Catalog

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p. 4 of 6 BACK | NEXT I. Introduction II. Regional Development and Strategic Context III. "Existing Instruments and Market Changes IV. Innovation and Pilot Concepts V. Implementation VI. Recommendation

Pilot Financing Instruments and Modalities

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IV. Innovation and Pilot Concepts

30. Clients across the region are becoming more sophisticated and sensitive to “all-in” cost. To remain engaged, relevant and responsive, ADB needs to change aspects of its business model. Some of the changes will need to be strategic, aiming at focus and selectivity. Through these changes, ADB would provide critical mass and continuity in key sectors. Other changes involve simplifying ADB’s procedures and practices, particularly for (i) consulting services, (ii) procurement, (iii) cost sharing and expenditure eligibility, (iv) investment and non-investment portfolio development and processing, (v) approval processes, and (vi) implementation. However, ADB also needs new financing instruments and modalities. Essentially, these would allow ADB to offer the most optimal transaction structures on attractive terms, target investment programs over time, and catalyze the mobilization of domestic savings and international finance. Cofinancing will involve other MDBs and bilateral agencies, export credit agencies as well as commercial banks, private equity, private companies, and capital markets. Innovative instruments can help ADB mobilize its own and other financing at attractive terms without crowding out others or increasing risks to DMCs or ADB.

31. The challenge and opportunity for ADB in the longer run is to make its interventions more programmatic, its products more innovative, and its practices and procedures more efficient. The following sections make the case for introducing new financial concepts on a pilot basis. These are not intended to replace existing instruments or weaken ADB’s credit standing. Rather, the objective is to provide ADB operational teams and its clients with more flexible alternatives to help finance individual projects and investment programs, and extend credit lines and guarantees.

A. An Innovation Framework

32. The proposal for new pilot financing concepts is anchored in the following guiding principles:

1. Fit with the strategic framework. The proposed concepts should advance, rather than hinder, choices ADB has made under its existing strategic framework. However, they also should be flexible enough to help the institution move in new directions. These directions are likely to be articulated under a future medium-term strategic framework. Without preempting the nature and characteristics of this framework, future instruments and modalities should support greater selectivity in investment programs, reforms, and public-private initiatives targeting poverty reduction in ADF and OCR countries. They should be fully compatible with the Reform Agenda and the harmonization programs. Further, the new instruments and modalities should encourage the results-based initiatives now under way. In addition, the concepts should be simple to understand and operate, and should not compromise any of the basic guiding principles, including (but not limited to) those related to safeguards and fiduciary oversight.



2. Demand-driven and client-oriented. The concepts should be driven by demand, and focused on client needs and requirements. They must be validated against real operations to test their on-the-ground relevance, effectiveness, and value-added. The proposed instruments are intended first and foremost to service clients better and more efficiently, not to support supply-driven interventions. A systematic demand assessment will be conducted in 2006 to identify priority clients, focusing on subsovereign borrowers and SOEs. It also will examine the potential market for refinancing facilities, reinsurance and coinsurance, and the multitranche financing concept. The assessment will look at the existing and projected market structure, as well as key features of the enabling environment. The review of the enabling environment will focus on legal and regulatory frameworks, as well as on structural reforms backing the decentralization process. It will examine the financial standing, investment programs, and borrowing requirements of key players. The assessment will identify critical issues, particularly in governance, safeguards, capacity, financial management, regulation, and tariff regimes. The assessment also will review cofinancing possibilities, the market for public-private initiatives, and the development of local capital markets. Its findings will be shared with the Board.



