment Bank are in certain markets, this is a significant advantage.8

Intercreditor issues arising in bank/bond co-investment are also mitigated by the appointment of an MBR. One example issue is the excessive influence sometimes enjoyed by small bondholder groups because of quorum rules. When an intercreditor decision is required, typically bondholders vote first to reach a ‘bond decision’, then the bonds count as a single vote when the banks vote. In this ‘single bond vote’ the bonds follow the earlier majority bondholder decision, but the vote counts for the entire exposure of the bonds. This can mean that under normal bondholder voting arrangements, if bondholders have 50 per cent exposure to a project and the banks collectively have a 50 per cent exposure, banks totalling a 49 per cent exposure could be outvoted by bondholders holding only around a 14 per cent exposure. This arises because 25 per cent of bondholders (equalling here around 14 per cent total exposure) could constitute a majority of the 50 per cent quorum usually required to vote the entire bond exposure9. While there are mechanics for avoiding this (for instance, giving the banks in this situation a right to require a re-vote with higher quorum requirements) an MBR considerably simplifies the position by forcing the bond to act as a block.

Other intercreditor and interface issues stemming from bank/bond co-investment will have to be structured on a case by case basis, depending on the total exposure of the bond and the respective bank shares. These mechanics become more important if there are divergent bond and bank interests in the long term, particularly if both parties feel the need for independent enforcement rights (to be balanced against the understandable sponsor concern that enforcement not occur lightly). Another common interface issue is the structure of drawdown, as institutional investors will prefer to fund completely on day one, or if pushed on a scheduled profile – rather than as funds are actually required for construction. This is usually managed through pricing compromise, and sometimes elaborate escrow account mechanics, in which drawn but as yet unneeded debt is held.

In future, the issues fleshed out in these negotiations may provide a route to more refined holding of institutional investor debt, in which separate tranches may have individual MBRs or constitute block investors, and vote as separate blocks.

8 Though we would note in the past multilaterals have sometimes invested through the bonds themselves – as EIB did on the Castor Gas project in Spain

9 The quorum figure can be much lower – on Castor Gas, a pure bonds deal, it was a low as 20 per cent for certain decisions.

MBR alternativesThe MBR structure probably represents the most sophisticated existing structure which:

• allows diverse bondholders to fund a project; while

• exercising effective Category B decision making rights.

An alternative is for Bondholders to rely on an MA to co-ordinate Category A decisions, and retain reduced ability to make Category B decisions. This approach was followed in Europe in some of the early EIB 2020 Project Bond transactions, and effectively constitutes a compromise between the two solutions to the Decision Making Problem.

There are, logically, two alternatives to an MBR structure when seeking high levels of Category B control:

• Appointing a non-institutional investor controlling creditor, as proposed under ING’s PEBBLE structure.

• Investing as a small group of major institutional investors, with each investor able to act in the same manner as a traditional bank lender.

The PEBBLE style structure is also relevant as a form of credit enhancement. In short, the concept calls for bond and bank debt to be partnered, with the bank debt taking first loss risk during construction. As a corollary of its risk position, the bank controls the project through construction. While this doesn’t give the bond direct control, it provides comfort that another (highly motivated) creditor class is monitoring the project’s progress. It seems doubtful that institutional investors would accept a similar position in the event that the controlling creditor does not take first loss risk, but it remains a theoretically workable solution. As bank and bond partnering becomes more common following deals like Aberdeen Roads, credit enhancement on a PEBBLE style basis may be used to take institutional investors into project jurisdictions and types presenting higher underlying risk.

In future, the issues fleshed out in these negotiations may provide a route to more refined holding of institutional investor debt, in which separate tranches may have individual MBRs or constitute block investors, and vote as separate blocks.



If this happened, the decision making corollary could become an important tool.

The alternative of institutional investors holding block positions will become increasingly plausible as deal team expertise proliferates from the relatively few institutions (for instance Allianz, M&G and L&G) which can already leverage the required expertise. It is likely, however, that there will always be a majority of institutional investors who lack this expertise. Accessing funds held by these institutional investors may continue to make MBR style positions preferable to ‘go it alone’ investments.

Problem solved?

Compared to bank finance in PF and PPP, funding by institutional investors remains in its infancy. This article has set the context, and explained how the one of the barriers to full participation by institutional investors is being overcome. While these structures continue to evolve, it is seems increasingly likely that their successors will enable institutional investors to become staple financiers in the PF market.

Aberdeen Roads PPP – the latest milestone

Aberdeen Roads PPP was the largest and most complicated joint bond, multilateral and bank debt PPP project yet to close in Europe. The project represents a significant civil engineering challenge, including 12 junctions, two river crossings, an underbridge for crossing the Aberdeen to Inverness Railway, four major pipeline crossings and three wildlife bridges, in addition to more than 100 other structures. By value, it is the largest PPP ever closed in Scotland.

Norton Rose Fulbright advised on the unique structure of the financing for this project comprising £600 million funding sourced from a combination of senior secured fixed-rate bonds purchased by funds managed through Allianz GI and third party pension funds, European Investment Bank debt, senior commercial term debt provided by Bank of Tokyo-Mitsubishi and equity bridge debt provided by Royal Bank of Canada and Barclays.

The bonds are listed on the Luxembourg Stock Exchange. Each debt tranche was innovatively structured to support the others. For instance the commercial term debt amortised ahead of the bond debt, suiting bank regulatory requirements and the bondholders’ preference for long term returns. The bonds will also be purchased in phases, mitigating the negative carry issues associated with purchasing all bonds on day one. Innovative intercreditor arrangements were based around a single point majority bond representative, allowing the institutional investors to negotiate and hold positions akin to a standard bank creditor. Across the contract package frequent mismatch arose between market expectations of bond and PF bank debt providers, requiring new solutions for points that would be boilerplate on other deals.

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Tax planning, tax avoidance and the OECD: the impact of OECD proposals for global infrastructure projects We look at the impact of OECD proposals on tax planning for global infrastructure projects

by Matthew Hodkin, London with Andrew Wellsted, Johannesburg and Darren Hueppelsheuser, Calgary

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Tax planning, tax avoidance and the OECD: the impact of OECD proposals for global infrastructure pr


Tax avoidance, however legitimate its mechanism, has become the new focus for public opprobrium in parts of the world. High-profile cases and media attention examining the tax strategies of major global companies operating primarily in the digital economy have all contributed to this shift of focus. How are the profits of multinational groups taxed? People want to know.

OECD measures to combat tax avoidance through international structuring are going to affect transactions across all industry sectors including infrastructure. We examine what is in store.

In November 2012 the G20 nations backed the OECD to produce a report on tackling the BEPS problem: ‘base erosion and profit shifting’. From that came a 15-point action plan, published in 2013, and, a year later, proposals relating to seven of the action points. These are the proposals up for scrutiny here.

The seven action points – published in September 2014 – cover matters as diverse as ‘neutralising the effects of hybrid mismatch arrangements’ and ‘guidance on transfer pricing aspects of intangibles’. To some extent, these are terms of art that have been evolving in the international tax advisory world; by their very nature, it is not always obvious to a non-tax specialist exactly what effect these could have in practice.

Not all of the areas being tackled by the BEPS project will have a marked impact on the way infrastructure projects are structured and on the underlying economics; some of them – the proposals relating to the digital economy, for instance – are unlikely to affect the infrastructure sector. It is also worth noting that some jurisdictions, such as Australia, are already trying to balance the effects of the BEPS project with a desire to ensure that investment in infrastructure is not prejudiced.

Implementation will take place through a mix of domestic legislation and changes to existing double taxation treaties. There will also be more international co-ordination on the way tax regimes are applied in cross-border situations.


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BEPS: seven OECD action points published in September 2014

Action point 1 of 15

Addressing the tax challenges of the digital economy


Neutralising the effects of hybrid mismatch arrangements


Countering harmful tax practices more effectively, taking into account transparency and substance


Preventing the granting of treaty benefits in inappropriate circumstances


Guidance on transfer pricing aspects of intangibles


Guidance on transfer pricing documentation and country-by-country reporting


Developing a multilateral instrument to modify bilateral tax treaties

A typical infrastructure projectA typical infrastructure project involving private sector investment might be structured along the lines shown here (although our diagram is inevitably simplified compared to the real world).

This structure involves a special purpose project company in the jurisdiction of the project (Jurisdiction A). This will, in simple terms, be funded by a mix of third party senior debt, subordinated shareholder loans and equity. The shareholder debt and equity is provided by a single holding entity located in another jurisdiction (Jurisdiction B). Investors are able to participate through the holding entity.

The taxation of the project during its life will be reliant on the availability of tax depreciation for the investment into the project and on tax deductions for finance costs. Over the life of the project, the project company is taxed on its economic (i.e. taxable) profit.

Investor 1 Investor 2

Joint Venture HoldCo (Jurisdiction B)

Investor 3

Project Company

(Jurisdiction A)

Banks

Project revenues

Project loans

Shareholder loans

The main tax threats to maintaining this return are withholding taxes on interest payments and restrictions on the tax deductibility of interest amounts paid to the sponsors or equity investors.

Withholding taxes

It is quite common to see the withholding tax risk mitigated by the use of a holding company in Jurisdiction B. Given the existence of a favourable double taxation treaty between Jurisdiction A and Jurisdiction B, the project company in Jurisdiction A can then make payments of interest and other distributions (such as dividends) without withholding taxes.

Action points 6 and 15 are likely to create uncertainty in this area.

Action point 6 ‘Preventing the granting of treaty benefits in inappropriate circumstances’ – targets what is known as ‘treaty shopping’. In future, it is likely that restrictions will be placed on the availability of the benefits of the treaty between Jurisdiction A and Jurisdiction B. Point 6 does not specify whether this will be by way of a ‘limitation on benefits’ article or a more general anti-treaty shopping principle. The former is designed to prevent benefits being available to a company that is not ultimately owned by investors who would benefit from equivalent treaty protection.

A typical infrastructure project structure


Tax planning, tax avoidance and the OECD: the impact of OECD proposals for global infrastructure pr

Either way, it is clear that the movement of travel is away from allowing SPV holding companies to benefit from favourable tax treaties where there is no real substance or where there is no reason for their establishment in a particular jurisdiction other than the availability of the treaties.

Action point 15‘Developing a multilateral instrument to modify bilateral tax treaties’ – is regarded by the OECD as desirable because the existing bilateral treaty network is unwieldy. At the moment, a single amendment to the ‘model’ treaty can take years to find its way into each bilateral treaty as and when it is renegotiated by the participating states. A multilateral instrument will enable OECD changes to the model double tax treaty to find their way into existing treaties much faster. In practice, this will make it easier for international consensus (as embodied by the OECD) to have a real and practical impact on existing double taxation arrangements.

Existing holding structures and new transactions will have to keep a watchful eye on these developments. Pay attention in particular to whether they will lead to changes to the way in which existing treaties on which reliance is being placed are being used.

Hybrid mismatch arrangements

It is also quite common for jurisdictions that have established themselves as ‘good’ holding company jurisdictions to have rules enabling the distribution of the return from the project in a quasi-equity form. These rules apply irrespective of whether the return results from interest on shareholder loans or from dividends.

Investors may as a result be entitled to receive a return in a form which, in their home jurisdiction, is not taxed, despite the fact that a tax deduction may have been obtained for the payment in Jurisdiction A.

Action point 2 ‘Neutralising the effects of hybrid mismatch arrangements’ – contemplates changes to domestic legislation to prevent tax deductions being granted in a paying jurisdiction (Jurisdiction A in the case of our example) where this is not taxed in the hands of the recipient.

We don’t yet know how these rules will apply where the instrument is taxed in the recipient jurisdiction but a return is earned in a third jurisdiction in a non-taxable form. Some

jurisdictions are already using the BEPS initiative to begin ‘looking through’ intermediate holding companies where there is insufficient substance to the holding company arrangement and applying rules to prevent tax deductions for interest payments where the return is not taxed in the hands of the ultimate recipient.

Tax incentives and tax avoidance

Tax incentives are a traditional means of encouraging investment in infrastructure and are frequently deployed on projects regarded as important long-term political and economic investments. This is particularly the case in emerging markets, where concerns around political instability and country risk can make investors wary of committing funds unless they have a degree of certainty as to the tax regime that will apply. This is often combined with some form of tax holiday or other incentive given by the home government. The OECD recognises the concern that this could lead to a ‘race to the bottom’, where governments compete to offer tax incentives that may not always be critical to the decision to invest.

In the infrastructure sector, however, such commitments and incentives can and do form part of an appropriate way of encouraging investment and it will have to be recognised that such behaviour should not be penalised through measures introduced as a result of the BEPS project.

A watching brief for 2015

There is little that can be done now to future-proof existing structures. Each existing investment structure will eventually have to be reviewed on a case-by-case basis, with findings very much depending on the jurisdictions involved.

Deliverables on other action points are due in 2015; these will include areas relevant to infrastructure funding, such as transfer pricing, so it will be important to track developments in the BEPS project.

Returns may be affected as a result of these changes. National governments will be observing all developments carefully: if the OECD measures have too radical an effect on the returns available to infrastructure funds (and, in turn, the pension and annuity funds that invest in them), a valuable source of capital investment for infrastructure spending may be restricted.

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Resolving China’s infrastructure disputes: five points to note for parties by James Rogers and Matthew Townsend, Hong Kong

3

Resolving China’s infrastructure disputes: five points to note for parties


China’s outbound investment boom has been to a large extent infrastructure-driven, with Chinese state and private contractors being increasingly retained to deliver roads and rail systems, power generation and electricity infrastructure, and telecommunications projects in many different jurisdictions.

Given the size and complexity of such projects, and the focus upon geopolitically and economically unstable parts of the world, it is especially important for all parties to China-related infrastructure contracts to ensure they have a suitable and effective dispute resolution mechanism to enforce them.

These mechanisms should account not only for industry-specific characteristics in the infrastructure market but also for the unique factors which arise when resolving disputes in the China context. Below we consider a number of issues industry participants should bear in mind.


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This is the case when it comes to many foreign court judgments and also to certain categories of disputes which PRC law treats as being properly resolved in the PRC.

As suggested above, absent any reciprocal enforcement treaty with China, foreign court judgments are not readily enforceable in the PRC. Some of the key targets for outbound Chinese Infrastructure investment do not have reciprocity arrangements with China (as do key trading partners, including the US, the UK, Germany and Japan). Accordingly, court judgments rendered in those countries face significant obstacles upon enforcement in the Chinese courts. This, as above, contrasts with the wide applicability of the New York Convention when it comes to enforcing arbitral awards.

Chinese law also prohibits the offshore resolution of purely ‘domestic’ disputes, and the PRC courts will likely refuse enforcement of foreign arbitral awards rendered in relation disputes where there exists no ‘foreign’ element. China’s Supreme People’s Court has published two judicial interpretations (in January 1998 and July 1992) which indicate that a ‘foreign-related’ dispute is one: (a) that involves at least one foreign party; (b) where the subject matter in dispute is in a foreign country; or (c) where there are facts establishing the legal relationship between the parties which occurred in a foreign country.

Importantly, foreign owned but Chinese incorporated subsidiaries of foreign companies are considered domestic and therefore also restricted in their choice of venue. Arbitration awards or court judgments rendered overseas notwithstanding this prohibition will not be enforced in China.

03 | Know the differences between Chinese and international arbitration

In infrastructure projects, it may often be the case that the (local) project developer has bargaining power over the (often Chinese) contractor or sub-contractor. Nevertheless, it is generally true in many industries, as the bargaining power of cash-rich Chinese parties has risen over past years, so too has the pressure on their counterparties to accept arbitration agreements specifying arbitration in the PRC. In these circumstances it pays to be aware of the differences between Chinese arbitration as practiced by mainland PRC arbitrators and counsel, and the international variant.

Historically, Chinese dispute resolution practices have emphasised negotiation and conciliation and Chinese arbitration procedures are shaped by that tradition. Chinese arbitrators are inclined towards mixing arbitration and mediation (so called ‘med/arb’), routinely acting as both conciliator and adjudicator in the same proceedings.

01 | Choose arbitration over litigationInfrastructure projects, whether China-related or otherwise, will typically involve multiple parties, jurisdictions and contracts. These factors will often militate towards the use of arbitration as the preferred dispute resolution mechanism.

Given that most infrastructure disputes involve highly technical subject matter, parties usually feel they will be better resolved by an arbitrator hand-picked by the parties for his or her particular knowledge and experience than by a national court judge. Litigation in the home courts of one or other of the parties may also compare unfavourably to arbitration before a neutral tribunal (often situated in a third-party country). This may be particularly the case given that many infrastructure projects involve a level of state involvement.

Moreover, in an industry with relatively few participants in which long-term relationships are at a premium, confidential arbitration proceedings will often be preferable to litigation in which the case becomes a matter of public record.

Arbitral awards are readily enforceable worldwide. Over 145 other states, including China, are signatories to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Accordingly, the Chinese courts routinely recognise awards rendered in any other signatory states and vice versa. By contrast, it is considered practically impossible to enforce a foreign court judgement before the PRC courts.

It is also worth noting that, since 1995, the Chinese courts have also implemented a special reporting system for the enforcement of foreign arbitral awards. Enforcement of a foreign or foreign-related arbitral award can therefore only be refused by the Supreme People’s Court in Beijing, the highest court in the land. This removes the parochialism of the local courts from the equation. Again this contrasts with the enforcement of a domestic court judgment, which will be controlled by the local court to which the application is made.

Having said this, there may be circumstances in which a party may consider litigation preferable to arbitration. Much will depend upon that party’s strategic objectives and the facts in question.

02 | Do not forget the impact of PRC lawEven for infrastructure projects taking place outside of China, should one or other project participant be Chinese, PRC law will still impact upon the appropriate choice of dispute resolution provision.

There are certain types of dispute mechanism which may lead to a judgment or award being unenforceable in China.



Historically, Chinese dispute resolution practices have emphasised negotiation and conciliation and Chinese arbitration procedures are shaped by that tradition.

arbitrators with the ability to deal with the complex issues raised in major infrastructure disputes.

Additionally, both have well-established local arbitral institutions (the Hong Kong International Arbitration Centre (HKIAC) and the Singaporean International Arbitration Centre (SIAC)) with modern, state-of-the-art arbitration rules and procedures.

There is little to choose between the two jurisdictions. However, it is worth noting that, in recent years Hong Kong has suffered from a perception issue – being seen by foreign observers as ceding excessive judicial and political control to the mainland Chinese authorities. Accordingly it is sometimes suggested that arbitration in Hong Kong may not be as impartial and independent as in some other jurisdictions.

In the authors’ opinion, this is not the case. Hong Kong is (and remains) a special administrative region of China and largely legally distinct. Parties can expect an impartial and independent process in that jurisdiction and can take for granted that the courts will maintain a rigorous ‘hands-off’ approach when it comes to exercising jurisdiction over Hong Kong seated arbitrations.

This approach has been bolstered by a recent string of pro-arbitration decisions in the Hong Kong courts. It has also been noted in the reasoning of an English court judgment handed down as recently as February 2015. In Shagang South-Asia (Hong Kong) Trading v Daewoo Logistics [2015] EWHC 194 (Comm)) the judge held that the Hong Kong (not English) courts had jurisdiction over a dispute pursuant to an arbitration clause providing for ‘Arbitration to be held in Hong Kong. English law to be applied’. In his decision the judge recognised Hong Kong as ‘a well known and respected arbitration forum with a reputation for neutrality, not least because of its supervising courts’.

Hong Kong awards are, for the purposes of enforcement in the PRC, treated on a similar basis as New York Convention awards pursuant to a 1999 arrangement between the Hong Kong government and Mainland China.

It is also worth noting that Chinese arbitral institutions are themselves internationalising. China’s most prominent arbitral institution, the China International Economic Trade and Arbitration Commission (CIETAC), published new arbitration rules in 2012 and 2015. It is empowered to administer arbitrations outside the PRC and has opened an office in Hong Kong, giving parties a further ‘offshore’ option when it comes to arbitrating China-related infrastructure disputes outside of Mainland China.

Tribunals seated in China are also able to decide matters on an ex aequo et bono basis upon concepts of ‘fairness’ and ‘equity’ rather than in accordance with the strict terms of the contract and its governing law. Traditional Chinese arbitration is also relatively short-form by international standards. It is inquisitorial, rather than adversarial, the issues and argument driven by the tribunal rather than the parties with curtailed hearings, little room for witness cross examination, and often no document production.

Chinese arbitral institutions and tribunals also tend to play a larger role in the administration of a matter, often interposing themselves between the parties and occasionally conducting what amounts to separate ex parte discussions with each.

By contrast, international arbitration procedure tends to be more party-driven and adversarial. While arguably more certain and predictable, it can be perceived by Chinese parties as unfamiliar, inefficient and lengthy.

04 | Consider compromise venuesHowever, the same factors which lead Chinese parties to question the merits of foreign seated arbitration (witness cross examination, document production and an adversarial process) arguably allow parties a better opportunity to present their case and ensure greater certainty of process.

As increased Chinese outward investment drives cultural change, Chinese parties are beginning to acknowledge this benefit. This has manifested itself in an increasing acceptance of venues in Europe for example, with the arbitral rules of the LCIA, the International Chamber of Commerce (the ICC) and the Stockholm Chamber of Commerce (the SCC) all regularly agreed to by Chinese parties.

However, the two arbitral ‘seats’ which have benefited most from an increase in Chinese investment have been Hong Kong and Singapore. Both of these two Asian venues benefit from a certain cultural and geographical proximity to mainland China. However both have arbitration-friendly and impartial courts, a large pool of experienced counsel and


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05 | Investment treaty arbitration Of particular significance to parties to infrastructure projects, where the state often plays a role, is investment treaty arbitration.

