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Financial Management and Analysis of Projects : 4. Financial Management of Executing Agencies : 4.2. Institutions and Systems
4.2.4. Financial Management and Governance Arrangement
4.2.4.1. ADB's Operating Principles
4.2.4.1.1.
ADB requires that a project be designed,
developed, and operated (among other factors) within the framework
of the financial policies, strategies, and systems prescribed by
those institutions of the government concerned which are responsible
for national and sectoral economic and financial planning.
4.2.4.1.2. The project should respond
to a clearly defined objectives, including among others, sustainable
economic goals, execution based on the least cost solution, time-bound
delivery of benefits, and financial viability. ADB has a broad interpretation
of financial viability in this context. It implies at an optimum,
the ability of a project to replicate itself, to finance day-to-day
operations and maintenance, and to service its debt. As a minimum,
financial viability should represent the provision of adequate funds
to finance day-to-day operations and maintenance. The provision
may come from either the operations of the project and/or from government
budgetary support. This will be sufficient to assure ADB that a
partial revenue-earning or a nonrevenue-earning investment will
generate the target levels of economic benefits throughout its working
life.
Exceptions to the Foregoing
4.2.4.1.3. Circumstances may exist
at fact-finding of a project where the prescribed financial policies,
strategies and systems of the governments concerned in part, or
as a whole, may contain defects not acceptable to ADB and which
may affect the design and execution of the project. In such conditions,
the design of the project should formulate means of eliminating
these defects in the financial policies, strategies, and systems
of the government concerned to enable the financial analyst to confirm
at appraisal that the EA's financial management systems will
be sustainable.
4.2.4.1.4. This means that the financial
policies, strategies, and systems of the government must be adequate
to underpin the EA's financial management systems, and will
support the project and the EA from project start-up, through implementation
and, where appropriate, during the operation of the project.
4.2.4.1.5. The project should include
as covenants in the legal agreements, steps to be undertaken by
the government in applying policies, strategies, and systems acceptable
to ADB. These steps should support the project from the start of
implementation through its working life. Also, policy dialogue should
be conducted to remove concerns or unacceptable policies and practices.
4.2.4.2. Sector Financial Specialist's Responsibilities
4.2.4.2.1.
The sector financial specialist has to obtain sufficient information
to assure ADB during fact-finding and by appraisal that a project
will be developed and operated within a framework of government
financial policies, strategies, and systems. And they should be
assured that said framework is fully aligned with ADB's policy.
4.2.4.2.2. ADB typically uses various
covenants in loan agreements, including financial performance covenants,
to reinforce these assurances.
4.2.4.2.3. Following project inception,
the sector financial specialist is required to continually assure
ADB management that the above framework will facilitate the accomplishment
of project targets.
4.2.4.2.4. The sector financial specialist
should also draw the management's attention to any change,
which has occurred, or could occur, in financial policies or strategies
or systems, (including failure to comply with financial covenants)
which could reduce project effectiveness.
4.2.4.3. Executing Agency
4.2.4.3.1.
A project may be designed and/or implemented
by an EA, which acts solely as a vehicle for its development, prior
to its transfer on completion to an operating agency.
4.2.4.3.2. More frequently, particularly
in the case of semi-autonomous public sector enterprises, the agency
is the project executing and operating agency, and is typically
referred as the EA in ADB documentation.
4.2.4.3.3. EAs typically have, as
their primary objective, the timely delivery of an operational project,
with parallel objectives of economizing and effectively using human,
physical and financial resources.
4.2.4.3.4. Operating agencies'
objectives should center on efficient operation by the effective
use of such resources to achieve economic objectives with capabilities
to: (i) adjust inputs and outputs to respond to changing objectives,
and (ii) constantly measure the impact and use of inputs and outputs.
4.2.4.3.5. A public sector enterprise,
as a project executing and operating agency, combines the two roles
above, and embraces all the objectives, normally with better opportunities
to adjust project development to meet changing operating objectives
as implementation proceeds.
4.2.4.3.6. Identification and confirmation
of the objectives of the project and those of the implementing and
operating agency, and the proposed and/or actual means of achieving
them, are the key tasks of the financial analyst.
4.2.4.3.7. While financial aspects of these
matters should attract the financial analyst's principal attention,
they must be intellectually aware of, and be capable of responding
to other factors. These may be related economic and technical objectives,
techniques of design and implementation, and the operation of the
project, together with the impact of any related, ongoing facilities
and activities with which the project will be linked.