3. Sound banking principles and preservation of AAA credit rating. The application of the proposed concepts must follow at all times the concept of sound banking principles. ADB’s AAA credit rating is non-negotiable. The new Credit Risk Management Unit (CRMU)³² and other relevant departments and offices across ADB, as appropriate, will work together with operational teams to safeguard the credit rating. The CRMU, in particular, is essential for the success of the new financing instruments and modalities. The risk profile of each of the transactions will be evaluated professionally and independently by the CRMU. Risk mitigation measures will be proposed and monitored. Provisioning requirements will take into account individual and collective transaction risk profiles. Portfolio management will be monitored, and any ‘workouts’ reviewed. In addition to its functional independence, CRMU’s mandate is to be accompanied by two fundamental procedural changes: (i) project teams will complete substantially all the standard project due diligence backing each transaction before the CRMU undertakes risk evaluations and sign-offs; and (ii) term sheet negotiations will be completed before any submissions are made to Management and the Board. This also implies the ex ante involvement of the CRMU in key issues, such as pricing, valuations related to equity subscriptions, guarantee ‘carve outs’, specific loan/equity transaction covenants, and the definition of the security package and exit strategies.



4. Compliance with ADB’s Charter. All proposals submitted in this paper must comply with the Charter. The Office of the General Counsel (OGC) will vet such compliance with respect to each transaction before ADB enters into any legally binding agreement with clients.



5. Alignment with existing policies. The concepts should follow prevailing ADB operational policies and procedures, with some changes resulting from the introduction of the pilot financing instruments and modalities. Some procedures will be tightened or strengthened, especially those related to credit risk management. Any changes that are found necessary will be evaluated and considered during pilot testing. No exemptions or changes are envisaged regarding safeguards, financial management, procurement, governance, or any other standard ADB policy, other then those taken up under IEI. The pilot instruments and modalities will adhere to provisions in place today, and adjust to any changes that might be incorporated in future. As the proposals made in this paper represent new concepts, they will be tested selectively and introduced gradually. Thus, not all staff will be familiar with the specific application requirements and approaches under them, at least in the short term. Training or coaching will be required and will be provided by the Regional and Sustainable Development Department (RSDD).



6. Harmonization. The proposals seek to align ADB’s financial instruments and modalities with those of comparator organizations. The concepts also will take ADB closer to the type of instruments used by other financiers. Capital markets operators, commercial banks, and private equity groups are major players in financing investments in emerging markets. ADB is expected to work more closely with them on projects and programs. What is more important is that ADB no longer can act as a sole agent in project financing. Partnerships and cofinancing with others will enhance greatly ADB’s impact and effectiveness at the DMC level. However, to achieve this, ADB’s financial instruments and modalities must mirror more closely those used by the market, rather than the other way around.



7. Simplicity. The new concepts should be simple to apply. Any deviation from this important principle will stifle creativity and client uptake. A growing inventory of modalities each with their own access and applicability conditions, but only incrementally different in substance and benefit, will be impractical and difficult to manage.³³ A better approach is to simplify, while maintaining flexibility.



8. Pilot testing. The concepts are to be pilot tested initially over three years (para. 67). This period is the minimum necessary to develop a pipeline of operations suitable for innovation. Few, if any, of these operations would have entered their full operational phase by the end of the test period. However, by that time, some preliminary results will be available, including the extent to which borrowers took up the instruments, how the due diligence process was conducted, what cofinancing was being put in place or envisaged, and how far ADB has progressed in investment program financing and implementation arrangements. It also should be possible to judge the fit with overall ADB strategy, the application of sound banking principles, the risk profile to clients and ADB, the uptake and relevance to OCR and ADF clients, and the range of borrowers serviced.³⁴

A. Pilot Concepts

33. New concepts have been developed that aim to provide ADB and DMCs with alternative instruments and modalities to respond better and more effectively to development financing needs. Specifically, the proposals will enable ADB to (i) improve service to existing and new clients; (ii) be more programmatic; (iii) mobilize other resources more efficiently, including domestic savings, and international finance; (iv) minimize currency mismatches at the project and client level; (v) reduce transaction costs; and (vi) provide refinancing to fundamentally sound projects with high development impact but weak financing plans.