International commercial arbitration arises out of a direct, contractual relationship between the parties. However, arbitration rights may also arise from international instruments agreed between nation states, such as bilateral investment treaties (or BITs), multilateral investment treaties (MITs), or free trade agreements (FTAs).

These treaties establish terms and conditions for private investment by nationals and companies of one state in another ‘host’ state, ensuring that investments are afforded certain minimum protections from adverse treatment by the host state. They often usually include a dispute resolution mechanism allowing an investor whose rights under the treaty have been violated to have recourse to international arbitration. This is often under the auspices of the International Center for the Settlement of Investment Disputes (ICSID).

This mechanism has the benefit of removing the dispute from the jurisdiction of the national courts of the host state, whose very actions will have led to the complaint.

Notably China is a party to the ICSID Convention. It also has the world’s second most comprehensive network of investment and trade treaties after Germany. However, despite the availability of these remedies, there have been comparatively few BIT claims by Chinese investors, and only one (short lived) claim reported against China itself.

Nonetheless, it is highly likely that the numbers of investors submitting themselves to investor treaty arbitration will increase. This may well include Chinese infrastructure project investors commencing proceedings against the states in which the investment is made.



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Building bridges: in search of solutions for Africa’s infrastructure gapby Tinashe Makoni, London

4

Building bridges: in search of solutions for Africa’s infrastructure gap


The infrastructure and energy challenges currently facing sub-Saharan Africa are immense, as are the opportunities for public and private sector investors, developers and financiers. Ellen Johnson Sirleaf, President of Liberia, speaking on the developmental challenges facing that country, provided a particularly poignant illustration when she lamented the fact that the AT&T Stadium near Dallas, Texas, home to American football team the Dallas Cowboys, uses more electricity than the total installed capacity of Liberia.

In this article, we examine the infrastructure challenges facing sub-Saharan African (SSA) countries and consider some of the initiatives under way to craft solutions to address these challenges.


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• Democracy seems to have taken root in much of SSA, along with greater accountability and improved economic management.

The challenges

Despite the significant progress made over the past 15 years, there are still formidable challenges, with inadequate infrastructure being a major obstacle to sustainable growth.

The infrastructure gap

The African Development Bank (AfDB) has identified infrastructure development as one of the keys to unlocking economic growth and development in SSA, and has estimated that inadequate roads, housing, water and electricity reduce SSA’s economic output by approximately 40 per cent.

In 2011, the International Monetary Fund (IMF) published an exhaustive study comparing the infrastructure in SSA to that of other developing nations and Organisation for Economic Co-operation and Development countries. The results set out below make grim reading:

Utility outage

Infrastructure in sub-Saharan Africa is far less developed on average than in other low-income countries around the world.

Low-income countriesSub-Saharan Africa

Rest of World

Road density1 137 211

Paved road density1 31 134

Power generation capacity2 37 326

Electricity access3 16 41

Access to reliable water3 4 60 72

Access to sanitation3 4 34 51

Source: Yepes, 20081 Kilometers per square kilometer2 Megawatts per population in millions3 Percentage of population4 At or above a standard threshold of quality

Source: IMF 2011 comparative study of African infrastructure

Poor roads, railways and ports are a major barrier to trade. Intra-Africa trade has traditionally been significantly lower than the continent’s trade with the rest of the world. In 2013,

The good news

It is fair to say that the narrative regarding Africa has, in recent times, shifted from one of despair and pessimism to one of hope and affirmation. A particularly striking illustration of this can be found in the December 2011 special report of The Economist entitled ‘The hopeful continent: Africa rising’ which stands in stark contrast to the May 2011 special report in which The Economist labelled Africa ‘the hopeless continent’.

Much of this optimism is well founded:

• In the past year, 12 of the 30 fastest-growing economies in the world have been from SSA.

• Boston Consulting Group’s sustainable development assessment methodology (an indicator of a country’s general welfare) found that, of the top 30 countries with the greatest recent progress in well-being, eight were from SSA.

• Standard Chartered forecasts that SSA’s economy will grow at an average annual rate of 7 per cent over the next 20 years.

• Standard Bank estimates that the African middle-class households in 11 SSA countries (Angola, Ethiopia, Ghana, Kenya, Mozambique, Nigeria, South Sudan, Sudan, Tanzania, Uganda and Zambia) have trebled between 2000 and 2014.

• Record amounts of foreign direct investment have flowed in – largely driven by high commodity prices over the past few years and China’s increasing demand for raw materials.

The African Development Bank (AfDB) has identified infrastructure development as one of the keys to unlocking economic growth and development in SSA, and has estimated that inadequate roads, housing, water and electricity reduce SSA’s economic output by approximately 40 per cent.



US$35bn

Current financing gap

US$37bn

Operation and maintenance

US$38bn

Infrastructure development

US$40bn

Current spend

43.70%

9.60%

3.60%

Transport

Power

ICT

Water supply and sanitation

Irrigation

19.50%

23.50%

Mind the gap

Sector-specific spending requirements

merely 11 per cent of total African trade took place within SSA. By way of contrast, 70 per cent of total European trade was intra-European. One of the barriers to intra-African trade is the poor infrastructure and the associated costs of transporting goods between African states.

• According to a United Nations (UN) report from 2010, it costs US$1,500 to ship a car from Japan to Abidjan, a distance of 13,947km, while shipping the same car from Addis Ababa to Abidjan, a distance of 4,698.3km, costs US$5,000.

• The US trade department estimates that it would cost more to ship a ton of wheat from Mombasa (in Kenya) to Kampala (in Uganda) than it would to ship the same consignment to Chicago.

• Only one third of Africans living in rural areas are within 2km of a paved road.

Africa’s power networks are woefully inadequate, and the costs of doing business in Africa are excessive and as a result economic growth and development suffer:

• Nigeria, Africa’s largest oil producer and most populous country with more than 160 million people, only produces 4,000 megawatts of power (less than half its total demand), which costs the country approximately 4 per cent in lost gross domestic product (GDP) annually.

• Power from private generators, a necessity in many African countries due to the unreliability of the national grid, costs up to ten times more than in OECD countries.

• Power shortages trim more than 2 per cent from annual GDP growth in SSA.

• The World Bank estimates that SSA (with a combined population of 800 million) generates roughly the same amount of power as Spain (with a population of 45 million).

The financial gap

In 2011 the World Bank estimated that approximately US$75 billion would be required each year to address Africa’s infrastructure gap. At the time, SSA countries were spending approximately US$40 billion each year on developing and maintaining existing infrastructure, leaving a financing gap of US$35 billion.

Source: World Bank 2011 (‘Africa’s Power Infrastructure: Investment, Integration, Efficiency’).

Recently the World Bank revised its figures and now estimates that, in fact, US$93 billion per year of infrastructure spending is required. This number is even more daunting when one considers that the total capital inflow into SSA for 2013 was only US$86.1 billion.

The AfDB estimates that in Nigeria alone, US$35 billion per year of spending is required for transport infrastructure, electricity, water, sanitation and telecommunications.


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Total capital cost of PIDA’s PAP by sector and region: US$67.9 billion through 2020

By sector

Financing infrastructure

Currently SSA attracts only 2 to 3 per cent of total global foreign direct investment, and only contributes 1 per cent to world GDP. The traditional model in many African countries has been for the government to act as the sole financier of infrastructure projects and to take responsibility for construction, operation and maintenance of these projects. However, it is clear that the sheer scale of the infrastructure and financial deficits require governments to look beyond their own means and develop partnerships with other African countries, multilateral financial institutions and, increasingly, private financial institutions.

Public private partnerships (PPPs)

While there have been a number of significant infrastructure transactions developed in SSA using the public private partnership model, many African countries have lacked the institutional capacity or even the legislative framework to facilitate greater private sector involvement in the development of key infrastructure projects. However, the South African government’s ambitious Renewable Energy Independent Power Producer Programme (REIPPP) has illustrated the hugely beneficial role that private sector know-how and capital can play in bridging the infrastructure and finance gaps. In 2011 the South African government launched a competitive tender process for the development of renewable energy power projects. Initial indications are that the programme has been a resounding success, with the initial projects reaching financial close and the process being widely considered to have been transparent and cost-effective. The projects attracted US$14 billion of funding from a mix of local and international banks, development finance institutions (DFIs), private equity and even institutional investors such as pension funds. South Africa is now ranked among the top ten countries globally in terms of renewable independent power investments.

PIDA

One of the most interesting recent initiatives has been the Programme for Infrastructure Development in Africa (PIDA), which the African Union has adopted as a framework for developing regional and cross-border infrastructure projects. Still in its infancy, PIDA has identified 51 priority action projects (PAP) which are of strategic importance in SSA. The projects that should be completed by 2020 will cost US$68 billion and will be funded by a broad mix of government coffers, public private partnerships, official development assistance (ODA), partners such as the EU–Africa Infrastructure Trust Fund, and regional development banks such as the AfDB.

US$25.4

US$0.5

US$1.7

Transport

Energy

US$40.3

ICT

Water

US$12.6

US$1.3

US$3.0

US$21.5

US$6.2US$23.3

East Africa

Southern Africa

West Africa

North Africa

Continental Central Africa

By region

Increased cooperation and pooling of funding

There has also been an increased emphasis on cooperation, partnerships and a pooling of funds by DFIs, state actors and private sector investors:



investors and can be linked to specific projects. The diaspora bond issuances by Ethiopia and Kenya have had a mixed reception from Ethiopian and Kenyan emigrants, but the AfDB is optimistic that SSA states can draw on the successful diaspora bond issuances by Israel and India and adopt some of the measures used in these issuances, such as ensuring that the funds from ‘diaspora bonds’ are segregated from all other revenue and only deployed for specific projects.

Lessons from Europe

An unlikely solution may be found in Europe’s Project Bond Initiative. This initiative was launched by the European Commission (EC) and the European Investment Bank (EIB) as a means of kick-starting infrastructure investment in Europe. Infrastructure investment had slowed down in the wake of the global financial crisis and regulatory reform (in particular, Basel III), which rendered the sort of long-dated loans typically required for infrastructure finance increasingly costly, and thus less attractive to international banks. The EIB identified the US$50 trillion pot of capital managed by institutional investors (such as pension funds, sovereign-wealth funds and long-term insurance) as a way of plugging the gap left by retreating banks. The EIB has sought to make infrastructure investments a more attractive asset class by providing some form of risk-sharing instrument, such as subordinated debt and/or debt guarantee, particularly in respect of projects that are deemed to be too risky for institutional investors or have not been able to achieve an investment grade credit rating.

Most African countries lack the necessary institutional, regulatory and economic environment for the successful issuance of project bonds. However, as EIB has shown in Europe, DFIs and multilateral institutions can play a crucial role in not only providing technical assistance but also in providing credit support where the conditions for a successful bond issuance are absent. In the same way that the EIB has sought to boost non-investment grade bond issuances, there is a clear role for DFIs (such as the AfDB and IFC) to provide credit support where the conditions for a bond issue are absent. Organisations such as the Multilateral Investment Guarantee Agency (MIGA) and the South African government backed Export Credit Insurance Corporation already provide credit enhancement and political risk insurance in developing countries, and one can certainly envisage an extension of their activities to providing support for project bond issuances.

• The Infrastructure Consortium for Africa was launched in 2005 as a partnership between the World Bank, the G8 countries, the AfDB and the European Investment Bank as a platform to increase infrastructure financing, sharing of knowledge, research and pooling funds for investments in energy, transport, water, and information and communication technology in SSA.

• China and the International Finance Corporation (IFC) have pledged US$3 billion for joint investments aimed at supporting private-sector-led development in emerging markets, including Africa.

• The African Finance Corporation (AFC) is a multilateral finance institution (established by treaty between Nigeria (the host country), Guinea-Bissau, Sierra Leone, The Gambia, Liberia, Guinea, Ghana, Chad and Cape Verde) whose public and private sector shareholders have contributed over US$1 billion in capital towards financing projects in SSA. Importantly, as one of the highest investment grade-rated multilateral finance institutions on the African continent (with an A3 (long-term)/P2 (short-term) foreign currency debt rating by Moody’s Investors Service), the AFC has the ability to raise funds on the international debt and capital markets at competitive rates – certainly much lower than any of its founding member states could on their own. Since its inception in 2007, the AFC has financed over 26 projects and deployed close to US$2 billion into private sector-led infrastructure projects.

• President Obama’s recent Power Africa initiative envisages a broad partnership between various US institutions (such as the Agency for International Development, the Trade and Development Agency, and the Agency for International Development) and bodies such as the World Bank and AfDB as well as US and international private sector investors and sponsors working together to double electricity access in SSA by installing an additional 20,000 megawatts (MW) of generation capacity by 2020.

Diversified funding sources

Since 2006, African countries have managed to raise over US$25.8 billion from international capital markets. In 2014 alone, Zambia, Kenya, Ivory Coast, South Africa, Senegal and Ghana all issued sovereign bonds. Impressively, the yields on some of these bonds were comparable to those from some European states, which is an encouraging indicator of the shift in the perception of risk in Africa. African countries have also sought to harness the steady stream of cash remittances by the 140 million Africans living outside Africa by issuing ‘diaspora bonds’ which are aimed at retail


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African capital markets

The AfDB’s experience with local currency bond issuances has shown that there is an appetite among African institutional investors for local currency denominated debt securities. In 2014, the AfDB established an NGN160 billion (approximately US$1 billion) Medium Term Note Programme, and issued its first tranche of local currency notes for NGN12.95 billion (approximately US$80 million). Interestingly, these currency bonds were structured to match the underlying projects to which the Bank will lend the proceeds, including infrastructure projects. The South African REIPPP initiative is living proof that pension funds and long-term insurers can play a key role in providing equity and debt funding for infrastructure projects.

As Africa’s middle class continues to expand, pension assets are similarly increasing at a rapid pace. For example, Kenya’s pension investments grew by 27 per cent in the decade up to 2013. In South Africa, the Government Employee Pension Fund (GEPF) currently has over US$100 billion in net assets and has targeted infrastructure projects as a key investment class, not only because of their potential for developmental impact, but also because of the consistent long-term returns and diversification benefits.

With the optimal regulatory and investment environments and an innovative approach to the development of suitable financial products for the growing African middle classes, it is by no means a stretch of the imagination to envisage a future where the growing pool of savings in Africa is used to finance the roads, ports, railways and power stations that will bridge the infrastructure gap.



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The European Commission’s investment plan for Europeby Tomas Gärdfors, London

5

The European Commission’s investment plan for Europe


On 26 November 2014, the European Commission announced its investment plan for Europe1 which is intended to facilitate investments in excess of €315 billion across the EU in the next three years alone. Outlined by the President of the European Commission Jean-Claude Juncker on 15 July 20142, the investment plan is required in order to stimulate growth and investment in the EU283. A new European Fund for Strategic Investment (EFSI) will receive €21 billion in guarantee and capital, which, with a multiplier of 15, could facilitate over €315 billion of investments. Some say that this is not feasible, too little and too late.

1 Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic and Social Committee, the Committee of the Regions and the European Investment Bank, An investment plan for Europe, COM(2014) 903 final, 26 November 2014

2 Opening statement in the European Parliament Plenary Session, Jean-Claude Juncker, 15 July 2014 (then presidential candidate)

3 The 28 EU Member States at the date of this briefing are: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and United Kingdom.


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EFSI will be open ended and initially focus on investments to support strategic investments of European significance in infrastructure, notably broadband and energy networks, as well as transport infrastructure, particularly in industrial centres; education, research and innovation; and renewable energy and energy efficiency.

Although very much in its infancy, we believe that the investment plan for Europe could assist in creating significant opportunities for investors, financiers, governments, promoters and contractors on a global scale. Investors worldwide, particularly pension and insurance funds, are looking for predictable returns, both as equity investors and debt providers, filling a gap left by contracting banks. Faced with a more benign monetary policy environment and low interest rates together with a requirement for long-term investments, and attracted by a combination of relative value, low but stable yield, long-term matching of asset and liability and benefits of diversifying portfolios, a growing number of institutional investors are seeking to invest in infrastructure debt. At the same time, many banks that had previously curtailed long-term lending to projects and several new-entrant banks are now targeting particularly ancillary income opportunities.

Matching the availability of abundant funds with a willingness to explore innovative, but risk-mitigated, structures and viable projects will create opportunities.

An investment plan for Europe

BackgroundThe lack of growth and investment in Europe is detrimental to the welfare of the more than 500 million people in the EU. The global financial crisis has hit Europe hard and most EU countries are struggling with high unemployment, limited growth (if any) and ailing investments despite huge needs. As a consequence of the economic and financial crisis, the level of investment has dropped off considerably. Compared to the peak in 2007, the current average levels of investment is reportedly 15 per cent lower4, with some Member States, such as Greece (minus 67 per cent) and Spain (minus 38 per cent), having seen their investments halved.


According to the European Commission and the European Investment Bank (EIB), the main reason for weak investment levels is low investor confidence5, rooted in low expectations of demand, fragmentation of financial markets and lack of risk capital that catalyses investment. For these reasons, together with a lack of confidence in the common currency and high levels of indebtedness in parts of Europe, access to credit remains difficult, in particular for long-term financing of projects and for small and medium sized companies (SMEs) in hard-hit Member States. This has been exacerbated by austerity measures in most if not all Member States.

It is neither possible nor advisable for the EU and its institutions to provide all of the funding required to bring back growth and investment to Europe.

The investment planThe investment plan aims to kick-start long-term investments across transport, broadband, energy infrastructure and infrastructure; innovation and research; renewable energy and energy efficiency; and support SMEs and mid-cap companies, in each case through utilising already existing EU funds in order to leverage private investments and to de-clutter the regulatory environment on an EU as well as on a national level. The investment plan is a package of measures to be implemented in order to unlock public and private spending of at least €315 billion over the next three years6, meeting the perceived mismatch between desired investment sizes and the size of projects. The plan consists of three steps:

• mobilising increased finance capabilities without increasing public debt

• supporting investment in key areas

• removing barriers to investment.

5 European Investment Bank, Fact sheets




Whereas, at first glance, it could seem hardest to fulfil the first two objectives, it is not unlikely that it is the last which will prove the most problematic. The predictability and coherence of the regulatory framework is a fundamental element of the risk assessment of any investment. According to the IEA7 (using the energy sector as an illustrative example), the European policy makers face difficulties as they seek to progress towards ensuring energy security, environmental stability, low prices and economic competitiveness. The messages that these policymakers need to grapple with are inherently conflicting. In the energy sector, a stronger focus on climate change, but a backlash against subsidies for renewables and energy efficiency; protests against nuclear and scepticism against carbon capture storage. Regulatory uncertainty is one of the main deterrents to investment and an ambiguous or changing regulatory environment will not attract investors’ funds, which will instead be deployed elsewhere in a globally competitive environment. Whilst the available funds are more abundant than only a year ago, they are still finite, and it is important that Europe retains the momentum of the current interest from the global investors.

EFSI will focus its financing potential on sectors of key importance to the EU where the EIB has proven expertise

7 International Energy Agency, Special Report, World Energy Investment Outlook, 2014

and capacity to deliver a positive impact on the European economy, including:

• strategic infrastructure (digital, transport and energy investments)

• education, research and innovation

• investments boosting employment, in particular through funding SMEs and measures for youth employment

• environmentally sustainable projects.

Funding would seek to direct efforts to where investment is needed most, notably by:

• responding to market gaps requiring higher risk-bearing capacity

• working with new clients and ensuring a larger sector coverage

• offering new products

• providing new delivery modes in cooperation with national promotional banks and private sector financial institutions.

The new European Fund for Strategic Investments – initial construction

EU guarantee

€16bn

European Fund for Strategic Investments€21bn

Total extra over 2015–17:circa €315bn

Long-term investments circa €240bn

SMEs and mid-cap firms circa €75bn

€16bn €5bnx15

European Investment Bank

€5bn

Possible other public and private

contributions


Nexus

Ultimately, the investment plan is intended to:

• reverse the downward investment spiral, boost new jobs and recovery without putting further burden on public budgets and spending

• take decisive steps to meet long-term needs of the EU economy, increasing competitiveness

• strengthen human capital, productivity and physical infrastructure across the EU.

The European Commission and the EIB will work together as strategic partners; as illustrated above, the European Commission will re-allocate €16 billion of funds from the EU budget in the form of a guarantee and the EIB will commit €5 billion, thus funding EFSI with €21 billion, which could mobilise at least €315 billion over the next three years or 15 times the EFSI funds8. The key that will unlock this is what the EU calls a ‘multiplier’. The unclear way in which this term has been communicated may have led to misunderstandings. Some critics, it seems, have understood ‘multiplier’ to mean ‘leverage’. More clarity in this respect would be desirable.

The multiplier effect that the EU is aiming to achieve is that the EFSI funds are conservatively leveraged three times from capitalisation to utilisation and five times from utilisation to project completion.

Intended to be available from mid-2015, the EFSI funds will be mobilised as financial instruments so as to attract and incentivise private financing through guarantees, first-loss debt pieces, equity or micro-loans. An assumed 20 per cent project support would result in a total project value five times


Project

Project

Project

EFSI

Debt

Debt

Equity Equity

EFSI EFSI providing 20% of total investment cost

the invested EFSI amount. Thus, the €63 billion become €315 billion.