4.2.4.3.8. These may include parallel
investments in the same or other sectors that are to be appropriately
linked to achieve common economic objectives. For example, the construction
of water supply and sewerage facilities by different EAs, or by
the same agency drawing on differing sources of funding, should
have common economic, financial, and environmental objectives. These
should primarily be related to achieving appropriate standards of
public health, including in particular recognition of the financial
impact which good health has upon the earning capacity of the population
concerned.
4.2.4.4. Financial Policies and Strategies for Projects and Executing Agencies
4.2.4.4.1.
Majority of ADB's operations is in the public sector. Therefore,
project EAs and the projects that they design and implement must
conform not only to their own policies, (where these are acceptable
to ADB) and to their prescribed systems, but also to the various
economic, technical, and financial policies and strategies of their
superior authorities or controlling bodies. This also applies, almost
without exception, to semi-autonomous public sector enterprises.
4.2.4.4.2. An example of an exception
could be a development bank (an FI) that is incorporated as a public
company with the government having 51% nominal financial interest.
It's an exception since it has its own Articles of Incorporation
which allows it to adopt its own policies, strategies and systems,
and be managed by a Board on which the government is either not
represented or is represented in a minority position only.
4.2.4.4.3. Government structures vary widely.
Therefore, it follows that a wide range of superior or controlling
authorities of EAs exist. Therefore, the financial analyst must
obtain a detailed working knowledge of such authorities' financial
policies and strategies, as well as of their financial systems of
budgeting, allocations, allotments, and accounting.
4.2.4.4.4. The example below states a case
where government may be encouraged to review its financial policy
with regard to a particular enterprise. A result of the financial
analyst's examination of the financial policy in detail recognizes
that the public sector enterprise could, in fact, be strengthened
by increasing its self-financing ratio, and by the government withdrawing
some of its financial support over time.
Example
of Policy Adjustments to Improve Opportunities for Market
Participation
In an
Asian Development Fund (ADF) recipient country, the Government
sought the assistance of the Asian Development Bank (ADB)
to finance part of the cost of a project to be executed by
an enterprise intended by the government to become involved
in open-market trading, particularly the capital market.
The government
traditionally has onlent ADF funds at about 1% under market
rates, and provides from its own resources (revenues or loans)
about 15% of the capital resources needed, leaving the entity
to provide the remaining 5% from its own resources.
The debt-equity
ratio of the entity is weak at 78:22, and examination reveals
that only 4% of the total capital structure has been self-financed
by the enterprise in recent years. Furthermore, in the past
2 years, the government has been increasingly unable to meet
its commitments to finance its share of projects as agreed
with ADB, and therefore its commitment to this proposed project
is insecure.
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4.2.4.4.5.
At fact-finding, the financial analyst and the project officer should
discuss overall financial planning with the enterprise, the sector
and key economic and finance ministry officials. Focus should be
made on the need to immediately improve the enterprise's debt-equity
ratio, particularly if it is to start market operations in the near
future.
4.2.4.4.6. Upon advising the government
to adjust the cash-based self-financing ratio over the maximum of
a 2-3-year period to about 20%, the enterprise should automatically
commence a program of reforming its debt-equity ratio by providing
self-generated contributions. As such, the government will then
be relieved from making any input after about three years.
4.2.4.4.7. The analyst should seek
commitments from the government and the enterprise that the self-financing
ratio will be increased for this and future projects, (whether financed
by ADB or not). This is to bring the debt-equity ratio, closer to
60:40 by the end of project implementation. At that level, the enterprise
is likely to have substantially greater opportunities of participating
in the capital markets as the new project comes on line.
4.2.4.4.8. As a result of the financial
analyst's methodical scrutiny of the institutional structures,
unforeseen issues and problems are revealed, therefore preventing
future hindrance in implementation and operations. The working knowledge
gained by the analyst in the review of the policies and strategies,
and their effectiveness would be essential in the following stages.
4.2.4.4.9. It must be ascertained
during appraisal that the institutional and financial management
systems of the EAs are capable of implementing the strategy. This
would include assuring the sustainability of the financial management
systems from start-up.
4.2.4.4.10. The financial analyst must be able
to specify the nature and form of the analysis to be prepared by
the EA. This should be in a manner that will enable the analyst
to determine whether the financial objectives of all involved are
credible. They should also be able to identify factors to which
the proposed implementation and operations may prove financially
sensitive.
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