1. Multitranche Financing Facility

34. The proposed pilot concept calls for the establishment of a debt financing facility to target (i) discrete, sequential components of large stand-alone projects, (ii) slices (or tranches) of sector investment programs over a longer time frame than the current norm, (iii) financial intermediary credit lines, and (iv) guarantees. The proposed multitranche financing facility (MFF) incorporates features of sector and cluster loans, although with the client and ADB adhering to much sounder cash and balance sheet management principles.

35. Investments with long gestation periods require phased disbursements. This implies large commitment fees, as well as more substantial balance sheet commitments. As a result, clients often agree to undergo repetitive processing tasks, and endure the cost of slow ADB processing and implementation procedures, rather than carry a major transaction on their books, or pay commitment fees on undisbursed amounts for a considerable period. Financial discipline and sound balance sheet management matter to most, particularly if large portions of the investment programs are cofinanced. Financing instruments and financing arrangements that are inflexible on these two fronts are not compatible with the long-term and programmatic sector investments that are so important from the perspective of developmental impact.

36. ADB needs to take a more programmatic approach toward the investment needs of clients. This is the only way to increase ADB’s productivity, provide critical mass and continuity, and improve quality (through greater attention to implementation and policy dialogue, instead of focusing on repetitive processing tasks). These objectives can be addressed through the application of more structured financial instruments. A programmatic approach would not compromise guiding principles such as safeguards, fiduciary oversight, and reforms. Indeed, the opposite should be true. Through the provision of greater critical mass, and particularly by ensuring continuity, project teams should be able to spend more time on these issues, and keep Management and the Board informed accordingly.

37. The MFF addresses the issue of commitment fees. However, its most interesting feature is its ability to minimize the negative impact that standard ADB financing now has on a client’s balance sheet and cofinancing capabilities. This is an increasingly important consideration for nonsovereign public sector borrowers rely more and more on capital markets, private equity, and commercial bank financing. Under a traditional public sector loan extended by ADB (stand-alone or sector), only the amounts formally withdrawn are registered as an obligation on the balance sheet.³⁵ However, the amounts undisbursed also have to be reported in the audited annual accounts as off balance sheet items. Although these are not formally recognized as contingent liabilities, few financiers would contemplate direct nonrecourse or limited recourse lending without considering the overall loan amount. Off balance sheet audited accounts notes can be as important as the loan amount registered as a contingent liability. ADB certainly would look at these in the context of any nonrecourse lending.

38. In practice, most projects take 4–7 years to implement. This means that funding is truly required in tranches, in line with implementation schedules. The commitment fee on undisbursed loan amounts contributes to the financial cost structure. The off balance sheet recognition of the total financing affects the financial standing of a client, particularly for operations that need to be cofinanced with others. At times, cofinancing can exceed ADB’s financing by several fold. Such fundraising efforts with third parties require a healthy or robust balance sheet, rather than sovereign guarantees, which quite often are unavailable to others. The stronger the balance sheet, the higher the chances of securing this other finance and the better the terms and conditions. ADB instruments and modalities should be tailored to allow clients to target longer-term investments and greater levels of cofinancing. An MFF would go a long way in helping clients achieve these objectives.

39. An MFF is akin to a standby letter of credit, or purpose-specific credit line. However, it does not become a contingent liability on the books of ADB clients or on ADB itself on approval. The unused parts of the facility are not registered as off balance sheet items. The MFF can be applicable to large stand-alone projects with discreet components, though it is particularly relevant to sector investment programs, to the provision of financial intermediary credit lines (e.g., those targeting SMEs), and guarantees. The MMF can be used across all sectors and in OCR- and ADF-eligible countries alike.

40. ADB approval arrangements normally involve a one-time submission to the Board. This would continue to be the case under the proposed MFF. The Board would be requested to approve the expected financing under clear terms, conditions, and eligibility criteria. This approval would be for a specified maximum amount, and for a given utilization period.