This means that every euro of risk protection provided by EFSI could generate up to €15 in what the European Commission calls the ‘real economy’ that would otherwise not be generated. EFSI will assume substantial risk support to encourage and incentivise private financiers and investors. As is the case with Marguerite Fund investments (see box below), it is not intended that any EFSI support or financing should crowd out any private financing or investment.

Marguerite Fund

2020 European Fund for Energy, Climate Change and Infrastructure (Marguerite Fund) was set up and funded by, amongst others, KfW Bankengruppe, the EIB, Caisse de Depots, Bank of Valetta and the European Commission as a long-term equity fund targeting greenfield transport and energy infrastructure in the EU28. The Marguerite Fund has invested €300 million across the EU28 with a total, aggregate investment value in excess of €4–4.5 billion. Similar to the concept of the investment plan, the Marguerite Fund has invested in projects, facilitating other investors and debt providers to assess the project risks differently, allowing projects to happen which would not necessarily have happened had it not been for Marguerite Fund. The actual multiplier on the Marguerite Fund projects is 15.

It is intended that the €315 billion complement already existing programmes such as the Connecting Europe Facility9, TEN-T10 and Horizon 202011. However, whilst the European Commission states that the EFSI funds are complementary to existing programmes, no new money is being raised. Instead, the contribution from the EU is a re-allocation of existing budget items and the EIB is able to allocate its contribution as a combination of funds raised and a better-performing portfolio. The European Commission has invited Member States, national promotional bank and private financers to fund EFSI going forward.

EFSI will be set up and operated within the EIB group in order to ensure risk-bearing capacity and mobilise extra investment. According to the European Commission,

9 Please see Norton Rose Fulbright LLP briefing on Projects of Common Interest (available on nortonrosefulbright.com) for more details on the Connecting Europe Facility and Projects of Common Interest

10 Regulation (EU) No 1315/2013 of the European Parliament and of the Council of 11 December 2013 on Union guidelines for the development of the trans-European transport network and repealing Decision No 661/2010/EU

11 Regulation (EU) No 1291/2013 of the European parliament and of the Council of 11 December 2013 establishing Horizon 2020 – the Framework Programme for Research and Innovation (2014-2020) and repealing Decision No 1982/2006/EC



and improving access to finance. The hub will assist project promoters, investors and public managing authorities.

The criteria for selection are intended to be simple and clearly stated and will include targeting higher societal and economic value. Projects need to have the potential for leveraging other sources of funding and should be of reasonable size and scalability.

This selection process is on a bottom-up basis and not dissimilar to other project identification processes that the European Commission has initiated, one example being the Projects of Common Interest or PCIs13. Whilst it is an admirable intention to have a substantial list of available projects in energy infrastructure, infrastructure, research and development, transport, telecommunications and for SMEs, it is an enormous task. It is important that the selection process and criteria do not become too complicated or entangled in red tape.

Investment risk

Every investment and financing transaction has its own risk profile. In each case, factors such as market, environment, technical, regulatory, political and financial interrelate differently. In particular, the project finance market has found ways to deal with regularly occurring risks and has developed tools to mitigate them: hedging to manage currency and price risk and fixed-price contracts and performance guarantees to manage cost overruns and delays; take-or-pay agreements to mitigate long-term power supply risks and power purchase agreements to manage offtake risks.

The financing of projects and the deployment of the funds need to be approached on a regional, if not on an individual, country basis. As illustrated overleaf, there are differences between the Member States that will drive or indeed prohibit investments. The European Commission is currently considering the ways in which the financial instruments can be best deployed so as to maximise utilisation and target those projects that are most in need of EU funding.

It is our view that the European Commission and EFSI need to apply a risk-based analysis when considering deployment and should focus on those projects that are not financially viable on a stand-alone basis from the market’s perspective but that are socio-economically important and have positive externalities.

13 Please see Norton Rose Fulbright LLP briefing on Projects of Common Interest (available on nortonrosefulbright.com) for more details on the Connecting Europe Facility and Projects of Common Interest

locating EFSI within the EIB group will help speed up mobilisation and funding, as the EIB group already has the internal infrastructure in place to handle complex finance transactions in February 2015.

The European Commission emphasises that it intends to use the EFSI funds for ‘innovative financial instruments’, which in effect means loans, equity and guarantees rather than grants. The ‘innovative’ aspect is to distinguish from pure grant funding. According to studies made12, the benefits of using innovative financial instruments rather than pure grants include the possibility of using the same funds several times through various cycles, allowing them to be recycled, which contributes to the impact and sustainability of the instruments chosen. The multiplier effect is further strengthened by accumulated interest and dividends.

Selection of projectsIn contrast to other EU-wide measures, such as TEN-T, Connecting Europe Facility or Horizon 2020, the EFSI funds are neither geographically nor thematically pre-determined, but are selected on their merits and their ability to maximise the effect of the financial instruments deployed.

In response to Europe’s Finance Ministers’ request in September 2014, the EIB, the European Commission and the Member States collaborated within a task force (the Investment Task Force) to:

1. identify new projects that could be supported

2. develop measures to better identify projects

3. identify structural reforms that can improve the business environment.

EFSI will draw on the results of the Investment Task Force. According to the European Commission, there is a perceived lack of viable projects which is one of the reasons it is setting up the Investment Task Force as a joint operation between the European Commission, the EIB and the Member States.

The plan is to create a list of vetted, available and potentially viable projects that are of European significance and to publish a regularly updated list of assessed and non-assessed projects. A new European Investment Advisory Service will be created to strengthen and accelerate investment. This advisory ‘hub’ will provide guidance on delivering quality projects and investments, using EU funds more efficiently, in particular through reinforced use of financial instruments,

12 European Commission, Commission Staff Working Document, Financial Instruments in Cohesion Policy, SWD(2012) 36 final, 27 February 2012


Nexus

the EU28 that are looking for opportunities in the region. As the radial graphs illustrate, there are Member States that have significantly weaker investor protections than others.

The risk grid

The investment parameters are described through radial graphs, applying the World Economic Forum’s 1–7 scale.

• Property rights | respondents were asked to rank the protection of property rights, including financial assets

• Intellectual property protection | respondents were asked to rank the strength of intellectual property rights, including anti-counterfeiting measures

• Judicial independence | respondents were asked to rank to what extent the judiciary is independent from members of government, citizens or firms.

• Efficiency of legal framework in settling disputes | respondents were asked to rank the efficiency of the legal framework (where private business is concerned) in settling disputes

• Efficiency of legal framework in challenging regulations | respondents were asked to rank the ability for private business to challenge government actions and/or regulations through the legal system

• Protection of minority shareholders’ interests | respondents were asked to rank to what extent the interests of minority shareholders are protected by the legal system

• Quality of overall infrastructure | respondents were asked to rank the state of the overall infrastructure, including transport, telephony and energy

The complete list of factors and indicators, the details of the methodology as well as the contextual comments on each country’s performance in the rankings can be found in the current edition of Global Competitiveness Report16.

16 The Global Competitiveness Report 2014-2015, World Economic Forum

Country risk

The inherent risks of investing in a specific sovereign country require detailed analysis. Euromoney Country Risk analysis14 is an example of how the Member States could be assessed broadly. Euromoney Country Risk evaluates the investment risk of a country, such as risk of default on a bond, risk of losing direct investment, risk to global business relations, by using a qualitative model, which seeks an expert opinion on risk variables within a country (70 per cent weighting), combining it with three basic quantitative values (30 per cent weighting). As illustrated overleaf, the Euromoney Country Risk analysis suggests that the country risks are higher in south and south-east Europe.

Key investment indicators and risks15

Global Competitiveness Report

For 35 years, the World Economic Forum has looked at factors that determine and drive economic growth and how they interact globally. Every year, they publish Global Competitiveness Report. Covering 144 countries, it uses key indicators across 12 pillars to rank the world’s countries. A key feature of Global Competitiveness Report is the Executive Opinion Survey, which, in the 2014–2015 edition, captured the views of 14,000 business leaders across 148 countries between February and June 201416.

Companies and investors cannot control political and regulatory risks. Set out opposite are a few key risk indicators that can affect investment appetite into the EU. These risk indicators represent a selection of the results presented in the Global Competitiveness Index Executive Opinion Survey. Despite the mitigants and tools available, there are still some investment risks that are more difficult to mitigate and that, ultimately, will determine whether investments take place in a certain jurisdiction or not. Whilst on a global scale, the EU28 may appear similar from a risk perspective, they are not if the comparison is limited to the EU. No two investors or debt providers will assess risk in the same way or have the same level of risk aversity or appetite. The analysis and graphically presented key facts and indicators are intended to give an indicative overview for investors and debt providers, perhaps mostly so for those that are based outside

14 Euromoney Institutional Investor PLC; Euromoney Country Risk index 2014, using their risk score as of 4 March 2014

15 The Global Competitiveness Report 2014-2015, World Economic Forum



Europe 2020 Project Bond InitiativeFinancing

From a financing perspective, cash flow and return on investment are fundamental. Obviously, if there is not enough cash to pay back the money invested and lent and to provide a reasonable return, it does not help if the market risk or political risk is low. EFSI is thus designed to take first loss piece in a variety of innovative ways. It is not possible to describe all conceivable financing structures that could be deployed for the projects to come to fruition. It is not unlikely, however, that most of them will be based on traditional project finance structures, but with credit enhancement features provided by EFSI.

Moody’s Investors Service (Moody’s) has recently published an analysis of the first five EIB Project Bond pilot transactions17 (Moody’s Report). Moody’s conclusions are that the pilots of the Europe 2020 Project Bond Initiative18 appear to be working and have catalysed market interest in a way that was intended. Whilst the focus on projects in western Europe that already achieve investment grade rating has led to criticism, this is encouraging for the investment plan.

According to Moody’s Report, the market has indicated a strong preference for the unfunded contingent guarantee – the Project Bond Credit Enhancement facility or PBCE facility. This means that the EIB provides contingent credit enhancement for certain qualifying infrastructure projects, so that the risk profiles for those projects become attractive for a wide selection of institutional investors. In particular, credit enhancements can limit key risks such as construction risk, market risk and operational risk and mitigate default risk and loss severity following default.

The focus for the European Commission should be to optimise the ability to respond to and to recover from, as well as to mitigate the risks that have been identified as, investment inhibitors. It can be argued that the funds should be deployed to bridge uncertainty, making those projects that come with greater risks, and that would otherwise not come to fruition, attractive for investors and financiers. Meeting the criticism raised against the EIB Bond Initiative, deployment in the most difficult jurisdictions and projects will open up for a wider use of the tools being contemplated.

17 Moody’s Investors Service, Sector in-depth, Pilot phase of Project Bond Initiative demonstrates early proof of concept, 18 November 2014

18 The pilot phase of the EIB Project Bond was established by EU Regulation 670/2012

EIB

Borrower SPV

EUSenior Noteholders

Project

Risk sharing

Payment bond guarantee facility

Bonds

Key PBCE facility facts

• The initiative aims to provide partial credit enhancement to attract capital market investors.

• The PBCE facility is provided to the Borrower to raise the likelihood of timely repayment of principal and interest to bondholders, therefore reducing the risk of the bonds and enhancing credit rating of the bonds.

• The size of the PBCE facility will vary from project to project.

• The PBCE facility can cover all project-related risks affecting construction and cash flow generation from the start of the operating period as well as project cost over-runs.

• Once drawn, the PBCE facility ranks subordinate to the bonds but senior to equity and any other subordinated debt so that it is subordinated to the senior debt; debt service is typically funded on a subordinated cash sweep basis, ranking ahead of other subordinated debt and equity.

• The mechanism of improving the credit standing of projects relies on the capacity to separate the debt of the project company into tranches: a senior and a subordinated tranche. Provision of the subordinated tranche increases the credit quality of the senior tranche to a level where most institutional investors are comfortable holding the bond for a long period.

• The subordinated PBCE tranche can take the form of a loan, which is given to the project company from the outset, a contingent credit line which can be drawn upon if the revenues generated by the project are not sufficient to ensure senior debt service or a guarantee. As Moody’s Report shows, the market prefers the unfunded contingent guarantee.


Nexus

5 Cyprus

0.9 9,250

16.50 -5.4%

0.4% 102.2%

12.5% 0%

Euro EU 2004

8 Estonia

1.3 45,000

18.61 2.2%

3.2% 10.1%

21% 0%

Euro EU 2004

6 Czech Republic

10.5 78,866

149.49 -0.9%

1.4% 45.7%

19% 15%

Koruna EU 2004

19 Malta

0.4 316

7.26 2.9%

1.0% 69.8%

35% 0%

Euro EU 2004

7 Denmark

5.6 43,094

248.97 0.4%

0.5% 45%

24.5% 15%

Krone EU 1973

3 Bulgaria

7.2 111,910

39.94 0.9%

0.4% 18.3%

10% 5%

Lev EU 2007

2 Belgium

11.2 30,528

382.69 0.2%

1.2% 104.5%

33.99% 25%

Euro EU 1952

16 Latvia

2.0 65,000

23.37 4.1%

0.0% 38.2%

15% 0%

Euro EU 2004

14 Ireland

4.6 70,000

164.05 -0.3%

0.5% 123.3%

12.5% 20%

Euro EU 1973

13 Hungary

9.9 93,000

97.95 1.1%

1.7% 77.3%

19% 0%

Forint EU 2004

10 France

65.9 550,000

2059.90 0.2%

1.0% 92.2%

33.33% 30%

Euro EU 1952

9 Finland

5.5 338,000

193.44 -1.4%

2.2% 56.%

20% 20%

Euro EU 1995

1 Austria

8.5 83,870

313.07 0.3%

2.1% 81.2%

25% 25%

Euro EU 1995

4 Croatia

4.2 56,594

43.13 -0.9%

2.3% 75.7%

20% 12%

Kuna EU 2013

11 Germany

80.8 356,854

2737.60 0.4%

1.6% 76.9%

29.58% 25%

Euro EU 1952

12 Greece

11.0 131,957

182.05 -3.9%

-0.9% 174.9%

26% 10%

Euro EU 1981

15 Italy

60.8 301,263

1560.02 -1.9%

1.3% 127.9%

31.4% 20%

Euro EU 1952

17 Lithuania

2.9 65,000

34.63 3.3%

1.2% 39%

15% 15%

Litas EU 2004

18 Luxembourg

0.5 2,586

45.48 2.1%

1.7% 23.6%

29.22% 15%

Euro EU 1952

Population (m)

Area (km2)

GDP (€bn 2013)

GDP growth (2013)

Inflation (2013)

State debt % of GDP (2013)

Corporate income tax

Dividend tax

Currency

Member of EU sinceEU

12

3

45

6

71

2

3

45

6

71

2

3

45

6

7

12

3

45

6

7

12

3

45

6

7

12

3

45

6

71

2

3

45

6

71

2

3

45

6

7

12

3

45

6

71

2

3

45

6

71

2

3

45

6

7

12

3

45

6

71

2

3

45

6

71

2

3

45

6

71

2

3

45

6

7

12

3

45

6

71

2

3

45

6

71

2

3

45

6

71

2

3

45

6

7

EU 28 key facts and risk indicators



Property rights

Quality

of

electr

icity

supply

Protection of minority

shareholders’ interests

Efficiency of legal framework in

challenging regulations Efficiency of legal framework in

settling disputes

Judi

cial

in

depe

nden

ce

Intellectual property

protection

2

3 4

5

6

7

8

9

10

11

12

13

14

15

16 17

18

19

20 21

22

23

24

25

26

27

28

1

Country risk analysis1

1 As determined by Euromoney Country Risk index 2014

1

5

2

3

7

4

6

26 Spain

46.5 504,782

1023.00 -1.2%

1.5% 92.1%

30% 21%

Euro EU 1986

21 Poland

38.5 312,679

389.70 1.6%

0.8% 55.7%

19% 19%

Zloty EU 2004

20 The Netherlands

16.8 41,526

602.66 -0.8%

2.6% 68.6%

25% 15%

Euro EU 1952

27 Sweden

9.6 449,964

420.85 1.6%

0.4% 38.6%

22% 30%

Krona EU 1995

22 Portugal

10.4 92,072

165.69 -1.4%

0.4% 128%

23% 25%

Euro EU 1986

23 Romania

19.9 237,500

142.26 3.5%

3.2% 37.9%

16% 16%

New Leu EU 2007

24 Slovakia

5.4 48,845

72.13 0.9%

1.5% 54.6%

22% 0%

Euro EU 2004

25 Slovenia

2.1 20,273

35.27 -1.1%

1.9% 70.4%

17% 15%

Euro EU 2004

28 United Kingdom

64.3 244,820

1899.01 1.7%

2.6% 87.2%

21% 20%

Pound EU 1973

12

3

45

6

7

12

3

45

6

71

2

3

45

6

71

2

3

45

6

7

12

3

45

6

71

2

3

45

6

7

12

3

45

6

7

12

3

45

6

71

2

3

45

6

7

HIGHrisk

LOWrisk

< 40

40 – 49.9

50 – 64.9

65 – 74.9

> 75


Nexus

through Member State resources for the benefit of certain undertakings, or for the production of certain goods, if there is a possibility the aid may distort competition or have an adverse effect on trade within the EU (unless limited exceptions apply). Such State aid can take a variety of forms ranging from direct funding/grants, interest/tax reliefs and guarantees to government holdings of all or part of an investor of the investment. Particular consideration must be given, if an investment is made jointly with a publicly controlled company. This can be any company controlled by the Member State, a region or a municipality. In such situations, it must be ensured that the same investment would have been adopted under normal market conditions by a private investor in a situation similar and therefore that such investment does not constitute indirect State aid.

The European Commission has already highlighted that, to ensure infrastructure and project investments supported under the investment plan are consistent with State aid rules, projects should address unmet needs, maximise private financing to the extent possible and avoid crowding out privately financed projects. The European Commission also advises that projects should generally be open to all users, including competing operators, on fair, reasonable and appropriate conditions, so as to avoid the creation of entry barriers to entry.

To maximise the impact of such investments, the European Commission will formulate a set of core principles, for the purpose of State-aid assessments, which a project will have to meet to be eligible for support under EFSI. If a project meets these criteria and receives support from EFSI, any national complementary support will be assessed under a simplified and accelerated State aid assessment, whereby the only additional issue to be verified by the European Commission will be the proportionality of public support.

Moving forward

The opportunityThere are opportunities for investors and financiers willing to commit capital to projects that would not have been viable, but now will be because of the investment plan.

Investors will be able to tap into a published list of possibly viable projects that have European significance, some of which have been vetted and are supported by the hub of advisors. The accessibility of information will allow these investors to identify projects across Europe across a number of sectors. EFSI can provide support to some of these projects, provided that they fulfil some very simple criteria, taking the first loss piece, making projects viable for the investors.

• Support will be available during the lifetime of the project, including the construction phase.

• In contrast to the monoline model, the mechanism of the initiative:

• is limited in amount from the outset (capped at EIB and EC commitments under the instruments) with a maximum size of individual transactions of up to the lower of €200 million or 20 per cent of credit enhanced senior debt

• as subordinated debt, targets an up-lift of the project rating, a positive notching, by at least one point

• is based on the EIB’s capacity to deliver subordinated loans and guarantees, not necessarily its rating

• only targets the EIB’s core business, i.e. infrastructure financing

• only supports robust projects

• benefits from the EIB’s proven due diligence, valuation and pricing methodologies.

In almost all of the pilot cases, the PBCE facility represented 20 per cent, equal to the same 1:5 multiplier as suggested under the investment plan. Each pilot project has achieved a positive rating notching uplift of at least one point with a few cases in excess thereof, even achieving single A rating in three cases. The pilot projects prove that it is possible to create a new market for funding infrastructure assets.

These pilot projects have been used to facilitate financing of already attractive infrastructure projects in western Europe, which, unenhanced, already attract investment grade rating. The projects that the investment plan is targeting are much wider in scope, covering a more diverse thematical and geographical space, supporting less robust projects. It is likely that it is the more accessible and less risky projects that are first to take off.

State aid

Compliance with State aid rules must be ensured in cases where investors receive direct or indirect government support from the Member States. State aid rules (Article 107(1) of the Treaty on the Functioning of the European Union) generally prohibit State aid granted by Member States or



As the projects that the investment plan is targeting are wide in scope, covering a more diverse thematical and geographical space and supporting fewer robust projects, it is likely that it is the more accessible and less risky projects that will be the first to take off.

Is it enough? As can be shown by analogies with the Marguerite Fund and the Project Bond initiative, an aggregate multiplier of 15 times is achievable. Whilst, therefore, it is not unlikely that €21 billion could facilitate aggregate investments in excess of €300 billion in the real economy, it is not enough. Global energy infrastructure alone will require US$53 trillion until 203520, US$2 trillion of which is required in Europe. It is helpful that the utilisation of the EFSI funds is flexible, as this will enable it to react quickly to market demands. In addition to the instruments discussed, however, EFSI funds could be used to take more construction risk in line with the Project Bond initiative and to allow projects to be operated on an availability basis, but on a European level, backed by EFSI.

Is it too late? The EU has been suffering from the effects of the global financial crisis since late 2007. Compared to the 2007 peak, investments have dropped by almost €450 billion, where five Member States account for 75 per cent (the UK, Italy, France, Greece and Spain)21. Seven years on, Member States are still suffering from austerity measures, imbalanced budgets and lack of investment, the latter trailing two percentage points below the longer-term average at just under 20 per cent of EU28 GDP. It is critical that this trend is reversed as soon as possible. Whilst the investment plan may not be enough, it is not too late.



19

CommentIs the investment plan, as some critics say, unfeasible, too little and too late?

Is it feasible? The investment plan is a start and, if it works, more funds could be raised. It will require regulatory alignment and Member States working together; it will require administrative red tape disappearing and investment hurdles being abolished. It is technically feasible, politically achievable and, in many cases, commercially viable, but requires significant funding, cooperation and regulatory alignment.


ü The European Council and the European Parliament to endorse the investment plan, including the decision to set up EFSI and fast-track the relevant regulation.

ü The European Commission proposes the regulation. ü The EIB will re-direct parts of its operation to pre-finance and

prepare the activities of EFSI. ü Member States will finalise the programming of EFSI to maximise

impact. ü Project identification is accelerated at EU level, based on the report

of the Investment Task Force. ü First steps are taken by the EIB and key stakeholders to build the

investment advisory hub.

December 2014/January 201519

ü Progress will be reviewed, including of Heads of State and Government.

ü Further options may be considered ahead of the mid-term review.

ü EFSI is operational. ü The EU produces its impact assessment in synergy with EU programmes. ü A transparent pipeline of projects is in place at EU level. ü The new investment advisory hub is operational. ü Follow-up activities have started at EU, national and regional levels. ü A dedicated website allows monitoring of the progress on the

investment plan in real-time.

By mid-2015

By mid-2016


Nexus







The circular economy revolution: the future of waste processing for Europeby Jenny Waites, London

6

The circular economy revolution: the future of waste processing for Europe


The EC and UK reports

In July 2014, the European Commission published its legislative proposals to review recycling and other waste-related targets. Around the same time, the UK government published its report, Growing a Circular Economy: Ending the Throwaway Society.

Both reports recognised that the way we consume resources in the UK and throughout Europe is not sustainable. All resources need to be managed more efficiently throughout their life cycle and the current ‘linear’ approach (where materials are extracted, made into a product and used only for one purpose before the product is discarded) wastes valuable resources and damages the environment.

The EU circular economy package came under threat with the change of European Environment Commissioner in 2014 and was quietly dismissed by the College of Commissioners on 25 February 2015 despite protests from the European Parliament and EU environment ministers. The package will be formally withdrawn and resubmitted later this year.

In its place the European Environment State and Outlook 2015 Report (SOER-2015) written by the European Environment Agency will inform the next five years of EU policymaking. The report states that despite recent progress in waste prevention and management, EU waste generation remains substantial, and performance relative to policy targets is mixed. ‘Waste management will need to change radically in order to phase out completely the landfilling of recyclable or recoverable waste,’ the report says.


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A zero waste programme for Europe

The first step towards legislative change was found in the European Commission’s 2014 communication, Towards a Circular Economy: A Zero Waste Programme for Europe. The communication was issued as one of the final acts of the outgoing Environment Commissioner, Janez Potočnik, and it sparked much commentary from the waste industry and interested parliamentarians.

However, the EU Commission First Vice-President Frans Timmermans was given a mandate from new Commission President Jean-Claude Juncker to cut red tape and deliver ‘better regulation’. The circular economy package came under immediate scrutiny.

The abandoned package of proposals included:

• setting a resource efficiency improvement target of 30 per cent by 2030

• raising the municipal waste reuse and recycling target from 50 per cent to 70 per cent by 2030, and raising the recycling targets in the Packaging Directive to 80 per cent by 2030

• cutting food waste by 30 per cent by 2030

• banning the landfill of recyclable waste by 2025, and by 2030 extending the ban to all recoverable (including energy recovery) municipal waste

• limiting energy recovery to non-reusable and non-recyclable waste.

It is not yet clear what will replace these proposals but Vice President Timmermans promised MEPs in December 2014 that the new legislation would be tabled in 2015 and would be ‘more ambitious’. He later added that the new bill would include laws to prevent waste being created in the first place and would involve legislating to encourage the use of materials that create less waste and which are easy to recycle. This, he said, can be achieved by ‘completing the circle’.

Whatever the EU comes up with Member States have, by agreeing the 2013 Seventh Environment Action Plan (EAP), committed to a process of more efficient implementation of legislation in an effort to move towards a circular economy.

A circular economy

In contrast to the current ‘linear’ approach, a ‘circular’ economy encompasses a range of processes, or ‘cycles’, in which resources are used repeatedly, thus maximising sustainable use and eliminating waste. A circular approach is also beneficial, economically-speaking, as the value of the resource is more likely to be maintained at each stage.

With global consumption levels on the rise, an international response to relieve pressure on resources is required. Scaling up a circular economy to an international level will require government support within EU Member States and many would welcome a coordinated approach by world leaders to introduce positive legislative drivers. As indicated by the EU, these are likely to include waste prevention targets and incentives to promote eco products that are easier to reuse, remanufacture and disassemble.

Measuring the circularity of the economy

There are several ways to measure the economy’s ‘circularity’. One headline figure is the household recycling rate, which reached 43 per cent in England in 2012–13, up from 12 per cent in 2000–01. However, waste collected by local authorities forms only 13 per cent of total waste produced in the UK. The main components are construction and demolition waste (49 per cent) and commercial and industrial waste (24 per cent).

In England, waste policy and regulation is informed by the ‘waste hierarchy’, as required by the EU Waste Framework Directive, and transposed into law by the Waste (England and Wales) Regulations 2011. The hierarchy, which is consistent with the circular economy approach is as follows:

In contrast to the current ‘linear’ approach, a ‘circular’ economy encompasses a range of processes, or ‘cycles’, in which resources are used repeatedly, thus maximising sustainable use and eliminating waste.



Using less material in design and manufactureKeeping products for longer: re-useUsing less hazardous material

Checking, cleaning, repairing, refurbishing, repair; whole items or spare parts

Turning waste into a new substance or product including composting if it meets quality protocols

Including anaerobic digestion, incineration with energy recovery, gasification and pyrolysis which produce energy (fuels, heat and power) and materials from waste; some backfilling operations

Landfill and incineration without energy recovery

Prevention

Preparing for re-use

Recycling

Otherrecovery

Disposal

STAGES INCLUDES

Source: http://www.ukwsl.co.uk/environment/compliance/waste-hierarchy

The waste hierarchy

Sourcing alternative technologies

To maintain the output of electric power, throughput has to increase, which in turn stresses the modelled predictions regarding the plant’s life cycle and maintenance. Waste processors would inevitably need to source a new fuel with a higher CV, such as refuse derived fuel (RDF), which can range from 7 to 30MJ/kg (compared to non-recycled plastic, which has an average CV of 35.7MJ/kg) If high-CV items are removed entirely, operators would have to source even greater volumes of waste to match the originally modelled power output.

The increased pressures on existing E-f-W plants are also likely to inform a change in strategy for EU countries that are currently dependent upon and planning more incineration-based E-f-W facilities. Capacity is very uneven across the EU, with some Member States struggling with over-capacity while others have little or no capacity to meet existing EU targets, let alone the more extensive targets that have been suggested.

Impact of the Commission’s plan

Implementing new EU legislation, in whatever form that takes, will undoubtedly impact upon the European waste management industries as Member States incorporate the higher municipal waste recycling rates into their national environmental plans.

As well as the need for more infrastructure to accommodate greater circularity, any measures that drive towards greater reuse and recycling will have an impact on existing waste treatment facilities, especially waste-to-energy plants. The drive to limit energy recovery from recyclable material could have the most significant impact on existing waste processing facilities.

The output of any incineration plant depends on the calorific value (CV), or energy content, of the fuel being brought into it. Recyclable materials are used to keep the CV at an optimal point. If the quantity of paper, plastics and other recyclable materials in the Energy from Waste (E-f-W) process is reduced, this affects the CV of the fuel and hence the process’ efficiency.


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A future for incineration?

In the UK, the government is keen to promote the ability of the GIB to invest in ‘pioneering projects’, such as specialist fuel supply and anaerobic digestion. GIB has already provided debt, equity and mezzanine finance to UK waste projects. However, the government’s report stated that it would like to see GIB move away from investments in incineration infrastructure (which represents over 90 per cent of its total waste sector investment since its creation in 2013), including projects related to E-f-W plants, because these potentially divert materials away from recycling and limit circular economy activity.

Although this view of incineration infrastructure is not necessarily shared by the industry, it has been recognised that GIB’s funding of anaerobic digestion plants (a method far removed from incineration) is an incredibly powerful signal to other potential investors that this is a technology, a process and a part of the market in which it has confidence, and is willing to invest.

Circular economy – a political dialogue?

The circular economy is high on the political agenda. On a global scale, much of the 2015 World Economic Forum in Davos focused on circularity of resources.

At a European level, those pro-circular economy await the new, and ʻbetterʼ, legislative proposals of the European Parliament. Industrialists have also joined the debate, with the CEO of Heineken leading talks with the European Commission on the concept.

Investing in new infrastructure

The 2014 report produced jointly by the UK Green Investment Bank (GIB) and specialist waste consultancy Tolvik concluded that an additional £5 billion of investment was required in the UK alone to close the gap between waste produced (post recycling) and the infrastructure available to process it.

A move to a more circular economy will need investment in new infrastructure, not least to increase capacity for recovery of reusable materials. For many of the existing major waste facilities financed through public–private partnerships (PPP) or private finance initiatives (PFI), there may be comfort under ‘change in law’ provisions in the long-term concession agreements.

However, for ‘merchant’ or privately contracted commercial waste facilities that depend on selling waste processing capacity on a more bespoke basis, there will be a greater challenge. They will need to finance new materials separation facilities or demonstrate that their existing economic model is still viable after a wholesale removal of high-CV recyclates from the waste stream. Promoting viable alternative options is likely to need greater government backing than is currently available.

Finance for new technologies

Without incentives and a progressive approach by central governments, alternative options will continue to struggle. Projects that include unproven technology will find it particularly hard to attract lenders and investors. Whilst the EU waste market is, on the whole, well established and there is already significant intellectual capital among bankers and investors, it is anticipated that those who have acquired know-how in developing and financing large scale PFI/PPP projects are likely to look to expand into a new space in the circular economy.

As a result of the increased risk associated with alternative technologies, developers can expect to see more stringent lender requirements and a shift away from the cautious yet moderate terms found on more established PFI/PPP schemes. To temper this, developers will need to present more innovative financing and delivery structures.

Without incentives and a progressive approach by central governments, alternative options will continue to struggle.



Domestically, waste and recycling, as an overarching theme, are not normally central to party manifestos in a general election. The Liberal Democrats’ manifesto submitted ahead of the 2015 UK general election, however, has fully embraced this hot topic, referring to a circular economy, and placing action plans and binding targets in relation to reducing waste levels and ending landfills at the forefront of their green policies. Achieving a circular economy, therefore, seems set to continue in the dialogue of global, European and UK politics and infrastructure over the coming years.

The circular economy revolution?

There is an uncertainty about what the next wave of waste management legislation is going to look like. Both the EU Commissioner and Commission Vice-President have publicly announced that they aim to strengthen the legislative packages: that illustrates the vital importance of the circular economy and resource efficiency for well-being and competitiveness.

Whatever the regulatory background, a circular economy requires businesses to rethink more than just their resource footprints and energy efficiency. It demands a more radical restructuring of business models.

Janez Potočnik, now co-chair of UNEP’s International Resource Panel, spoke recently after collecting his 2015 Circular Trophy for leadership. ‘We have to fundamentally rethink the economic model,’ he said. ‘The message is that it is possible to create opportunities.’

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The Latin American infrastructure pipelineWe identify infrastructure opportunities in Brazil, Chile, Colombia, Mexico, Paraguay and Peruby Pablo Jaramillo, Bogotá

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The Latin American infrastructure pipeline


Vast tracts of land; liberalised, business-friendly regulatory regimes; major markets and a previously non-existent spending capacity – these are just a few of the factors which explain Latin America’s enhanced global competitiveness. The region was enjoying strong economic growth based on its raw materials production, propelled by China’s seemingly infinite demand: but all the signals now point to a slow, steady reduction in growth. Latin America’s development strategy – and its continuing flow of foreign investment – is now dependent on the development of its infrastructure.

Project finance declined across the globe in 2014. In Latin America, however, the pace of project finance and public-private partnership transactions increased, from 198 deals in 2013 to 222 in 2014, with a value of US$56.3 billion.

With more investment opportunities came a growth in confidence across many sectors. As a result, projects have not been solely reliant on debt finance: developers have been able to access finance through a range of sources including private equity, international financial institutions, pension and sovereign wealth funds.


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In general, the regulation of prior consultation in Latin America is poor. Time limits are usually not clear and there are no obvious legal remedies to overcome negotiation deadlocks. This has led to major delays in the development of projects. In some cases, sponsors have been compelled to conclude agreements with neighbouring community which seriously affect the investment return rates of projects.

Environmental issues

The procedure around granting environmental permits may be burdensome in infrastructure development projects in Latin America. In Colombia, for example, the Council on Social and Economic Policies – CONPES – established that 79 per cent of the 29 toll road projects they reviewed ran into difficulties through delays in obtaining environmental licenses. Delays are usually attributable to bureaucratic requirements, poor coordination among public entities that intervene in the process, and an absence of official industry guidelines.

The problem has been clearly identified, and those countries that are currently developing ambitious infrastructure programmes have over the last year all put in place regulatory regimes that allow for a faster, simpler request procedure.

Exchange risk

Financing choices affect the amount of exchange rate risk borne by different participants in the project. The UN’s Economic Commission for Latin America and the Caribbean (UNU/WIDER-ECLAC) project highlighted that, in particular, loans requiring repayment in foreign currency expose shareholders to a major exchange rate risk. To diminish that risk, most originating governmental entities have put in place some form of foreign exchange coverage mechanism.

Opportunities

Although all Latin American countries have an infrastructure programme, the most dynamic developments are taking place in Brazil, Colombia, Peru, Chile, Mexico and Paraguay. Project pipelines range across sectors and are varied in size, investment requirements, state involvement and contractual structure. All these countries share a policy that is open to private investment in infrastructure.

Latin America’s infrastructure gap is widely recognised:

The OECD view – decades of low and inefficient public investment coupled with timid private investment (limited to the role of EPC contractors).

CG/LA’s 2018 data model – most countries in Latin America need to increase their infrastructure investment by 250 per cent over the next five years in order to meet the needs of their growing popularity.

The IDB and CAF – average investment per country in Latin America and the Caribbean must reach five per cent of GDP (double the current average) in order to eliminate, or diminish, the competitiveness gap with developed countries caused by sub-par infrastructure.

Challenges

Despite the difficulty in generalising across the region, one can say that project developers and sponsors of projects in Latin America should aim to have measures in place to respond to the following scenarios.

Delays

The development of infrastructure projects in Latin America usually faces two types of socially-related challenge. By law, local communities and municipal authorities must receive full information regarding the specifications and effects of the projects. That does not confer a veto right on the community, but experience has shown that strong opposition to projects by local communities is usually a major factor of project overhead and delays.

Furthermore, by law, indigenous and traditional African-American communities must be consulted before implementing any infrastructure project that can affect them or which is developed on their traditional territories. Although similar to community consultation, the indigenous and African-American consultation requirement is subject to a stronger, more stringent legal analysis and a requisite in order to apply for an environmental license.



Brazil

Brazil was not significantly affected by the global financial crisis of 2008 but in recent years its economic growth has slowed down. One of the contributing factors to that stall is the accumulated time of neglect towards its infrastructure and a lack of maintenance that has seriously affected its reliability.

PPPTo tackle this problem, various Brazilian state governments were early adopters of PPP mechanisms as instruments to develop expensive infrastructure projects. In 2004, the Federal Government passed a comprehensive PPP law. In 2006, the Government of the State of São Paulo approved the contract for Brazil’s first PPP for the construction and operation of the São Paulo Metro.

Under the Brazilian PPP regime, concession contracts range from five to 35 years in extension, and require a minimum private investment of at least BR£20 million (US$8.82 million); public sector contributions are limited to 70 per cent of the consolidated cost of the project. Public funding for infrastructure is provided by the government financial institution, Caixa Economica Federal, a promoter of urban development, and by the Brazilian Development Bank (BNDES), the main financing agent for development in Brazil.

Despite social unrest following the cost overruns on the projects required for the 2014 Fifa World Cup, the PPP mechanism is still the preferred choice for infrastructure development in Brazil. More than 65 per cent of the construction work under way for the 2016 Rio Olympic Games is linked to PPP.

At the same time, there has been a major review of the structuring mechanisms: most cost overrun risks have now been shifted from the state to the private sponsors.

Although the Brazilian construction and PPP market is largely dominated by local construction companies – which act as sponsors in most projects – there are opportunities for foreign players and financiers.

EnergyA principal energy tender anticipated is for the 6,133MW São Luiz do Tapajós hydroelectric power plant (HPP) on the Xingu River, valued at US$9.2 billion. Brazil’s national power regulator – the National Energy Agency – plans a further 15,573km of transmission and hydroelectric projects over the next three years.

Transport sectorMost significant investment opportunities are likely to arise in the transport sector in Brazil. The country’s ports, railways, airports, roads and distribution centres are generally in poor repair, with extensive shortfalls in capacity. Brazil’s transport infrastructure suffers in particular from the lack of a national rail network. Upcoming railroad projects between Rio de Janeiro and São Paulo include the Vitoria–Rio de Janeiro railway, Uracu–Campos Freight Railway and Rio–São Paulo–Campinas High Speed Rail.

A number of major road projects have recently been announced: 103.8km Rodoanel Sul e Leste Highway, Rodovia do Progresso, Northwest Corridor of Campinas EMTU and the Acciona BR-393/RJ Highway PPPs.


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Chile

In February 2010, central Chile was hit by a massive earthquake. As a result, the power generation, telecommunications and transportation infrastructure was badly damaged and required extensive rebuilding. At the time, the Chilean government estimated the cost of repair and rebuild at around US$1.2 billion.

Chile 2020The Chile 2020 infrastructure programme – announced by the Public Works Ministry before the earthquake occurred – set potential investment at up to US$28 billion and included 25 PPP-based projects.

Chile had great success in the tendering of the concession of Santiago’s Arturo Merino Benitez Airport in February, 2015. With more 10 international companies interested including various newcomers to the market, the country demonstrated once again that its stable political and economic conditions are very attractive for investors around the world.

Major infrastructure opportunities in Chile, which will go to tender in the near future, include:

• Building the Costanera Central highway; US$1.98bn.

• Creating reservoirs, irrigation canals, shipping and a coastal road that will run for two-thirds of the length of the country.

• The improvement and expansion of the dual access highway to Valdivia roads.

• The express carriageway connection concession for connectivity improvements between routes 78 and 68 between Pudahuel and Maipú.

• The La Serena–Coquimbo road which is a key project for the development of one of Chile’s tourist hotspots.

• The development and expansion of Iquique’s Diego Aracena and Puerto Montt’s El Tepual airports which will require investments for the construction of new terminals, road improvements, parking lots and increased demands.

• The construction and expansion of the Punilla reservoir which is likely to have a great influence in the development of agriculture on the basin of the Ñuble River.

Social infrastructureChile has run a number of prison PPPs in recent years and is making progress with some hospital projects (such as the Salvador Geriatric Facility) – despite initial resistance from the Chilean government toward PPP-based structuring.



Colombia

Colombia probably has the greatest infrastructure needs in Latin America. Despite a stable political situation and a relatively large economy, its turbulent past and complex geography have taken a toll on the country’s competitiveness. In 2014, transporting a container from Colombia’s ports in the Caribbean to its inner (and larger cities) was found to be more costly than taking it from that same port to China.

4G programme Colombia’s 4G programme (the ‘fourth generation’ of road concessions) aims to reduce the gap in infrastructure and consolidate the country’s national road network.

The government intends to grow the national highway system by more than 400 per cent: it plans to build more than 2600km of two-lane highways by the end of 2018 and a total of 6000km of new roads. The estimated value is US$22 billion; this will be jointly financed by public contributions and private funds obtained via equity and debt. A first group of projects in this ambitious package was awarded in 2014 and a second and third wave will follow in 2015 and 2016.

The projects will be carried out through PPP schemes with 20- to 30-year concessions awarded to project sponsors. The government has made significant efforts to ensure that real estate, environmental and social risks are mitigated to a level in which sponsors will be able to commence construction as soon as financial closing is ensured.

In January 2015, the National Infrastructure Agency published terms of reference for the 4G road concession project Bucaramanga–Barrancabermeja–Yondó. This has a 1.68 billion pesos investment estimate (approximately

US$715 million) and includes works along 151.74km involving the construction of 22 bridges and two tunnels adding up to 5.96km.

The second wave of 4G programme projects has been structured and a set of pre-qualification terms published. These projects will be awarded in 2015.

The 2015 projects include:

• Neiva–Girardot: 79km double-lane construction; 190km improvement; US$980 million investment estimate

• Villavicencio–Yopal: 48km double-lane construction; 212km improvement; US$1000 million investment estimate

• Rumichaca–Pasto: 80km double-lane construction; 212km improvement and maintenance; US$1000 million investment estimate.

The Bogotá subwayBogotá’s subway system is considered to be the country’s single largest project opportunity. First line designs were unveiled in October 2014; they include 27km of track and an equal number of stations at an estimated cost of US$7.5 billion.

Environmental license approvals The Colombian government is seeking to reduce the timeframe for environmental license approvals, in response to long-standing industry requests. These licenses are mandatory for oil, mining, energy and infrastructure projects.


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Mexico

Mexico’s PPP Law, enacted in 2012, regulates the involvement of private capital in the provision of public goods, services and technical innovation. It provides for a dynamic risk allocation on a case-by-case basis; and sets limitations in value and term of contractual renegotiation.