41. Entries in ADB and client balance sheets (and off balance sheets) under the MFF would be made only after loan agreements related to specific periodic commitments have been signed and made effective¬—in line with the terms, conditions, and criteria approved by the Board. Commitment fees would only apply with respect to such signed loan agreements in accordance with ADB’s policies. In the case of public sector recourse financing, the respective governments also would approve a global sovereign guarantee at the same time. However, the guarantee would be structured in tranches through a standardized procedure to cover each of the individual loans. Most financial requests or commitments under the MFF are expected to be made annually. However, clients would be given the option to make more frequent or, in some instances, less frequent requests. This would be reflected in the report and recommendation of the President (RRP), taking into account the nature and characteristics of the investment program and the specific subproject preparation and implementation schedules.

42. The MFF can apply to stand-alone project loans, guarantees, sector loans, and credit lines processed by the regional departments. It would provide the equivalent of recurrent business to ADB, which should help prevent the inflation of booked achievements and counter the approval culture by shifting the focus from processing to execution or implementation.

43. The MFF essentially would be structured and staggered into multiple loans. In this manner, ADB could finance a longer-term investment program without creating large financial entries in the balance sheet of its clients, and triggering commitment fees only with respect to signed loan agreements in accordance with ADB’s policies. With the standby nature of the financing, the MFF would finance subprojects as they come up ("finance as you go"). Commercial banks follow this practice. EBRD and the Inter-American Development Bank (IADB), have instruments with similar characteristics. The World Bank’s Adjustable Program Loan facility shares some features with the proposed MFF. Appendix 4 provides a more detailed account of the proposed instrument, as well as the main guidelines for its application. IEI, through the Special Initiatives Group in RSDD, will work with project teams on the first set of transactions structured around the MFF. Staff instructions will also be prepared to help project teams work efficiently with this facility.

2. Sub-Sovereign and Nonsovereign Public Sector Financing

44. The proposed pilot concept calls for the provision of debt finance (loans and guarantees) directly to selected subsovereign, quasi–sovereign and other nonsovereign public sector entities, including SOEs, on a nonrecourse or limited recourse basis. The introduction of the concept requires a number of preconditions, including the establishment and operation of the independent CRMU (footnote 32). Processing this type of financing requires detailed due diligence with independent risk assessment on a range of standard project finance areas, and strengthened processing procedures conforming to best market practice. The latter should include the substantial completion of due diligence on standard areas such as technical, commercial, financial, legal, regulatory, safeguards, management, governance, institutional and other matters, and term sheet negotiations (including pricing, equity subscription valuations, exit strategies and security package agreements) on the final transaction structure before any formal submission is made to Management and the Board.

45. The decentralization process witnessed across the Asia and Pacific region has become an irreversible trend. Effectively, this is transferring ownership of, and responsibility for, investment and management of key services and projects to local government. The driving forces behind this trend are political and economic. Decentralization takes place in two stages and at two levels of local government. First, it targets the provincial or state administration. Second, the provincial or state administrations replicate the process vis-à-vis municipal entities. This is not an easy undertaking. In addition to strong political will, decentralization requires the necessary financial means, suitable and predictable legal and regulatory frameworks, and local capacity. These frameworks are generally weak, or at best incomplete, which probably constitutes the single biggest bottleneck faced by local government in assuming these new responsibilities. This is also a considerable obstacle to private sector involvement.

46. Increased urbanization leads to huge financing requirements of provincial and municipal entities, particularly for utilities (e.g., water, wastewater, and waste management), urban transport and the infrastructure and systems to run it, housing, health, and education. The transfer of ownership and responsibility for these services has not always been matched by a pro rata transfer of financial resources, which is a major issue across the region. This can lead to budget deficits, which in turn increase local governments’ difficulties in raising financing. It also can lead to a rapid deterioration in the quality and efficiency of service delivery, as measured in terms of quality, coverage, and continuity. This affects end-users and, ultimately, the achievement of the MDGs. However, some public entities are bound to be sound credit risks, particularly if they continue to deepen and expand structural reforms to cut deficits, and introduce transparent financial management systems and better governance. These entities are potential demonstration cases, and a reference for others that have not introduced reforms.