FonadinThe national infrastructure fund, Fonadin, has promoted the development of the most recent infrastructure undertakings and provides a source of state finance.

Over the next four years, the government of Mexico plans to invest more than US$600 billion in its energy, transport, telecommunications, water and environment sectors, in order to support the country’s ambitious reform efforts.

Top 100Five Mexican infrastructure projects were included in CG/LA’s top 100 strategic infrastructure projects under development in Latin America in 2014. Two projects that stood out were the construction of a new airport for Mexico City and the Mexico City–Toluca passenger rail line (estimated at a US$2.9 billion investment).

Social infrastructureMexico has run a number of prison PPPs in recent years and has used the PPP system for the construction and operation of a large number of healthcare facilities.

Paraguay

Paraguay depends heavily on land and water transport, but both modes of transportation require urgent investment in improvements, expansion and modernisation. Only 6.8 per cent of the country’s inter-urban network is paved, and waterways, especially the widely used Parana–Paraguay waterway, require urgent dredging and continued maintenance. The government has decided to structure a

PPP model under a new law that will serve as the legal basis for future infrastructure projects.

One to watchLittle is known about the upcoming project pipeline, but it is clear that Paraguay will rapidly become one of the markets to watch.



Peru

Peru’s PPP Law regulates the involvement of private capital in the provision of public goods, services, public infrastructure and technical innovation. Peru’s project portfolio requires the investment of an estimated US$4 billion across all sectors.

Longitudinal de la Sierra The road subsector Longitudinal de la Sierra road project, Section 4 – set to be awarded by the end of 2015 – involves the improvement and rehabilitation works of 117km, the regular initial maintenance of 311km and its subsequent maintenance and operation. The investment is estimated at US$178 million.

Lima Metro ProInversión (Peru’s private investment promotion agency) conducted technical studies and promotion of private investment around the concession of the design, funding, construction, operation and maintenance of Lima Metro’s Line 2; this was recently awarded with an investment value of US$5075 billion.

The Peruvian Ministry of Transport and Communications, MTC, has commissioned ProInversión to conduct pre-investment studies for Lines 3 and 4, and to handle the promotion of private investment.

Social infrastructurePeru has run a number of prison PPPs in recent years.

The consultancy hiring process is under way at the moment for the construction of new replacement correctional facilities in Lima and Cusco (Mujeres Chorrillos, Lurigancho, Miguel Castro Castro and Cusco). The government has not indicated the value of the proposed investment.

In Latin America, Peru has perhaps the most sophisticated PPP regime for the construction of social infrastructure. A notable example is the PPP-based project for the construction and operation of the Callao and Villa Maria del Triunfo Hospitals, in which IBT Group and Ribera Salud from Spain are currently involved.

ReferencesAssociated Press, Chile’s Earthquake-Delayed School Year Begins, March 8, 2010 Caf.com, Latin America must double investments in infrastructure, October 25, 2013 Cepal.org cg-la.com Strategic Top 100 Emerging Markets, Latin America: filling the infrastructure financing gap, March 2014 Infra Deals, country factbook, Brazil Morningstar, Investing in Latin American infrastructure, January 12, 2011 Newsedge.com, Brazil, January 2015 OECD, Bridging infrastructure gaps through smart investment 2014 USTDA.gov (United States Trade and Development Agency)

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Export Credit Agencies and energy in Asia Pacific: a changing role?by Hannah Logan and Tessa Hoser, Sydney

8

Export Credit Agencies and energy in Asia Pacific: a changing role?


According to the International Energy Agency, global energy demand will grow by a third by 2035, requiring more than US$48 trillion in investment. Emerging markets, many of them in Asia Pacific, are expected to account for more than 90 per cent of this growth1.

Both export, and import orientated energy markets have a keen eye on the opportunities this demand will bring.

Export Credit Agencies (or ECAs) in Asia Pacific have had, and will have, a key role to play in helping to support international trade and investment in energy and resources-related infrastructure, technologies and commodities.

1 International Energy Agency, 2013, World Energy Outlook 2013, Paris (under the new policies scenario)


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lower sovereign-level funding costs. The Ichthys LNG project in Western Australia required an enormous debt financing of US$20 billion. When it closed in 2012 it was regarded as the largest project financing in global finance markets at the time. 24 commercial banks funded US$4.8 billion in uncovered loans but the project needed US$11.2 billion in support from 8 ECAs giving direct loans, guarantees or insurance cover, in order to get the financing over the line2. At US$5 billion, Japan Bank for International Cooperation’s (JBIC) loan into the Ichthys project was its largest ever.

Large scale export infrastructure projects in Asia Pacific in the energy, resources and port sectors continue to look to ECAs to supplement and facilitate finance. This may be partially due to insufficient liquidity in the local bank market for commercial banks to fund all of the debt (covered or uncovered), the long lifespan of a project or a potential political or economic risk. ECAs will also be keen to be involved to ensure critical energy exports or imports are protected.

The A$7.2 billion Roy Hill mine project financing in Western Australia which closed in April 2014 was facilitated by A$2.35 billion in ECA-backed facilities (offered by Korea’s Exim Bank (KEXIM) and Korea Trade Insurance Corporation (K-Sure) and Japan’s Nippon Export and Investment Insurance (NEXI)) and by just over A$2 billion in direct ECA loans from KEXIM, JBIC and US Ex-Im3. ECA involvement helped to stimulate commercial bank financing from an additional 19 commercial banks which may otherwise have been wary of falling commodity prices.

Looking at Asia, energy development in Vietnam and Laos (for example) is also bringing increasingly high value Japanese and Korean ECA investment. The US$1.7 billion 1200MW Vinh Tan 4 Thermal Power Plant being developed by Vietnam Electricity Group is benefitting from a US$300 million loan from KEXIM and a US$338 million loan partially provided by JBIC. K-Sure is also providing cover for US$455 million of the commercial debt4. In Laos, the US$1.582 billion 1,070MW Nam Theun 2 hydroelectric power project involved support from at least three ECAs including Thai Eximbank supporting Thailand’s power offtake. At the time [2015] this was reported as the largest cross-border power project in Asia and the largest privately financed hydro project globally5.

2 http://www.ijonline.com/articles/81726/ichthys-lng-australia

3 http://www.ijonline.com/data/transaction/28051/roy-hill-iron-ore-mine

4 https://ijglobal.com/articles/94991/vietnams-vinh-tan-4-set-for-april-drawdown

5 http://www.ifrasia.com/nam-theun-2-powers-ahead/21073485.article

ECA role

Traditionally, the role of ECAs in energy project financing has been mainly focused on helping to boost the export activities of that ECA’s home country construction, engineering and energy technology companies. This has been achieved through tied lending or other support where there has been a market gap in available liquidity, or a need for insurance or other risk transfer, in relation to projects in countries with a high risk profile.

Depending on their mandates, ECAs can offer buyer credit facilities, direct financing, guarantees and commercial and political risk insurance to bolster private investment and assist in getting challenging or high value project finance deals completed. They can provide credit enhancement for securities or other funding to support future cash-flows from untested SPVs. Their involvement can help to improve bankability, reduce equity dilution and lower costs in a capital intensive industry.

In the wake of the Global Financial Crisis (GFC), regulatory restrictions and capital adequacy and liquidity requirements imposed by Basel III meant that credit and liquidity became scarcer. The global recession also saw energy and commodity prices drop in some sectors as demand fell. Venture capital and private equity became correspondingly more expensive. As a result, ECAs needed to step in to fill the funding gap with either credit support or direct loans where new projects were being undertaken. Commercial and political risk insurance offered by some ECAs also gave nervous commercial lenders the necessary protection and comfort to continue lending.

In the post-GFC market with more funding from US private equity and institutional investors, and higher banking and market confidence, do ECAs still have the same role to play?

The old normal

With more liquidity in some sectors in the current market, ECAs in Asia Pacific can play the ‘normal’ ECA role of supporting home-grown export industries and also providing country risk support.

The involvement of an ECA can continue to offer a number of benefits for high value long term energy infrastructure and resources projects.

Big ticketsECAs can fill a gap in funding requirements for a project with high value contributions from deep reserves and at



payments or breach their contractual obligations; bank collapses, coups, strikes, terrorist incidents, currency devaluations, changes in law and poor physical and legal infrastructure can all derail a project.

ECAs continue to help investors to take country risk in emerging or politically difficult markets by providing skilled contractors, political influence, improved bankability and direct financing or political risk insurance, subject to the restraints of international sanctions.

One example is the leading role being played by Chinese ECAs in facilitating investment in new frontiers in Africa – a strategic market for China. In November 2013 it was reported that the Chinese central government would provide US$1 trillion in financing for Africa up to 2025, with China Exim Bank (CEXIM) accounting for 70-80 per cent of the total figure.6 In 2012, Korean ECAs provided US$1.8 billion for the Surgil gas and petrochemicals project in Uzbekistan, also offering commercial and political risk insurance.

In the Asia Pacific region, the opening of the market in Myanmar is likely to be another area of focus for ECA financing and political risk insurance. With Myanmar’s under-developed legal framework for large scale infrastructure projects, and ongoing political and military uncertainty, commercial lenders are likely to need support from ECAs to take on Myanmar country risk. As one example, in January 2015 the Japanese/Thai joint venture Toyo Thai announced that it is looking to JBIC to finance 80 per cent of the US$2 billion required in financing of its 1,280MW coal-fired power project in Myanmar, with the remaining 20 per cent of debt to be provided by other ECAs and commercial lenders7.

Indirect supportECAs can also provide ‘soft support’ through their intra-government relationships, political knowledge, diplomatic goodwill and reputational strength. They can offer the benefit of cooperation agreements and relationships with multilateral agencies (such as the Asian Development Bank and the International Finance Corporation (part of the World Bank)), offshore banks, private insurers and other ECAs offshore. ECAs can also use their local knowledge to assist offshore ECAs and other lenders to navigate onshore due diligence issues.

6 http://www.scmp.com/business/banking-finance/article/1358902/china-provide-africa-us1tr-financing

7 https://ijglobal.com/articles/94919/toyo-thai-lines-up-jbic-debt-for-myanmar-power-project

TenorWith a long term strategic focus, ECAs can offer loans or other support for longer tenors than are often available in the commercial market, particularly in Australia where tenors are typically around five years.

On the Gladstone LNG project, Australia’s ECA, Export Finance and Insurance Corporation’s (EFIC) facility had a 13 year tenor. ECA support in Ichthys also enabled longer tenors to be offered by the commercial banks benefiting from cheaper capital commitments, helping to mitigate refinancing risk. The tenor for ECA loans and insurance on the Surgil gas and petrochemicals project in Uzbekistan referred to below was 16 years. KEXIM can offer tenors of 18 years for renewables, hydro and nuclear projects and Chinese ECA financings have been known to offer tenors extending to 25 years.

As the Basel III matched funding requirements continue to impact the commercial bank market in the coming years, this aspect of ECA support will become more crucial.

Enhanced termsGiven their status as semi-governmental institutions, the cost of borrowing, capital reserves and return expectations for most ECAs is lower than that of commercial lenders – meaning that cost savings are often passed on to borrowers. This assists with blending of funding levels and through fixed rate CIRR (Commercial Interest Reference Rate) funding offered by most OECD ECAs, can reduce overall project costs. ECAs from non-OECD countries which are not bound by the OECD CIRR guidelines can offer even more preferential rates.

Country riskIn addition to construction and credit risks which may arise on any energy project, those being developed in developing countries or volatile regions also carry political risks. Governments may topple, nationalise projects, freeze

Large scale export infrastructure projects in Asia-Pacific in the energy, resources and port sectors continue to look to ECAs to supplement and facilitate finance.


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Strategic investmentsA number of ECAs now include support for overseas investment in, and acquisition of, natural resources as key policy aims.

As an export driven energy economy, Australia will be looking for investment and offtake from markets in Asia (and elsewhere) with a high energy demand but few viable natural energy resources.

Attracting energy resources investment in Australia and growing its energy export capacity and competitiveness are twin pillars of Australia’s Energy White Paper. According to the Bureau of Resources and Energy Economics (BREE), Australia’s resources and energy commodity export earnings reached A$195 billion in 2013-2014, and are forecast to increase at an average rate of 7 per cent per year from 2013-2014 to reach A$274 billion in 2018-1911. According to the Energy Green Paper 2014, Australia is currently the world’s second largest exporter of coal, number three exporter of uranium, and number four exporter of gas12 and is looking to become the largest exporter of LNG by 201813.

For natural resource-challenged economies such as Korea and Japan, diversification of energy supply is a critical strategic concern.

In Japan this is particularly the case in light of the move away from nuclear energy after the Fukushima nuclear disaster. According to Japan’s FY2013 Annual Report on Energy (Energy White Paper 2014) Outline, Japan and South Korea were respectively 33rd (6 per cent) and 30th (18 per cent) in ranking of energy self-sufficiency for the 34 OECD countries in 2012. Pre-Fukushima, Japan’s self-sufficiency was much closer to South Korea’s at 19.9 per cent.

Korea reportedly relies on imports to meet 97 per cent of its energy demand.14 From an ECA perspective, energy projects feature strongly in KEXIM and K-Sure’s portfolios, and KEXIM has a specific mandate to provide natural resources development loans.

Japan’s debt financing of Train 1 of the landmark US$11 billion Freeport LNG Project in the USA in 2014 demonstrates its national strategic focus on energy diversification. At US$2.7 billion, JBIC’s direct loan was its largest in the USA.

11 Bureau of Resources and Energy Economics, 2014, Resources and Energy Quarterly, September Quarter 2014, http://www.bree.gov.au/files/files//publications/req/REQ-2014-09.pdf

12 Energy Green Paper 2014, http://ewp.industry.gov.au/files/egp/energy_green_paper.pdf

13 http://www.theaustralian.com.au/business/mining-energy/australia-to-be-worlds-largest- LNG exporter-hsbc/story-e6frg9df-1227108582779

14 http://www.eia.gov/countries/cab.cfm?fips=ks

Changing role – adaptation and innovation

AdaptationECAs and their mandates are constantly evolving to adapt to changing market conditions, new opportunities, competition and political priorities.

SME facilitationHelping small and medium-sized enterprises (SMEs) to overcome financial barriers to market entry is now a key focus of most ECAs.

In Australia, EFIC’s expanded powers (which recently passed the Senate and received royal assent)8 to allow direct lending for export transactions involving all goods, not just capital goods, indicates an increased level of Australian government support for smaller scale contractors and suppliers to energy and resources projects.

Support for SMEs has also been a driver of US Ex-Im’s support of large project financings, where US manufacturers have been key suppliers of goods.

A focus on supporting SMEs is likely to increase in Australia given the structural obstacles for SMEs in accessing finance identified by the Final Financial System Inquiry Murray Report in December 2014.9 These obstacles echo those that apply to SMEs elsewhere and include:

• information asymmetries between lenders and borrowers• greater requirement for collateral• higher interest rates• higher fixed costs of raising funds in capital markets• onerous non-monetary terms• fewer economies of scale.

Korea’s KEXIM is also focusing on assisting SMEs in line with government policy and its mandate. It has ear-marked 26.5 trillion won (approximately US$24.5 billion) for such purposes in 2015, an increase of 1 trillion won (approximately US$925 million) compared to 2014.10 In Japan, NEXI has offered insurance to support the export activities of Japanese SMEs since 2005. JBIC’s mandate includes six support measures aimed at promoting Japanese SMEs, including preferential loan conditions, specific credit lines and long-term local currency loans with fixed interest rates.

8 Export Finance and Insurance Corporation Amendment (Direct Lending and Other Measures) Act 2015

9 http://fsi.gov.au/publications/final-report/appendix-3/

10 http://www.koreatimes.co.kr/ 14 January 2015



Kredit Fonden, guaranteed approximately 80 per cent of the US Dollar tranche of the US$315 million financing of Energy Development Corporation’s 150MW Burgos Wind farm in Ilocos Nortes in the Philippines17.

The ‘new normal’?If the ‘new normal’ of falling oil prices is maintained, then we are likely to see an increased focus on diversification of energy supply and alternative energy investments outside oil. ECA funding focus is expected to adjust accordingly.

ECAs can help E&P (exploration and production) companies finance new projects where traditional sources of financing are becoming scarcer. This can be achieved by providing direct finance, credit support guarantees and insurance to improve bankability and mitigate contractor and counterparty risk and bank exposures, as was the case for a number of projects during the GFC. For example, Vung Ro Petroleum, the sponsor for a new US$4 billion Phu Yen oil refinery project in Southern Vietnam, is looking to ECAs for a large proportion of the financing for the project18.

Other economic developments on the world stage are also focusing attention on ECA funding. KEXIM sees its ability to lend to Korean exporters and to local project developers as a key buffer against the weak yen, (relative) Chinese slowdown and Eurozone uncertainties. Its funding capacity for 2015 has increased from 79.7 trillion won (US$7.2.2 billion) in 2014 to 80 trillion won (US$72.5 billion).

Green financeAlthough not as active in this area as multilateral and development finance agencies, a number of ECAs have responded to a growing trend for socially and environmentally responsible investment and fossil fuel divestment by adapting their mandates accordingly.

JBIC amended its mandate in 2010 to establish a financial product called GREEN (Global action for Reconciling Economic growth and Environmental preservation) under which it has provided financing for clean energy projects in India, Malaysia, Colombia and other countries.

Korea’s KEXIM has included green financing as one of its priority sectors. In 2013 it issued a US$500 million five-year green bond, the proceeds of which are fed back into renewable energy, energy efficiency and low carbon projects19.

17 http://www.txfnews.com/News/Article/3345/Banks-and-EKF-team-to-close-loan-for-largest-wind-farm-in-the-Philippines

18 https://ijglobal.com/articles/94918/vietnams-vung-ro-starts-to-approach-banks

19 http://www.koreaexim.go.kr/en/exim/investor/InvestorLetter.jsp

The JBIC loan was supported by a commercial bank tranche backed by NEXI. The financing allows equity investors and offtakers Osaka Gas and Chubu Electric to source LNG on prices based on US natural gas prices, rather than being tied in to volatile oil-linked LNG prices.

For China, there is a strategic focus on mineral resources as well as energy imports. Chinese investment and ECA financing in Africa has partly been with an eye to securing lucrative and strategically important export contracts or repayment in kind with oil or minerals.

Opportunities abroadECAs are continually diversifying geographically and looking at new emerging markets from a commercial as well as a strategic perspective. For example, ECAs (and multilaterals) are key players in opening up African markets to foreign commercial investment in the burgeoning energy and infrastructure space.

The continuing prominence of Asia in both the global economy and global energy demand means that Asia will continue to be a key focus for investment.

Japanese, Chinese and Korean ECAs continue to look to other parts of Asia to diversify and promote local technology, construction and engineering, and energy offtake. With an ever-increasing demand for energy Indonesia has been a key focus for those ECAs for many years. CEXIM was involved in the financing of a substantial proportion of Indonesia’s Fast Track 1 procurement process for 10,000MW of power in Indonesia in 2008-2009, with Sinosure providing backing for commercial debt tranches.

Looking at Japan, at US$1.64 billion, JBIC’s funding to projects in Indonesia over the last 3 years is more than three times that of the next largest financier (the ADB)15. Most recently (in January 2015) JBIC lent an additional US$313.7 million to Mitsubishi Corporation to support its investment in the US$2.8 billion Donggi-Senoro LNG Project. JBIC also participated in the project financing of the project in September 2014, alongside two other Asian ECAs (KEXIM, providing a direct loan of US$191.8 million and an insurance guarantee of commercial tranches, and NEXI, providing insurance guarantees)16. Japanese and Korean utilities are long term offtakers of the LNG, thus enabling Japan and Korea to benefit from a lower cost stable diversified energy supply.

Non-Asian ECAs are also looking to Asia for financing opportunities. In October 2014 Denmark’s ECA, Eksport

15 www.infra-deals.com, Indonesia Country Profile

16 www.infra-asia.com


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ECA innovation – what next?ECAs are also adapting to new market conditions and the challenge of operating in a more competitive environment by developing new products – including venturing into capital markets.

To bond or not to bondECAs involved in the projects sector have looked at the example of ECAs such as US Ex-Im, UK Export Finance and COFACE in the aviation sector, and have begun to consider ECA-wrapped project bonds. Investors who may generally otherwise be wary of taking construction risk can have the benefit of an unconditional and irrevocable guarantee supporting repayment of the bonds during the construction phase before project revenues become established.

Euler Hermes was a frontrunner in developing an innovative refinancing facilitation structure whereby a syndicate bank refinances its participation by taking a funded participation from a German covered bond issuer. Euler Hermes provides enhanced 100 per cent ECA cover through an on demand securitisation guarantee. ECAs in France, Belgium, Switzerland and the Netherlands have all also developed securitisation guarantee schemes.

KEXIM has also expanded its mandate to provide guarantees to support the issuance of project bonds.

In Australia, there is currently limited interest for ECA-wrapped project bonds for a number of reasons. These include greater liquidity, construction risk, mixed appetite for fixed income securities and greater attractiveness of more mature longer term offshore bond markets. However, we anticipate this may be an area to watch in coming years as the market seeks alternatives to traditional debt financings. In appropriate circumstances, it is possible that under its mandate EFIC could issue a guarantee of a project bond in future – an interesting potential development.

Catalysing super bond investmentECAs may be able to play a role in encouraging superannuation funds to invest in the bond markets.

Given investment mandate restrictions for superannuation funds relating to illiquid investments, ECAs could look to offer super funds a get out clause by providing support which would help to develop a liquid bond market. This could take the form of a government-backed infrastructure funding corporation providing credit-wrapping of infrastructure bonds or a bond redemption facility for eligible projects.

The Export-Import Bank of India has also entered the green finance arena, raising an oversubscribed US$500 million from a five-year green bond issue in March 2015.

In Australia, both EFIC and foreign ECAs could play an important role in helping to boost the renewables industry. New investment in greenfield renewables projects in Australia has fallen to an all-time low, largely due to continuing low energy demand and ongoing policy uncertainty around the national Renewable Energy Target. Of the few renewables projects which have been financed in the last few years, a number have had the benefit of support from the Clean Energy Finance Corporation (CEFC). In its first full year of operation, the CEFC invested A$930 million, supporting projects with a value of over A$3.2 billion.20 The future of the CEFC and green securitisation options are both uncertain under the current Australian government but green bonds could be a future initiative for ECAs.

The announcement in the UK in mid-February 2015 of a cross-party declaration to accelerate the transition to a competitive, energy-efficient low-carbon economy and to end the use of unabated coal for power generation (announced as part of the UK’s commitment to tackling climate change in the run up to the UN Climate Change Conference (COP 21) in Paris 2015) could also signal a change in levels of investment in the global coal industry. ECAs could have a significant role to play in facilitating green finance initiatives developed in light of Paris 2015.

Islamic financeIn recent years there has been some interest from the Middle East, Malaysia and Indonesia in developing Shariah compliant ECA products. The German ECA, Euler Hermes, has supported Islamic finance transactions in the past. This could also be a new offering for Australian and Asian ECAs.

New recession?In light of on-going regulatory pressures for commercial lenders, and wider concerns about the Chinese slowdown, continuing volatility in financial markets and low commodity prices, export markets could go full circle and see ECA support being essential again to fill the funding gap for many projects. Export credit insurance is also seen as critical in some scenarios to mitigate political and non-payment risks.

20 CEFC Annual Report 2013-14, www.cleanenergyfinancecorp.com.au/reports/annual-reports/files/annual-report-2013-14.aspx



Securitisation guarantees along the lines of those offered by European ECAs could also be developed in Australia to encourage super fund investment in project-backed bonds.

Equity investmentsAnother interesting development amongst Asia Pacific ECAs is the ability to make equity investments.

KEXIM’s mandate was amended in early 2014 to allow it to make equity investments in projects where it has a lender or guarantor role without needing formal approval from the Ministry of Strategy and Finance. In October 2014 KEXIM took its first equity stake – US$7.15 million in the 54MW Semangka Hydroelectric Power Project in Indonesia, being developed by POSCO Engineering Consortium21. JBIC can also invest equity. This may become a new trend to facilitate projects across the region.

Conclusion

The gap in the market caused by capital adequacy and poor liquidity is perhaps closing but new challenges are presented by falling commodity prices, a relative Chinese slowdown and ongoing instability in financial markets. ECAs are proving adept at developing new mandates and products to deal with changing market conditions.

With a renewed focus on global trade and productivity in the wake of the G20 Leaders’ Summit in November 2014, it will be interesting to see what the future holds for ECA assistance and investment in energy infrastructure and resources projects in Asia Pacific.

21 http://www.businesskorea.co.kr/article/6582/first-equity-investment-export-import-bank-korea-invests-waterpower-generation-project

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Project Sukuk: Islamic finance solutions for funding infrastructureby Mark Brighouse, London

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Project Sukuk: Islamic finance solutions for funding infrastructure


What are Sukuk?

Sukuk exist to replicate the commercial effect of bonds whilst adhering to Islamic principles which prohibit the charging or payment of interest and the trading of debt other than at par value.

Sukuk differ from corporate bonds in that they represent undivided ownership interests in defined assets or rights of use of assets that have been transferred by the originator to the issuing vehicle. Income derived from those assets form the basis of the cashflows between the originator and Sukuk-holders delivering a profit on the Sukuk-holders’ investment. The assets themselves may be tangible or intangible provided that they are certain, income-generating and not being used for any ‘immoral’ purpose such as gambling or the sale of alcohol.

Sukuk are not, however, necessarily asset-backed in the sense that in an enforcement scenario, recourse to the assets underlying the structure is often limited to a right to put those assets back to the originator giving rise to a contractual claim for payment. Whilst that contractual claim may be secured by recourse to assets this is a commercial consideration rather than one of Shariah compliance.


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Key features of Sukuk

• Shariah-compliant equivalent of a bond, issued only for Islamic-compliant projects and purposes.

• May be assessed and rated by international rating agencies, giving investors the means to assess risk and return parameters.

• Tradable capital market product, providing medium to long-term fixed or variable rates of return.

• Liquid instrument that is tradable in secondary markets, except where the certificate represents a debt to the holder in which case it is held until maturity or sold at par.

• Allows the owner to claim an undivided beneficial ownership in the underlying assets and thus share in the revenues generated by the assets and in sale of the assets though the formula for revenue and sale price are typically agreed at the outset such that investors expect a certain fixed or floating rate of return.

Sukuk structures

There are 14 eligible types of Sukuk identified by the Accounting and Auditing Organisation for Islamic Financial Institutions (‘AAOIFI’), of which Sukuk al-ijara and Sukuk al-murabaha are the most common.

Sukuk al-ijara Sukuk al-ijara typically involve an SPV issuer and originator entering into a sale and purchase agreement in relation to certain assets and an ijara agreement to lease those assets back to the originator.

The SPV issuer applies the Sukuk issuance proceeds in acquisition of the assets and periodically pays over the rental income to the Sukuk-holders. At maturity, the asset is sold back to the originator under a sale undertaking and the proceeds distributed to the Sukuk-holders. If the originator defaults on its rental payment or other obligations the Sukuk-holders may vote to compel the SPV issuer to exercise its rights under a put undertaking whereby the originator buys back the assets.

The main drawback of this structure for project financing is that the project company may not have assets at the commencement of construction on which to base the structure. Whilst a Sukuk al-ijara might be suitable for re-financing at completion of the project, for the construction phase, an absence of tangible assets may dictate a different structure.

Sukuk al-murabaha Sukuk al-murabaha have the advantage of not requiring the originator to put its own, unencumbered assets into the structure.

A Sukuk al-murabaha involves a cost-plus transaction of marketable commodities, most commonly metals traded on the London Metal Exchange or the London Platinum and Palladium Market.

The issuer uses the Sukuk proceeds to acquire the commodities from the market, which are sold to the originator at a mark-up and on deferred payment terms. The issuer’s mark-up may be fixed or benchmarked against a conventional index such as LIBOR. The originator immediately sells on the commodities in the market so as to obtain funds. For Shariah compliance, the sale and purchase of the commodities are generally made through different brokers.

If the rate of return is benchmarked to a conventional index, periodic commodities trades will be required to ‘re-set’ LIBOR. Generally, the proceeds of each periodic cost-plus transaction will be netted against the deferred amount payable in respect of the previous transaction such that only one deferred payment is owed by the originator at any given time.

There are two main drawbacks to the murabaha structure. First, it creates a debt rather than an interest in an asset and so a pure Sukuk al-murabaha cannot be traded other than at par. Hybrid structures where murabaha payment obligations constitute a minority of the Sukuk-holders’ return, such as the latest Goldman Sachs issuance, avoid this pitfall but still require the originator to put suitable assets into the structure to form the basis for the majority of the return.

Secondly, there is a preference amongst Shariah scholars for structures underpinned by assets or trades linked to the actual business of the originator to avoid any suggestion of artificiality. AAOIFI publishes Shari’a Standards for Islamic Financial Institutions which, whilst not accepted and adhered to by all Islamic financial institutions, represent the



closest the industry comes to consensus. The AAOIFI Shariah standard sets out that Islamic financial institutions should ‘restrict the use of monetization [which includes murabaha] to the cases of clients whose transactions cannot be disposed of through other means of financing and investment such as Musharaka, Mudaraba, Ijarah, Istisna and the like’.

Sukuk al-istisnaOf these alternatives, Sukuk al-istisna is the often most appropriate structure for project financing.

The word istisna means procurement – it is a contract for the manufacture or construction of an asset in return for up-front payment.

Under a Sukuk al-istisna, the SPV issuer issues Sukuk certificates to investors in consideration for the amount of the issue proceeds. The SPV issuer, as purchaser, pays the proceeds in consideration for the construction and delivery of the project (the ‘istisna assets’) to the originator under the terms of an istisna agreement. During the tenor of the Sukuk the return on the investment is generated:

• during the construction period, under a forward lease of the istisna assets

• following delivery under a lease of the completed istisna assets.

In each case, by the SPV issuer to the originator who pays, respectively, advance rental and rental. Separately, the SPV issuer appoints the originator as its servicing agent to repair, maintain and insure the istisna assets.

At maturity, the investors’ initial investment is returned on the same date as the final payment is made under the lease. The mechanic for this return is a sale of the istisna assets from the SPV issuer to the originator for an Exercise Price equal to the amount of the proceeds of the original issuance.

Each payment made to the SPV issuer, whether in the form of advance rental, rental or sale price is distributed to the Sukuk-holders by a paying agent.

Credit enhancement

Investors are often reluctant to take construction risk and institutional investors focus principally on project bonds with ‘A’ credit rating, which have the right combination of yield and risk for them. Without credit enhancement, this focus on ‘A’ credit rated bonds and Sukuk does not fit with investments into greenfield projects with the risks of construction delays and cost overruns, since such projects are unlikely to receive such rating for their bonds/Sukuk. There are a number of ways in which the credit of the Sukuk structure outlined above might be enhanced.

A government may be prepared to make a contribution to a project by way of equity or a fully subordinated facility or a limited recourse guarantee such that it takes first loss. Alternatively, a financier might provide credit enhancement of its own by extending a subordinated facility to the project company.

Depending on the rating agency’s views on the overall risk of the project, any such subordinated ‘cushion’ might be limited to the construction and ramp up phase of the project where the risk to investors is generally considered greatest. This was the case with the world’s first project Sukuk issue, a US$1 billion (equivalent) issuance launched in 2011, to finance a joint venture between Saudi Aramco and Total for a refinery in Saudi Arabia. Both Saudia Aramco and Total provided a construction guarantee with Saudi Aramco separately guaranteeing the Sukuk during the refinery’s construction phase.

Saudi Aramco similarly supported the Sadara chemicals complex US$2 billion (equivalent) project Sukuk with construction guarantees from itself and its co-sponsor, Dow Chemicals. The Sukuk was also granted pari passu status with other senior debt and shared in the project financing security on a pari passu basis with the other secured creditors.


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Local law issues

It is important to establish whether the sale of the assets underpinning the Sukuk requires registration in order to be enforceable or whether the sale will attract any tax or other duties.

Using freehold title to real property as the asset can be problematic for this reason and if the project is to constitute real property once complete, local law may dictate an alternative structure.

The outlook

The Indonesian government has signalled its intention to issue project finance Sukuk over the next 12 months whilst the Department for Trade and Industry in the UK is actively seeking Islamic finance for a range of projects where project Sukuk may form a part of a broader financing package. As recent issuances have demonstrated, there is an appetite for project finance Sukuk for projects supported by well-rated sponsors known to investors. In the right circumstances, the same forces that impel sponsors to seek project bond financing in the conventional market in response to tightened bank lending following the implementation of Basel III look set equally to drive the expansion of the project Sukuk market.



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Breaking the resource curse: an opportunity for investment in Africa’s process sectorby Matthew Hardwick and Sonam Kathuria, London

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Breaking the resource curse: an opportunity for investment in Africa’s process sector


Reforming trade law and policy is high on the agenda for states in Sub-Saharan Africa as they seek to secure long term and sustainable benefits from the extraction and exploitation of domestic raw materials.


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It is expected that this will stimulate domestic and foreign investment in the local manufacturing and processing sectors, thereby boosting exports of ‘value added’ goods, which in turn will generate higher export and tax revenues and create jobs and opportunities for the wider population.

This move by African states is seen by many to present a significant investment opportunity for the international investment community.

Export restrictions

Export restrictions can take the form of ‘tariff’ restrictions or ‘non-tariff’ restrictions.

Tariff restrictions involve some kind of payment on export, such as taxes or duties. Non-tariff restrictions include export bans, quotas, export licences, minimum export prices and other conditions such as high fees on exports and requirements of prior exporting experience.

Non-tariff restrictions have recently been introduced by Mali, who as part of 2012 mining code required that mineral products be treated, refined or transformed in-country, unless otherwise authorised by the mining administrations.

Guinea has recently introduced tariff restrictions in the form of taxes on the export of certain unprocessed metals and minerals (e.g. bauxite, iron ore and uranium).

The resource curse

There is no doubt that the relative abundance of raw materials within resource-rich African countries creates a significant economic opportunity for these countries. This presence, however, has tended not to bring with it sustained growth and development. In particular, the generation of income from natural resources has tended to occur in relative isolation and without linkages into other higher value economic activities. 1

The Organisation for Economic Cooperation and Development (OECD) has defined raw materials as follows, ‘the minerals and metals that are crucial inputs for the capital and consumer goods industries around the world and the agricultural commodities that supplement domestic food supplies in many countries and sustain the global food processing industry’.1

In this article, we explore the export restrictions by which African states are seeking to secure wider economic benefits from resource exploitation. We assess the wider legal and economic implications of such measures, and look at the factors to be assessed by potential investors when considering the viability of a particular investment opportunity in the process industries in these countries.

Achieving value addition

Countries in Sub-Saharan Africa are increasingly using direct or indirect restrictions on the export of raw materials to stimulate investment in domestic downstream processing industries and to move domestic industry up the value chain.

By restricting the export of certain raw materials, domestic downstream sectors which directly or indirectly rely on those raw materials are likely to benefit from increased supply at lower prices as competition from export markets for those raw materials is undermined or even eliminated.

1 Export Restrictions in Raw Materials Trade: Facts, Fallacies and Better Practices, Organisation for Economic Cooperation and Development (2014)



Table 1 below provides a high-level overview of the restrictions on exports of various categories of raw materials being employed in Sub-Saharan Africa. Table 2 provides a few specific country-wise examples of 'export restricted' raw materials.

Table 1Country Minerals and metals Waste and scrap Wood Agriculture

Cote d’lvoire 4

Gabon 4

Gambia 4 4

Ghana 4 4 4

Guinea 4 4

Kenya 4

Mali 4

Namibia 4

Nigeria 4 4

Rwanda 4 4

South Africa 4 4

Senegal 4

Sierra Leone 4

Tanzania 4

Uganda 4 4

Zambia 4 4

Zimbabwe 4

Source: Export Restrictions in Raw Materials Trade: Facts, Fallacies and Better Practices, Organisation for Economic Cooperation and Development (2014)

Note: for industrial raw materials, information relates to the period 2009-2012. For agricultural commodities, information relates to the period 2007-2011.


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Table 2Country Export tax Licensing requirements Export prohibition

Cote d’lvoire Waste and scrap of iron and steel

Waste and scrap of iron and steel

Gabon Manganese oresGambia Waste and scrap of gold,

platinum, silverDiamonds

Ghana Precious metal ores Waste and scrap of cast iron and steel

Guinea Aluminium oresKenya Waste and scrap of cast iron,

steel, tinned iron or steel, copper, aluminium and zinc

Mali GoldBase metals or silver

Namibia Diamonds (unsorted)Nigeria Waste and scrap of cast

iron, stainless steel, copper, aluminium and iron

Rwanda NiobiumTantalum or vanadium ores

Waste and scrap of iron and steel

South Africa Diamonds Lead oresTungsten oresGoldPlatinumCopperWaste and scrap of gold, iron, platinum, steel and tinned iron

Senegal GoldSierra Leone Diamonds Gold

Base metals or silverTanzania Waste and scrap of iron, steel,

copper, aluminium and zincUganda Non-agglomerated iron ore Waste and scrap of cast iron,

steel, copper, aluminium and zinc

Zambia Waste and scrap of cast iron, stainless steel, alloy steel, copper, aluminium and zinc

Waste and scrap of cast iron, stainless steel, alloy steel, copper, aluminium and zinc

Zinc Waste and scrap of magnesium and tungsten

Copper oresZimbabwe Chromium ores and

concentrates

Source: OECD Inventory of Restrictions on Trade in Raw Materials, Organisation for Economic Cooperation and Development (2014)



Multilateral and bilateral efforts to curb export restrictions on raw materials

Whilst there are economic benefits to be achieved from the introduction of export restrictions for a domestic economy, the impact on foreign countries and their ability to compete may be significant.

First, there is the initial impact of a constriction in global supply of the raw material. Second, a significant impact on world prices may be felt, particularly where the country imposing the restrictions has a major share of the world production of the relevant raw material. The much-publicised export restrictions placed by China on rare earths were controversial for this reason, as 95 per cent of the world's production of rare earths comes from China. In this context, export restrictions could potentially have the effect of putting foreign downstream producers out of business owing to the pressure they create on the global supply of the relevant raw materials.

Achieving a reduction in export restrictions on raw materials has, therefore, become a key policy objective for the European Union (EU) and the United States, both of whom rely heavily on imports of critical raw materials for their industries from countries having near monopoly positions on supply.2

The EU, in particular, over the last few years has been looking to use multilateral trade agreements at the World Trade Organisation (WTO) level as well as bilateral trade agreements, called Economic Partnership Agreement, amongst other measures, to curb the regulation of exports on key raw materials by countries in the Sub-Saharan region.

2 A Willems et al, The EC and US WTO Challenge to China’s Export Restrictions: Will It Increase Their Downstream industries’ Competitiveness?, 2009 International Trade Law & Regulation 171.

Multilateral trade agreements

At an international level, multilateral trade agreements seek to control the extent to which countries may limit their exports, with a view to opening up international trade and preventing the anti-competitive effects that restrictions on exports may have.

Many countries in the Sub-Saharan region are members of the World Trade Organisation (WTO), and are therefore subject to the WTO regulatory regime. The key legal requirement under the WTO regime is Article XI of the General Agreement on Tariffs and Trade 1994 (Article XI). Article XI requires WTO members to eliminate prohibitions and quantitative restrictions on exports (unless one of the limited number of exceptions apply).3 WTO member states are, therefore, not permitted to impose export prohibitions and quantitative restrictions such as exports quotas. Tariff restrictions such as export taxes are, however, a permissible trade policy tool under Article XI.

It is worth noting that very few disputes relating to the imposition of export restrictions have actually been brought before the WTO Disputes Settlement Body.

Bilateral Economic Partnership Agreements

The EU has in the past sought to secure elimination of export taxes at the WTO level, but such proposals were rejected by other WTO members and criticised by developing countries who, as this article has described, see such taxes as an important policy tool to promote domestic local value addition and industrial development.

Since the EU did not succeed in getting its way on export taxes in the WTO, it shifted its efforts to negotiating regional Economic Partnership Agreements (EPAs) in Africa.

3 These exceptions to the Article XI requirements include measures temporarily applied to prevent or relieve critical shortages of foodstuffs or other products essential to the party, and certain generally applicable exceptions relating to protection of human, animal or plant life or health, conservation of exhaustible natural resources and domestic stabilisation plans where the domestic price for raw materials is held below the world price to ensure essential quantities of domestic materials are available to the domestic processing industry (provided these are not 'protectionist' or discriminatory in nature).

In this context, export restrictions could potentially have the effect of putting foreign downstream producers out of business owing to the pressure they create on the global supply of the relevant raw materials.


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Currently, there are five regional African EPAs being negotiated – covering West Africa, Central Africa, Eastern and Southern Africa, the Eastern African Community and the South African Development Community – each being at a different stage in the treaty process. Some of these are pending signature and ratification, and some are in provisional application.4 Provisional application does not, however, impose legally binding obligations and can be terminated at any time, pending formal ratification.

The EU has sought to include a clause on export taxes in the draft EPAs that would prohibit African countries from introducing any new export taxes, as well as from increasing those currently applied. In exceptional circumstances, and only subject to agreement by the European Commission, could export duties be temporarily introduced under the proposed provision.

Negotiations with African regions have proved difficult for the EU with African states asserting that the abolition of export taxes would remove the policy space which enables them to encourage domestic value addition. Moreover, they point to the fact that export taxes are not prohibited under WTO rules and assert that the WTO is the right forum for any such debate. Accordingly, none of the EPAs with the African regions have to date been concluded and ratified.

Impact on in-country upstream producers

Whilst the implementation of export restrictions may be justified on the basis of a boost to in-country downstream manufacturers, the measures could, of course, impact on the fortunes of domestic upstream players, such as mining companies who typically invest a great deal of money in exploration and development before mineral extraction takes place. Their decision to invest in primary extractive industry will have been driven to a great extent by commodity price projections. The effect of export restrictions on commodity price, coupled with capacity constraints in the downstream sector could, however, undermine their investment decisions and place the growth of extractive industries under stress.

It is apparent then that plans to implement export restrictions must take account of the impact on producers of raw materials. It would be disastrous if the measures undermined primary extraction. Export restrictions must, therefore, be backed by strong regulation and support for the domestic extractive industries to prevent any damaging impact on the

4 European Commission, Overview of EPA negotiations (Updated October 2014) available at http://trade.ec.europa.eu/doclib/html/144912.htm

relevant parties. Encouragement of partnerships between producers and processors, and reserving certain existing processing capacity for ‘open use’ are kinds of regulatory features that African states should contemplate as they seek to take full advantage of export regulation and to effectively achieve domestic value addition.

Key considerations underpinning any downstream investment decision

There are several factors that a potential investor will need to consider before making a decision to invest in Africa’s processing and manufacturing sector.