47. In addition to local governments and other subsovereign entities, this form of financing also is useful for selected SOEs across the region. Special financing arrangements are required for these enterprises to deliver the services they were set up to provide. A number of these SOEs are financially sound, transparent, and well-managed due to (i) increased emphasis on sound corporate governance; (ii) stronger regulatory regimes and sector reforms; and, (iii) in some instances, partial sales through public offerings, private placements, and joint ventures. The SOEs targeted under the proposed facility are focused on businesses that provide access to public goods and services and have a high development impact, such as water, wastewater, waste management, power, energy, transport, telecommunications, or improve business competitiveness. This means they may in many cases not be hugely profitable, though they should be financially sustainable in the long run. In many cases, they are long-standing clients of ADB (albeit financed with sovereign guarantees). As a result, ADB has built up a considerable knowledge base on the sector and on their functioning and operations. Under certain conditions, these companies could be acceptable credit risks for direct ADB financing. ADB’s involvement should help bring about improvements such as specific reforms, mobilization of domestic savings, direct foreign investment or trade, stronger corporate governance, better financial management and information systems, and the incorporation of the private sector in either the enterprises themselves or in their investment programs. The incorporation of the private sector can take place through a variety of modalities, including selected domestic and international public offerings, partial sales, joint ventures, concessions, BOTs, and management contracts. Outright sales also could be encouraged and figure in the reform agenda of DMCs, particularly in relation to sectors such telecommunications, power and energy.

48. Nonrecourse and limited recourse financing under this facility should normally be coordinated through the regional departments, and be embedded in the CSP.³⁶ This approach does not limit the involvement of PSOD in these transactions. New internal incentives structures will be required to encourage teams to work together more effectively (para 72). However, most of these transactions would have a major impact on the sector and reforms, and in this sense go well beyond actual deal structuring. Hence, the overall coordination of these operations would be the responsibility of regional departments.

49. The decentralization process suggests that local government financing sooner or later will become a part of ADB’s core business activities. SOEs also might be appropriate for direct ADB financing, if such financing were to pave the way for (i) cofinancing, (ii) significant reforms on sector-wide issues, (iii) better internal corporate governance, (iv) enhanced regulatory frameworks, (v) improved tariff regimes, (vi) public and private placements in the local and international markets, and (vii) privatization. This form of financing would encourage central governments to move away from a ‘doing business’ mode toward a more regulatory function. Although central governments will remain a major source of financing to local governments, they also will call upon institutions such as ADB and others to provide assistance through new financing modalities and approaches that can bring about new solutions to old problems.

50. Sovereign guarantees will not always be available to finance local governments and SOEs. Some middle-income countries already are asking financiers such as ADB to share risks, a trend that will spread. Indeed, this trend will accelerate once local government finances strengthen further. Provincial, and particularly selected municipal entities, eventually will secure nonrecourse or limited recourse financing from the market, as will some SOEs. Such a process obviously will have to be tightly regulated at the center to avoid the development of a debt overhang and ’moral hazard’. Loss of confidence in local governments and SOEs could have major negative repercussions on the financial, economic, and investment standing and climate of a country.

51. ADB is in a unique position to start the process of working directly with selected subsovereign entities, especially municipal entities. Unlike the World Bank, ADB’s Charter does not impede its working with these clients without a sovereign guarantee. However, direct, limited, or nonrecourse financing would need to be accompanied by major reform preconditions and the application of sound banking principles. It also would involve tailored pricing and security package arrangements, aligned with market practices and with the terms offered by other cofinanciers. ADB’s role must be to bring in other financiers, not to crowd them out.