We use the example of the copper processing sector in Zambia opposite to identify some of the key considerations that potential investors in Zambia’s downstream copper sector may need to factor into their investment decision. This is not an exhaustive or definitive review, but should hopefully provide the reader with a flavour of the issues at hand.



A case study

Opportunities for investment in copper smelter processing in Zambia

Consideration PositionMarket considerations: what are the medium to long term global demand and price projections?

Global supply of copper is expected to peak this year at around 20 million tonnes, with a decline to follow thereafter. It is expected that global demand for copper will however increase year-on-year by three per cent, reaching 25 million tonnes by 2020.The recent fall in copper prices is generally viewed by analysts as the result of short term market volatility and uncertainty around the general health of industrial economies, as opposed to any deterioration in fundamentals.Whilst there is some downgrading of future demand growth projections from China, the longer term view is that there will remain a supply gap which is likely to mean copper prices will improve, and long term forecasts are generally positive.Even projections of oversupply for this year have been downgraded as production from the likes of Glencore and Rio Tinto fell short of projections (mainly due to technical issues).

Supply considerations: will sufficient supplies of ‘input’ raw materials be available domestically?

Copper is the main mineral resource in Zambia. In 2010, Zambia was the seventh largest global producer of copper in terms of mine production volume, with annual production at 715,000 tonnes.Zambia is expected to become one of the world’s major copper producers in the near future, driven by high grade reserves and several expansion plans by the likes of First Quantum at its Sentinel and Kansanshi mines.The projected increase in copper output in the coming years is expected to make Zambia one of the five highest copper producers in the world.There is also increased copper mine production capacity in neighbouring DRC, increasing the need for copper beneficiation and smelting in Zambia. Clearly, this also raises the possibility of competition from copper processing capacity in the DRC.

Capacity considerations: what scope is there for further domestic processing capacity?

It is estimated that there is a current shortfall in copper smelting and refining capacity in Zambia of 300,000 tonnes per year. Whilst it appears that there are plans by existing miners to construct their own smelters, it is not clear if and to what extent current and future capacity shortages will be met. Further analysis would be required in this regard.

Export restrictions: what form do local export restrictions take and do they fall within prohibitions under international treaties?

With an export value for refined copper and copper alloys accounting for over 60 per cent of copper’s aggregate trade value, there is clearly potential for value addition through in-country processing.The Zambian government has been actively encouraging domestic value addition of metals.Key to this has been the introduction of a 15 per cent export tax on copper and cobalt concentrates.All the countries in the Eastern and Southern Africa region, except Eritrea, are members of the WTO. Tariff restrictions, such as export taxes are, however, a permissible trade policy tool under Article XI.The EU is currently negotiating an Economic Partnership Agreement with Djibouti, Eritrea, Ethiopia, Sudan, Malawi, Zambia, Zimbabwe, Comoros, Mauritius, Madagascar and the Seychelles.In August 2009, Madagascar, Mauritius, the Seychelles, and Zimbabwe signed an ‘interim’ Economic Partnership Agreement with the EU. Zambia, however, has not signed the interim EPA.In negotiations to date, the Eastern and Southern African Counties maintained their position that they require policy space to impose export taxes to encourage industrial development without prior approval of the European Commission.


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The advice required will relate not only to plant construction and operation,5 but also advice relating to:

• setting up business in a particular country

• local regulatory and tax environment

• international regulation (including risk of legal challenges to export restrictions on which the investor may indirectly rely)

• other ‘country specific’ issues, such as political risks and corruption risks (including identification of appropriate mitigants)

• best practices drawn from similar projects in other parts of the world.

Restrictions on the export of raw materials in African countries present a great business opportunity which, when combined with preparation and openness, could lead to more than one success story.

5 As a practice, we produce comprehensive guides on legal and commercial issues with regard to the construction and operation of process plants. These guides are accompanied by more focused country guides which cover most Sub-Saharan African countries.

Consideration PositionLocal considerations Zambia gets an annual rainfall of 1000mm and has relatively abundant underground and ground

water sources. This is favourable to copper beneficiation since refined copper is produced mainly by the solvent extraction electro winning method, which requires large quantities of fresh water.There is strong local support for investors through the Zambian Development Agency.There is a comprehensive tax incentive regime for the mineral beneficiation sector, including corporate tax discounts, ability to carry forward losses for up to 10 years, VAT relief, capital allowance relief and tax reliefs based on levels of capital expenditure on industrial building construction.Zambia has a relatively stable political system.Investment guarantees are available against state nationalisation.Repatriation of profit and dividend can be achieved free of charge.

Conclusion

In pursuit of domestic value addition, export restrictions are likely to remain high on the agenda for many states in Sub-Saharan Africa. It would appear that many of the export restrictions being utilised are unlikely to contravene multilateral trade agreements (and even if they do, the risk of challenge appears remote for the time being). Furthermore, moves by the EU to abolish export taxes under the terms of the regional trade and investment agreements appear unlikely to see the light of day in their current form in the near future.

It is clear then that there may continue to be potentially lucrative opportunities for investment in the right project in the right jurisdiction. To many potential investors – particularly those who haven’t previously ventured into a particular African country or indeed the African continent – the risks may appear daunting at first. However, it is our experience that on the right terms and with the right partners, these projects are no more or no less risky than similar projects elsewhere in the world, with potentially far more attractive returns on investment. Thorough due diligence is, of course, an important first step in the process for potential investors, and therefore aligning themselves with advisers and partners who have been there and done it before is crucial.

From a legal and regulatory perspective, this will require use of experienced international counsel who have a sound understanding of the particular local and project-specific risk issues and that will need to be addressed contractually or through other appropriate mitigation strategies, and also have relationships with reputable and experience local lawyers on the ground.

It is clear then that there may continue to be potentially lucrative opportunities for investment in the right project in the right jurisdiction.



Sharing mining infrastructureThe challenges and opportunities for shared use infrastructure in the African mining sectorby Martin McCann and Mark Berry, London

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Sharing mining infrastructure



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Recognising the potential for shared use

It will come as no surprise that a discussion on infrastructure in Africa highlights the limited access to infrastructure across the continent. The estimated annual funding gap for infrastructure development is staggering. According to the World Bank’s Africa Infrastructure Country Diagnostic published in 2008, the cost of redressing Africa’s infrastructure deficit is estimated at around US$75 billion, with the current funding gap being around US$35 billion annually.

While its infrastructure is underdeveloped and spending needs are vast, Africa is hailed as a resource rich continent. About a third of the world’s mineral reserves are in Africa, including more than half of the world’s platinum group metals, cobalt and diamond reserves and nearly 40 per cent of its gold reserves. Africa has among the largest reserves of manganese and chromium in the world, and is also a major producer of nickel, bauxite, and uranium.

The need for infrastructure development, including railways, ports, power capacity, water and information and communication technology, to making extracting these valuable resources viable means that the infrastructure spend for mining companies often dwarfs the spend required to construct the mine. As mining companies already anticipate that they will have to finance and deliver the infrastructure they require, there is an opportunity for governments to leverage mining-related infrastructure for regional economic development. Governments will try to coordinate delivery of this infrastructure with their national infrastructure objectives to narrow the funding gap.

Facilitating shared use of mining infrastructure between the mining company and third parties is the key to distributing the benefits of mining-related investments more widely. But this is by no means a simple solution:

• governments may prefer to target tax revenues rather than infrastructure sharing solutions;

• mining companies typically prefer vertically integrated logistics which they can control to ensure sufficient capacity for their operations; and

• potential third party users may have very different needs which infrastructure designed to service a mine may not be able to deliver.

To be a viable solution the mining and associated infrastructure project needs to align with the country’s long-term infrastructure strategy, and mining companies need to be offered the right incentives.

It is crucial that the parties involved explore the potential for shared use infrastructure in the early stages of structuring a project. There are a myriad of important issues to consider, and the earlier on in the process these issues are discussed with the relevant government, the better. In our experience acting for both lenders and sponsors, the parties frequently seek to progress a transaction on the basis of a term sheet which hasn’t been negotiated taking all possible stakeholders’ views into account. Dealing with bankability issues upfront in discussions with government, and in structuring the implementation of a transaction, goes a long way towards creating a package that is both practically workable for the mining company and bankable for its lenders.

This chapter considers the case for shared use infrastructure in the context of mining in Africa. It explores some of the key issues role players including governments, mining companies, third party users of infrastructure and funders will consider in relation to shared use infrastructure. It sets out some of the barriers to implementing the shared use of infrastructure and ways to facilitate it. It then proposes some structures for delivering shared use infrastructure, picking up on some of the more practical implementation issues.

The case for shared use mining infrastructure

Factors to consider: is it feasible in the circumstances?It is important for governments planning for their current and future infrastructure needs to consider the potential benefits of leveraging off the demand to exploit their natural resources. Local communities also have an expectation that they will benefit from the development of mining and infrastructure projects in their region. A number of factors will influence whether it’s worthwhile for a government to press for a shared use model when granting infrastructure development concessions alongside mineral development rights:

• The specific mineral to be extracted will dictate the infrastructure requirements of the mining company. For example, whilst coal mining will require rail networks and a port terminal with coal handling capability to get the product to market, processed gold may well be airlifted by helicopter.

The shared use of mining infrastructure requires coordination between the government, the mining company, the mining company’s funders and potential third party users of the infrastructure, including other mining companies and local users.



• Whether any processing will take place at the site of the mine will inform decisions as to whether there is a need to develop additional power capacity, or water storage or wastewater facilities.

• The location of the mine will play into the strategic importance of shared use infrastructure and whether there will be any demand for its shared use. The rail links of remote mines may provide little benefit as passenger rail links, but may have the ability to make smaller scale mining by juniors in the area viable. This would enable the government to grant a greater number of mining concessions to investors who would not have been able to develop the necessary infrastructure themselves.

• Alternative infrastructure which already exists or may be developed in the same area may compete with the newly developed infrastructure. The option to use a road or alternative rail line may result in more competitive access tariffs for third party users of all sectors. However, if the sponsors and funders of a new rail line are relying on the demand of other users to cover the costs of developing more capacity than the mining company needs, they are unlikely to support shared use if potential demand is likely to be low.

Economic developmentA major focus for mining companies is the development of rail and port access, which are also two of the most complex types of infrastructure for which to grant access to third party users. However, the economic benefits for a country in developing these types of infrastructure in the right geographic locations cannot be underestimated. For example, forestry and agriculture in fertile but rural

areas can be properly developed where there is a means to transport the timber and crops to urban markets, processing plants and ports for export. ‘Stranded’ mining assets can also be accessed by junior miners using shared infrastructure, allowing development where majors would previously have had the competitive advantage. Mining companies are showing an increased willingness to contribute to this strategic economic development. Rio Tinto states in relation to its Simandou iron ore project in Guinea (which is being developed with associated rail and port infrastructure) that it is ‘making sure its investments are in line with Government’s development priorities’.

Access to finance sourcesPlanning infrastructure around mineral resource exploitation would allow mining companies to involve private and public finance options which would not otherwise have been available. Both commercial banks and development funders such as development finance institutions (DFIs) and export credit agencies (ECAs) are more likely to participate in financing infrastructure where the cash flow and other risks can be mitigated by guaranteed use of the infrastructure by the mining company.

Economies of scaleThe economies of scale and lower marginal costs derived from shared use infrastructure, particularly in the context of rail links and port terminal usage, means increased profit margins for mining companies. It also generates higher tax revenues for the government.

Nigeria: capitalising on coal reserves

As part of its efforts to boost power generation in Nigeria, the federal government is capitalising on the country’s coal reserves. In August 2013 the Nigerian Ministry of Mines and Steel Development signed a memorandum of understanding with Chinese-Nigerian consortium HTG-Pacific Energy relating to the mining licence granted for the exploitation of the Ezinmo coal block in Enugu State. The consortium will develop a mine to extract coal and as part of phase 2 develop a 1000MW coal-fired power plant near the mine site. Total development costs in the region of $3.7 billion are expected to be funded by foreign institutions. Power generated is expected to supply the national grid: developing this infrastructure alongside the mine will substantially increase power capacity in Nigeria.


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the more incentives governments will have to offer to encourage the mining company to develop multi-user infrastructure.

A mining company will also be concerned with being exposed to the credit risk of its competitors if another user of the infrastructure becomes unable to pay its way. The mining company will either accept this risk (and have to become comfortable that it may be underwriting its competitor) or seek to cover the risk with security from each other user of the infrastructure. Depending on the quantum of the security, that requirement alone can make the shared use of infrastructure unviable.

Vale builds a rail link in Mozambique

Given the limited capacity of the Sena railway connecting its Moatize mine with the port of Beira (which is currently being expanded and rehabilitated), Vale is constructing a multi-million dollar 912 km long railway line linking the mine in Tete province to Nacala in Nampula province, where Vale will build a deep-water sea port. The railway will pass through southern Malawi. There has been talk of allowing other companies developing mines in the region, including Rio Tinto and Beacon Hill Resources, access to the railway line. Vale is familiar with sharing infrastructure with third party users – it currently operates railway lines in Brazil which offer logistics services to third parties, and operates long distance passenger trains along stretches of those lines.

Funders’ viewsProject finance lenders, whether banks or DFIs, lending to companies developing mines and infrastructure assets typically require extensive risk analysis and due diligence. They focus particularly on completion risk and ensuring cash flows will be available to service debt during the operational phase. Lenders are also concerned with interface risk, and accordingly prefer to finance an integrated development of the mine and associated infrastructure as this is the most predictable structure allowing lenders to have the greatest level of control. The less integrated the project, the greater the complexity and associated costs and risks from a lender’s perspective. A single EPC wrap with integrated completion testing is possible in an integrated project, resulting in minimised completion interface risk and delays.

However, where there is a proposal that certain aspects, such as the rail or port, will be shared use, a fully integrated

Perspectives of different role players

A balancing actMining companies are already incentivised to raise large amounts to spend on infrastructure development: there is the potential to offer them additional incentives to develop extra capacity to be taken up by third party users. To make this work, governments have to address the concerns of the mining company to ensure an efficient, cost effective mining and logistics operation. They also have to address the concerns of the project’s funders who are seeking to mitigate construction, operational, cash flow and interface risks.

The shared use of mining infrastructure requires coordination between the government, the mining company, the mining company’s funders and potential third party users of the infrastructure, including other mining companies and local users. Each of these participants has a different assessment of the risks, and a preferred approach to designing, funding, delivering, accessing and owning the infrastructure. These must be carefully balanced and negotiated to achieve a successful outcome.

The mining company’s approachMining companies are typically not incentivised to coordinate their infrastructure development efforts with a country’s national infrastructure development plans. A mining company’s objective is to ensure it has sufficient infrastructure capacity to meet its needs. To guarantee the highest level of efficiency, mining companies typically seek to implement a vertically integrated operations and logistics model and require control of the construction and operation of their infrastructure.

A mining company needs:

• Priority access rights to its required capacity

• Operational control to avoid disruptions, delays and additional repair and maintenance costs, and have flexibility to deal with breakdowns and force majeure events

• To maintain competitive and first mover advantage

In addition to capacity and efficiency, a mining company may also have other concerns with a proposal that it share its infrastructure. Where the mining company is required to share with competitors mining in the same region, it may lose the competitive and first mover advantages gained by controlling access to the region and having an integrated business. The more costly and strategic the infrastructure,



and passengers using the same railway line. For example, on shared rail infrastructure passengers are usually given priority over freight which can become problematic for the developer of the infrastructure, particularly if that developer requires priority access to the infrastructure.

In all cases where the third party users are reliant on their rights to access the mining company’s infrastructure, the users will aim to obtain access rights which secure their required capacity, are granted for a long term, and to which reasonable and predictable access tariffs apply.

Where the third party users are other mining companies, these users may seek an equity share in the infrastructure asset to secure access to excess capacity – this will usually depend on the timing of the project and the financial resources of the user. Alternatively, these users may only seek access on the basis of user fees once the infrastructure is completed, in which case they may prefer a third party operator to manage the asset.

Shared rail infrastructure options tabled in Cameroon

Sundance Resources has had formalised discussions with several other mining companies with projects neighbouring Sundance’s Mbalam iron ore project in Cameroon, including Equatorial Resources, Core Mining and Legend Mining, to explore sharing the rail and port infrastructure it is developing alongside its mine. Options being considered are direct investment by other miners in the infrastructure, or granting access on a fee for service basis.

Governments may seek to intervene to ensure that users are granted access rights for a reasonable tariff. Neither the forestry nor agriculture players, and certainly not the passengers, who are relying on the infrastructure will have the financial resources to fund access charges which seek to recover capital and all operating costs. Government subsidies and regulatory intervention are likely to feature heavily in these contexts, particularly where the infrastructure investment to accommodate other users diverges from the mining company’s requirements – passenger rail links require additional safety measures, stations for regular stops, and different rolling stock for trains which travel faster. A mining company is likely to look for government support for capital expenditure and the operation of these aspects, although the government will be looking to the mining company to subsidise the use of the infrastructure by those users less able to pay.

approach may not be the funders’ preferred structure. Lenders will want to know in advance who the future users of the assets will be, or have the right to consent to new users being granted access to the infrastructure if their identity is unknown at the outset. This can mean that a third party mining company seeking to access the infrastructure is exposed to extensive due diligence by its own lenders and the lenders of the mining company developing the infrastructure. This level of scrutiny may not be acceptable to a third party user if it is concerned with information about its development flowing back to its competitor (as the developer of the infrastructure).

Lenders may also require additional sponsor completion if one or more of the infrastructure assets will be owned separately. Lenders will closely scrutinise the pricing and risk allocation between the various entities (usually SPVs) that hold each asset.

Different users means different issues

Shared use infrastructure: the Richard Bay coal terminal

An existing example of infrastructure developed for the shared use of mining companies is the Richards Bay Coal Terminal in South Africa, the largest coal export terminal in the world. RBCT is run independently, with its shares held by mining heavyweights Anglo American, BHP Billiton, Glencore, Exxaro, Sasol Mining and Total Coal, amongst others. The railway servicing the RBCT is owned and operated by stated-owned Transnet, who is considering developing another coal terminal near RBCT to service the needs of other, smaller mining companies who have limited access to the RBCT.

Third party users of mining infrastructure will differ depending on the circumstances. It may be that a mining company is required to share its infrastructure assets with other miners in the region – this may be the case where a large-scale mining operation is adjacent to junior mines or undeveloped mineral deposits. Alternatively, the focus may be on allowing one or more diverse users access to the mining company’s infrastructure – in the context of rail or road infrastructure this may mean allowing forestry or agriculture players, or even passengers, to use the transport network. Different issues will arise where the shared use is between multiple users with similar requirements, such as multiple miners, and where the shared use is between multiple users with different requirements, such as a miner


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Ultimately the government’s stance on a particular project will depend on the strategic importance of developing the specific type of infrastructure in the specific region.

Implementing shared use infrastructure

Cost and timing implicationsShared use infrastructure has short and long term cost implications: initial capital costs for construction, possible expansion or future development costs to increase capacity, and maintenance and on-going operating costs. Who will bear each of these costs, and in what proportion, will be a critical aspect of any shared used negotiation.

Access requested to ArcelorMittal’s railway in Liberia

ArcelorMittal has been requested by the government of Liberia to grant access to its railway line, linking iron ore mining operations with Buchanan port, to Sable Mining and other third party users, to facilitate the export of iron ore from Guinea. Expansion of the rail line will be required to ensure excess capacity is available for shared use whilst maintaining capacity for ArcelorMittal’s operations – how potential users will contribute to the costs of the expansion is under discussion.

To accommodate excess capacity for third party users the initial capital costs may well exceed the mining company’s original estimates. Where users have similar needs to the mining company, the additional costs will be lower – for example where the other users of a rail line are mining companies, costs will include additional spurs, loading facilities and extra rolling stock. Where the users have different needs there is a potential for vast sums of additional capital costs – for example, if passengers will have access to a rail line being built to transport coal, different rolling stock with enhanced safety specifications, and new passenger stations, will be required. This is one of the many reasons why sharing mining rail infrastructure with passengers is so difficult to achieve in practice.

Similar considerations apply to the operating costs. Multi-purpose infrastructure has to be carefully coordinated to ensure each user has access to its required capacity, at the times and intervals most efficient for its operations. Of course this depends on the infrastructure in question – it is easy to see complex coordination issues arising where coal freight and passengers use the same line, especially where it is only single-track, but a power station is unlikely to face the same

The government’s focusUsing the exploitation of resources to build long-term assets has the potential to support sustainable and inclusive growth. This may provide greater benefit for the country than focusing purely on tax revenues and other fiscal advantages of granting mining rights.

Governments already take into account certain non-fiscal returns such as social and environmental development in the area adjacent to mines. However to incentivise mining companies to participate in shared use infrastructure models and compensate them for the capital expenditure required to develop excess capacity, governments may have to consider fiscal trade-offs such as agreeing to lower tax revenues.

The Putu Project in Liberia: power to the people

In Liberia, the government requires the mining company developing the Putu iron ore project to ensure that the power plant being constructed as part of the project has excess capacity to service local communities within a 10km radius of the mine. Charges for the electricity provided must be based on residential users’ ability to pay, and for commercial users should be reasonable rates based on their usage.

This means governments have to internally prioritise the benefits of granting mineral extraction and infrastructure concessions. Where the minister of finance may be pushing for increased tax revenues, the minister of transport will be seeking to deliver logistics solutions for industry and possibly public transport solutions, while the interior minister is focusing on social welfare and employment opportunities – not all of these priorities can be achieved in every instance. This is where discussions with government early in the structuring process can yield real results for the sponsor by ensuring the best possible package is negotiated.

Ultimately the government’s stance on a particular project will depend on the strategic importance of developing the specific type of infrastructure in the specific region



The natural alternative is to follow the ‘golden share’ approach, where ownership is separated into different SPVs which may have some common shareholders, and where the government holds an ownership stake in the infrastructure SPV allowing it to influence key strategic decisions.

Separate ownership: the Simandou project, Guinea

The development by Rio Tinto of the Simandou iron ore project in Guinea provides a good example of separate ownership of mine and infrastructure, and an interest held by the government. The Simandou project consists of an open-pit mine in South East Guinea, a 650km long railway and a port at Conakry, along with associated infrastructure generally required for the operation of the mine such as water supply, power plants and access roads. The mine and the rail and port infrastructure will be developed as two separate projects: The mine will be developed and owned by project company Simfer, held by Rio Tinto, China’s Chalco and the IFC, with share options held by the Government of Guinea. A third party consortium will fund, build and own the rail line and the port infrastructure. This infrastructure will be accessed by multiple users, opening up the interior of Guinea.

Acknowledging the risksIdeally a discussion of the potential for the shared use of mining infrastructure should take place early on between the mining company and the government, so all stakeholders are aware of and can manage and negotiate the risk allocation.

Having these negotiations early on alongside the negotiation of the applicable fiscal regime means that governments will be in a better position to clearly set out the full incentive package to the sponsor. This may include protections and compensation for the mining company in the event that it suffers losses directly related to granting access to third parties – for example, government guarantees to support the obligations and liabilities of third party users. Mining companies may also look to governments to provide additional flexibility in markets where commodity prices are falling, acknowledging that the profitability of the project will be affected in these circumstances.

It also means that once the design stage commences, the parties are clear on the capacity constraints and requirements which must be achieved, and incremental capital costs can be avoided.

coordination issues as long as it has sufficient capacity to supply all its users.

Mining companies should seek appropriate incentives and support from governments to mitigate these costs and risks.

The timing of construction can also become an issue, particularly if multiple mines are sharing the same infrastructure. The infrastructure must be fully available for use whether only one, or all, the associated mines are operating and ready to access it. The result is that the early user may end up paying disproportionately high tariffs until other users start accessing the infrastructure. Alternatively, later users may be required to enter into take or pay arrangements for their access rights, paying tariffs whether or not they are ready to access the infrastructure. To mitigate this, mines would need to developed in line with the infrastructure development timetable, which reduces the flexibility of the mining company to speed up or slow down the mine development based on changes to market conditions. In Australia proposals for shared use infrastructure projects have not proceeded due to this scenario being unacceptable to the parties involved – this is likely to be the case in Africa too.

The ownership dilemma and government’s golden shareOne of the principal dilemmas in facilitating the shared use of infrastructure is how to structure the ownership of the infrastructure and mining concessions.

Mining companies, particularly large scale iron and coal miners, want to avoid the coordination costs and loss of control which result from separate ownership. They prefer an integrated approach where the mine and infrastructure are owned by the same entity. However, where the mining company owns the infrastructure governments may be concerned that it will exert its monopoly power, possibly charging high access tariffs and restricting access directly or indirectly by limiting available capacity.

A separation of ownership of the infrastructure and the mine, typically with the mine acting as the anchor tenant of the infrastructure, incentivises the owner (or third party manager) of the infrastructure to maximise profits. This model facilitates shared use because the infrastructure is designed and operated to maximise capacity. However, this focus on profits, often in an environment with no competitors, means that the infrastructure is likely to be expensive for users, including the mining company, which may ultimately hinder third party access.

It is important that the mining company carefully plans the proposed delivery solution at project inception stage to achieve a cost effective and bankable solution.


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issues in the structure that were not properly addressed through the project planning stage and which cannot, in the view of the lending market, be appropriately mitigated by the mining company.

Construction risk is a key concern for lenders, since until the relevant works are completed there is no project and no access to cash flows to service debt repayment – but at the same time the lenders will have money out of the door and in the ground. A key mitigant to construction risk for lenders will be the manner in which the works are delivered and the party delivering them.

Single versus multi-contract approachesThe lenders will prefer to see the works being delivered under a lump sum, turnkey engineering, procurement and construction (EPC) contract arrangement. Under this contracting structure, the contractor will guarantee completion of the works on time, on budget and to a required specification. Depending on the covenant strength of the contractor and the security package it offers, lenders are likely to be more comfortable that completion support (or at least uncapped support) will not be required from the mining company when contracting on this basis. Conversely, where a multi-contracting solution is adopted using, for example, engineering, procurement and construction management (EPCM) arrangements, the lenders will typically see interface risk which may give rise to time and cost overrun exposure that is not easily transferred into and managed by the contracting structure. Consequently, lenders are more likely to require completion support and other contingencies and reserves from the mining company.

Key for the mining company will be to secure a position where recourse to its balance sheet, the requirement for uncapped credit support and other forms of liquidity support is limited to the fullest extent possible.

The role of a regulator and controlling tariffsCurrently, there is little or no regulatory incentive for private developers to design projects, or expand them, to create excess capacity (other than potential excess capacity the mining company may require in the context of an expansion of its mining operations). Alongside bilateral negotiations with mining companies, governments are likely to start implementing a regulatory framework that encourages sharing infrastructure with third parties.

They are also likely to put in place strong regulators to oversee the implementation of shared use infrastructure. For example, a regulator may be required to set, or if there is regulation in place which already does so, enforce the application of maximum access tariffs to ensure users are not exploited.

What are the possible structures for delivery?

When it comes to structuring delivery of the various types of infrastructure required by mining companies, there are a range of options to consider. The mining company may look to:

• Develop and finance all related infrastructure itself under a single financing or series of separate financings; or

• Develop and finance only parts of the infrastructure itself and instead participate with other interested parties in the financing and development of the remaining required infrastructure.

Typically mining infrastructure will be delivered using a project finance solution under which there is limited recourse for the lenders against those developing the infrastructure. Instead, lenders’ recourse will be to the assets and cash flows of the relevant project. Therefore it is on these assets (including project contracts) and cash flows that the lenders will perform due diligence to establish the extent to which the project is ‘bankable’.

It is important that the mining company carefully plans the proposed delivery solution at project inception stage to achieve a cost effective and bankable solution. Any bankability concerns later will usually give rise to a lender requirement for the mining company to provide liquidity support to meet contingent risks not adequately transferred into the contracting structure.

You don’t have to look far to see examples of projects falling at the final hurdle prior to financing because of bankability

Lenders for Port

Lenders for Mine

Lenders for Rail

EPC for Port

EPC for Mine

EPC for Rail

MineCo

PortCo

RailCo

A non-integrated infrastructure delivery solution for the mine, port and rail giving rise to increased interface risk.



Rail and port infrastructure will lend itself to a multi-user solution. Mining companies have tended to take a monopolistic approach to rail infrastructure, in particular, not wanting to open up opportunities for competitors and wanting to retain operational freedom on the infrastructure which will best enable it to achieve efficiencies and a stronger internal rate of return. This being said, the cash flow advantages that shared use can bring cannot be ignored.

Provided that the mining company retains design control and is able to manage the extent of spare capacity that is able to be used on a multi-user basis, it may feel that it retains sufficient control for such shared use of its infrastructure not to impact materially on its operations. Also, it is more likely to achieve government support if access is opened up, both in terms of restrictions being placed on competing infrastructure and subsidies on tariffs charged, for example, to private individuals using a rail line. It may also be able to obtain first refusal rights on future expansion as operations grow.

It is likely that the government will want control over tariff setting and indeed there may be independent regulation in this regard. Project finance lenders may want to see a floor price below which the local government will subsidise tariffs and they may even seek a guaranteed level of usage to remove, to some extent, demand risk from the project. It is not unusual for lenders to look for the mining company itself to accept take-or-pay obligations in respect of infrastructure usage, again to mitigate against any demand risk being assumed by lenders.

Fully integrated infrastructure delivery solutionA fully integrated solution under which the mining company finances all aspects of mine and infrastructure delivery using a single EPC contract arrangement will provide least complexity from a delivery and financing perspective.

The EPC ‘wrap’ of project delivery risk will facilitate an integrated completion test and will minimise project-to-project interface risk. Accordingly, it is this structure that is least likely to require mining company completion support. This being said, it is likely that the EPC contractor will include significant contingency within its price to manage known and unknown risks. This can give rise to affordability concerns. There is also the risk that there may be no single contractor prepared to accept full project delivery risk or indeed, even if there is such a contractor, lenders may not accept that it has the covenant strength to manage this risk in a cost overrun scenario.

Whilst a single integrated completion test may be possible, there will be the possibility to stagger the financing and phase the manner in which the individual infrastructure projects are brought on-line. This may assist in opening up cash flows to the lenders to start servicing debt at the earliest point possible, to the extent that any aspect of the infrastructure is able to operate on a standalone basis. Naturally the lenders will want to control use of this cash flow until such time as the fully integrated project is completed. Lenders are also likely to require that mining company support remains in place for each aspect of the project infrastructure until the fully integrated project is complete.

Lenders for Mine/Rail/

Port

EPC for Mine/Rail/

Port

MineCo

PortCo

RailCo

Lenders prefer to finance an integrated development of the mine and associated infrastructure, such as a rail link and port terminal, as this is the most predictable structure allowing lenders to have the greatest level of control.

Whilst the mining company will not be controlling the development of the relevant infrastructure, it will have a seat at the table with an opportunity to shape the development to meet its own particular requirements.

Infra Co

Concession Co

Mine Co

Debt

Agri Co Gov Development institutions

Regulation

Equity

Access agreements

Infrastructure company formed by key stakeholders to procure infrastructure on a long-term concession basis.


Nexus

Rail and port infrastructure may be developed on a fully open access basis and this may improve the credit profile for these funding packages. The funders may still require the mining company to be the anchor user under a take-or-pay type arrangement and the funder for the mine will perform extensive due diligence on these arrangements and the mining company’s access rights and exposure to tariff escalation.

The inherent interface risk created under this structure is likely to give rise to a requirement for credit support from the mining company, particularly with regard to construction completion. The key risk for the mine funder, for example, will be non-delivery of infrastructure required to transport raw or processed materials to market. The sizing of any completion support required from the mining company by its lenders is likely to take into account worst-case scenarios but perceived risk may be mitigated through the use of contingent facilities required to be utilised cost to complete-type tests are failed.

Funders of each of the separate portions will also be sensitive to intercreditor risks, particularly as the rail and port lenders will be structurally subordinated to the mine lenders due to the direction of cash flows through the project as a whole. Cross default provisions will have to be carefully structured to balance risk between the different groups of lenders.

Collaborative approach to infrastructure deliveryAn alternative approach would be for the mining company to participate in the development of one aspect of the infrastructure, for example the rail or port, along with the

Non-integrated infrastructure delivery solutionIn contrast to the fully integrated solution, limited or no integration of the separate infrastructure projects is likely to lead to increased complexity. By way of example, this may involve separate funding and a separate EPC arrangement for each aspect of the infrastructure.

Whilst increased complexity will be seen because of the interfaces created under the separate funding solutions, it is these separate funding solutions that will provide enhanced flexibility with regard to the project-wide funding mix. This may be of particular advantage where the level of debt required for one project cannot be satisfied by one source or type of funding. The structure and risk profile for each infrastructure type can, under these proposals, be shaped to suit preferred categories of debt and equity providers.



Delivering infrastructure on a shared use basis is not without its challenges and the above examples represent only suggestions as to how this may be achieved.

It is clear, however, that the success of any such strategy will require cooperation and planning, starting at central government level. This must be used to foster public and private sector investment, participation and innovation to properly harness the potential that Africa has to offer.

Conclusion

The infrastructure shortage in Africa is a hindrance to economic development and wider prosperity. It is therefore necessary for infrastructure development to be planned from a strategic point of view at a national and cross border level if such infrastructure is to properly support broad based economic development.

The opportunities for governments to leverage off the demand for their natural resource wealth should not be underestimated, but as this chapter highlights, doing so is not without its challenges. Key issues to consider are the incentives which drive each of the stakeholders and how ownership and risk allocation should be structured.

Ultimately, the higher the benefits of shared use and the more stakeholders are involved, the more important it is for the government to play an active role in negotiating and incentivising, facilitating the delivery of infrastructure with sufficient capacity, and overseeing the operation of a shared use access model.

Shared use is always going to require a give-and-take approach from all parties involved, and governments will have to take the lead in ensuring collaboration and coordination between the multiple stakeholders.

third party users, whether they are other mining companies or users from other sectors also requiring development of infrastructure to more fully exploit a commodity or product, such as investors in the agricultural sector. Investment in small holding farmers by international food producers (such as that by Nestlé and Unilever) to generate reliability in crop supply and quality will yield little if the international markets cannot be opened up due to the lack of transportation infrastructure required to get product to market.

Early feasibility planning in respect of the relevant infrastructure may be performed by government bodies or other quasi-governmental agencies with a view to attracting key stakeholders. The relevant interested parties may then form a development company (InfraCo) to coordinate completion of feasibility studies, outline the design and agree a share in development cost risk. These arrangements must be sufficiently flexible so as to allow new participants to join during the development process, subject to the interests of the other parties not being materially affected.

Whilst the mining company will not be controlling the development of the relevant infrastructure, it will have a seat at the table with an opportunity to shape the development to meet its own particular requirements.

Once the proposals have been agreed and the outline design finalised, the project may be procured by the relevant government on a concession basis with a private sector bidder financing, constructing and operating the infrastructure for the agreed concession period. It is likely that members of the InfraCo would retain a right to contribute equity in the project to retain a level of control over key issues around access and tariff setting.

The concession will be likely to prescribe the means by which tariffs will be set but it is also likely that these aspects will need to be subject to independent regulation. The concessionaire will enter into direct access agreements with the relevant participants.

Whilst the mining company will have less control over the development, it will also have a reduced risk in the development when compared to the other structures discussed above. Its lenders for the mine development will scrutinize the shared use arrangements and will require that the mining company has certain controls (akin to a golden share type arrangement) over the granting of new access, use of spare capacity and the revision of tariff levels. The credit exposure for this lender could also be said to be mitigated through open use as an element of the demand risk to which the mining company may otherwise be exposed is reduced.


Nexus

Contacts

Nick MerrittGlobal head of infrastructure, mining and commodities, SingaporeNorton Rose Fulbright (Asia) LLP Tel +65 6309 [email protected]

United States

Michael E. PikielPartner, New York Norton Rose Fulbright US LLP Tel +1 212 318 [email protected]

Jeffrey H. Goodman JGPartner, Washington DCNorton Rose Fulbright US LLP Tel +1 202 662 [email protected]

Jeremy A. Hushon Partner, Washington DCNorton Rose Fulbright US LLP Tel +1 202 662 [email protected]

Sarah Devine Partner, Washington DCNorton Rose Fulbright US LLP Tel +1 202 662 [email protected]

Emeka Charles ChinwubaCounsel, New YorkNorton Rose Fulbright US LLPTel +1 212 318 [email protected]

Canada

Crae Garrett Partner, CalgaryTel +1 403 267 [email protected]

Geoffrey Gilbert Partner, OttawaNorton Rose Fulbright Canada LLP Tel +1613 780 [email protected]

Robert BorduasPartner, MontréalNorton Rose Fulbright Canada LLP Tel +1 [email protected]

Australia

Alen PazinPartner, PerthNorton Rose Fulbright AustraliaTel +61 8 6212 [email protected]

Jo CrewPartner, MelbourneNorton Rose Fulbright Australia Tel +61 3 8686 [email protected] James Morgan-PaylerPartner, MelbourneNorton Rose Fulbright Australia Tel +61 3 8686 [email protected]

Adrian AhernPartner, SydneyNorton Rose Fulbright AustraliaTel +61 2 9330 [email protected]


Contacts

United Kingdom

Martin McCannGlobal Head of Business, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Chris BrownPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Mark BerryPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Andrew BuissonPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Daniel MetcalfePartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Matthew HardwickPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

South Africa

Muzi KubekaPartner, JohannesburgTel +27 11 685 [email protected]

Steven GamblePartner, JohannesburgTel +27 11 685 [email protected]

The Netherlands

Wouter Hertzberger Partner, AmsterdamNorton Rose Fulbright LLP Tel +31 20 462 [email protected]

Daphne BroersePartner, AmsterdamNorton Rose Fulbright LLPTel +31 20 462 [email protected]

Germany

Dirk TrautmannPartner, MunichNorton Rose Fulbright LLP Tel +49 89 212148 [email protected]

Anthony MortonPartner, FrankfurtNorton Rose Fulbright LLP Tel +49 69 505096 [email protected]

France

Anne LapierrePartner, Paris and MoroccoNorton Rose Fulbright LLP Tel +33 1 56 59 52 [email protected]

Alain MalekPartner, Paris and MoroccoNorton Rose Fulbright LLP Tel +33 1 56 59 53 [email protected]

Poupak BahaminPartner, ParisNorton Rose Fulbright LLPTel +33 1 56 59 54 [email protected]


Nexus

Italy

Arturo SferruzzaPartner, MilanNorton Rose Fulbright Studio Legale Tel +39 02 86359 [email protected]

Gennaro MazzuoccoloPartner, MilanNorton Rose Fulbright Studio Legale Tel +39 02 86359 [email protected]

Poland

Rafal Hajduk Partner, Warsaw Norton Rose Fulbright Piotr Strawa and Partners, Limited Partnership Tel +48 22 581 [email protected]

Middle East

Charlotte Bijlani Partner, DubaiNorton Rose Fulbright (Middle East) LLPTel +971 4 369 [email protected]

Joanne Emerson Taqi Partner, BahrainNorton Rose Fulbright (Middle East) LLPTel +973 16 500 [email protected]

Paul Mansouri Partner, Abu DhabiNorton Rose Fulbright (Middle East) LLPTel +971 2 615 [email protected]

Japan

George GibsonPartner, TokyoNorton Rose Fulbright Gaikokuho Jimu Bengoshi JimushoTel +81 3 5218 [email protected]

China

Tom LuckockPartner, BeijingNorton Rose Fulbright LLPTel +86 (10) 6535 [email protected]

Barbara LiPartner, BeijingNorton Rose Fulbright LLPTel +86 10 6535 [email protected]

Peter Haslam Partner, Hong KongNorton Rose Fulbright Hong KongTel +852 3405 [email protected]

Singapore

Nick MerrittGlobal head of infrastructure, mining and commodities, SingaporeNorton Rose Fulbright (Asia) LLPTel +65 6309 [email protected]

Vincent DwyerPartner, SingaporeNorton Rose Fulbright (Asia) LLPTel +65 6309 [email protected]


Contacts

Thailand

Somboon Kitiyansub Partner, BangkokNorton Rose Fulbright (Thailand) LimitedTel +662 205 [email protected]

Indonesia

Benny Bernarto Partner, JakartaSusandarini & Partners*Tel +62 21 2924 [email protected]

*Susandarini & Parners in associaton with Norton Rose Fulbright Australia

Greece

Dimitris Assimakis Partner, AthensNorton Rose Fulbright Greece* Tel +30 210 94 75 [email protected]

*Norton Rose Fulbright Greece is the trading name of Norton Rose Fulbright, Sofianopoulos, Tsohou, Cheilas, Kelly, Koroxenidis, Assimakis, Liberopoulos and Partners Law Firm

Russia

Aydin JebrailovPartner, MoscowNorton Rose Fulbright (Central Europe) LLP Tel +7 499 924 [email protected]

Levon Kocharyan Partner, MoscowNorton Rose Fulbright (Central Europe) LLPTel +7 499 924 [email protected] Valentina Gluhovskaya Senior partner, MoscowNorton Rose Fulbright (Central Europe) LLPTel +7 499 924 [email protected]

Kazakhstan

Yerzhan KumarovPartner, AlmatyNorton Rose Fulbright (Kazakhstan) Limited Tel +7 727 331 [email protected]


Nexus

Contributors


David CarterAssociate, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Bevan PeacheySenior associate, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Tax planning, tax avoidance and the OECD: the impact of OECD proposals for global infrastructure projects

Matthew HodkinPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Andrew WellstedDirector, JohannesburgNorton Rose Fulbright South Africa Inc Tel +27 11 685 [email protected]

Darren HueppleheuserPartner, CalgaryNorton Rose Fulbright Canada LLP Tel +1 [email protected]


James Rogers Partner, Hong KongNorton Rose Fulbright Hong Kong Tel +852 3405 [email protected]

Matthew TownsendAssociate, Hong KongNorton Rose Fulbright Hong Kong Tel +852 3405 [email protected]


Tinashe MakoniSenior associate, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]


Tomas Gärdfors Partner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]


Jenny WaitesSenior associate, London Norton Rose Fulbright LLP Tel +44 20 7444 [email protected]


Contacts


Pablo Jaramillo Senior associate, BogotáNorton Rose Fulbright Colombia S.A.S. Tel +57 [email protected]


Hannah LoganSenior associate, SydneyNorton Rose Fulbright Australia Tel +61 407 454 [email protected]

Tessa HoserPartner, SydneyNorton Rose Fulbright Australia Tel +61 2 9330 [email protected]


Mark BrighouseAssociate, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]


Matthew HardwickPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Sonam KathuriaAssociate, LondonNorton Rose Fulbright LLP Tel +44 20 7444 5487 [email protected]


Martin McCannGlobal Head of Business, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Mark BerryPartner, LondonNorton Rose Fulbright LLP Tel +44 20 7444 [email protected]

Law around the worldnortonrosefulbright.com

Documents

A global infrastructure resource May 2015