52. Few SOEs and local government entities in the market now are likely to qualify for direct financing without sovereign guarantees. ADB could work with the eligible ones in the short term. Meanwhile, others could start the reforms needed to qualify for this financing down the road. Some of ADB’s development partners, such as the World Bank, are recognizing the importance of this “third generation” of clients. The latter is considering setting up a special vehicle to work outside its charter restrictions, probably through the establishment of an off balance sheet special fund. IADB also is planning to lend directly to subsovereigns and SOEs. Starting with a small operation in Budapest in 1993, EBRD has been providing nonrecourse financing to local government entities for more than a decade. It has also financed SOEs in the process of transition to becoming predominantly privately owned. The European Investment Bank (EIB) was the first, and is still the most effective, of the multilateral institutions in this area. Its municipal financing portfolio is large and growing. Appendix 5 provides more detailed information on the proposed instrument. It provides information on the main conditions and eligibility criteria for extending finance on a nonrecourse or limited recourse basis, and the key procedures and due diligence required to do so. These key procedures and due diligence cover financial, technical, legal, regulatory, commercial, capacity, governance, sector and internal entity reforms, safeguards, fiduciary oversight, institutional arrangements, and social aspects. Local government and SOE entities are divided into three categories (green, amber, and red) based on their suitability for direct nonrecourse or limited recourse financing. The transactions to be supported by ADB on this basis would need to follow prevailing operational policies and procedures, have a high developmental impact, and be compatible with the country’s and ADB’s poverty reduction agenda.

3. Local Currency Financing for the Public Sector

53. Associated with the decentralization process is the potential mismatch between borrowing in hard currency and having income streams in the domestic one. This currency mismatch occurs irrespective of the strength or suitability of the policy and tariff regime governing a specific service or project. In addition, the local cost component of projects has generally increased over time. While there is little rationale to provide local currency to central governments (which can raise local currency on terms similar to or better than ADB can), in the case of SOEs and local government, ADB might offer a significant comparative advantage.

54. Local currency financing is particularly important in the case of public services, utilities, and infrastructure projects that are subject to tight tariff regimes. It is also applicable to countries that face higher than average exchange rate volatility. The long gestation period can adversely affect the viability of these operations. Tariff regimes might become unsuitable or insufficient for political and social reasons. In fact, governments have often hidden the true cost of services in the past. However, although regimes can be modified, one bottleneck that is more difficult to overcome is the ability and capacity to pay. The elimination, or at least the partial reduction of the currency risk, might go some way to cutting overall project risks and make investments and reforms more viable

55. There is considerable interest in local currency financing among a wide range of stakeholders, including project sponsors, commercial lenders, international development financing institutions, and export credit agencies. Demand for local currency financing by ADB is likely to be significant, in particular when combined with extension of financing to other public sector borrowers on a limited or nonrecourse basis. Demand is expected to be significant, even if extended with sovereign guarantees. Local currency financing is also likely to lead to considerable financing partnership opportunities.

56. A key challenge for ADB will be treasury related. In structuring this type of transaction, there will always be a concern about currency-related risks, especially when trying to match funding and lending operations in quite often illiquid markets and with limited hedging opportunities. ADB has, in principle, the capability to structure transactions around local currency financing, and is well placed to respond to the challenge. But this must be done in a careful and measured way. A proposal for a pilot concept to extend local currency financing to public sector borrowers, as well as draft guidelines for its application, is detailed in Appendix 6.

4. Refinancing

57. The proposed concept calls on ADB to help restructure or expand projects involving public or private sector assets, or assets under public-private partnerships. This facility should be used selectively. Whenever possible, it should be accompanied by new investments and by adequate reform measures to ensure the long-term viability of the restructured operations. The facility would not be used to cancel ADB or other MDB loans. Refinancing would not be used to bail out governments or sponsors that performed poorly, or to finance cost overruns. The latter are addressed through ADB’s supplementary financing policy.³⁷

58. A number of investment operations with a high development impact might have been exposed to high interest and foreign exchange rate volatility. As a result, these projects might have encountered difficulties during their commercial phase. The repayment and risk profile of the financing plans (debt and/or equity finance provided by development or commercial banks, private sponsors, and private equity groups) might have become inappropriate as conditions on the ground changed. The maturity periods of the debt financed might be tighter than average, at least in relation to the current and projected cash flow. Working capital finance³⁸ also might be narrower than needed. The original financing plan structures might have missed out on hedging possibilities through interest and currency swaps. In the case of equity finance, this might have been extended more efficiently through other alternatives, such as quasi-equity or mezzanine finance. On the other hand, debt might have been more suitable for the longer-term viability of the project if put together based on temporary cumulative preference share schemes. Repayment schedules might have been mismatched with the projected cash flow. Guarantees might have been used to encourage shareholder advances and better debt financing packages from third parties. Local currency might have been more suited to the transaction instead of foreign exchange financing. Transition strategies might have been put in place to help overcome inappropriate tariff regimes of the past, thus to reinforce the cash flow. The list of problems with financing plans can be extensive.

59. Although these projects might be technically, economically, and socially viable, some might falter purely due to the inadequacy of their financing plans. In some instances, project targets (measured in terms of quality, coverage, and continuity) might be at risk due to these financing considerations, rather the project concept itself. Increasing tariffs could be part of the solution, though this might not be sufficient to ensure viability. While some investment plan components could have been phased differently over a longer period (or even phased out), this might have compromised the integrity of the project. Given the exclusive focus on operations in the commercial phase, this option would be academic in any case. A number of these projects might be close to reaching their full operational capacity point, or they might be at a stage where they need upkeep, rehabilitation, or extensions. However, their original financing plans might make such undertakings difficult, if not impossible. Financial plan restructuring might be an effective way to save these projects.

60. This assumes, of course, that cost recovery is an integral part of the project structure. Refinancing purely due to the wrong tariff regime, or the wrong cost recovery arrangements, would be unjustified, unwarranted, and uncalled for. It would merit a different set of actions, not refinancing. Similarly, financial problems resulting from operating inefficiencies or poor management should not be addressed through a refinancing facility.

61. An increase in fees or tariffs, or a capital increases, can effectively address a high financial cost structure. Refinancing can and should be accompanied by these reforms whenever feasible and ADB’s role would include making available its expertise and resources in relation to the related industry, sector, as well as the project itself. However, these changes alone might not be enough to compensate for a distressed financing plan and ensure a project’s longer-term financial viability.

62. In view of this assessment, ADB should allow refinancing on a selective basis where such refinancing has a high and demonstrable development impact. To the extent possible, ADB should encourage third party financing which may be credit enhanced through ADB guarantees, including the utilization of securitization structures to tap into capital markets for mobilizing required capital. In such case, the same strict credit analysis as that made with regard to fresh financing would apply. ADB’s prevailing operational policies and procedures in respect of safeguards and themes will also apply. Appendix 7 details the concept, conditions for refinancing, and basic guidelines for its application.

5. Financing Syndications and Risk-Sharing

63. The proposal recommends the introduction of new forms of cofinancing through active financial syndications and risk sharing with commercial financing partners in the public and private sector. These could include “sell-down” of nonsovereign exposure by ADB, as well as reinsurance and counterguarantee agreements with nonsovereign third parties. This would be important to bringing in commercial financing to ADB operations, and improving ADB’s risk management, particularly for nonrecourse and limited recourse financing operations. Pricing information provided by cofinancing partners would be an important indicator for ADB’s own price determination. Financial syndication and risk-sharing arrangements would be carried out in collaboration with leading commercial banks, and with the financial industry. Within ADB, the Office of Cofinancing Operations (OCO) will coordinate this process in close consultation with CRMU, OGC and operational departments. OCO is adjusting its skill base, and recently recruited specialist staff with extensive expertise in financial syndications and political risk insurance in the private and public sector.

64. ADB has not taken full advantage of the considerable potential that its credit enhancement instruments offer for market collaboration and risk-sharing partnerships. Generally, cofinancing or guarantees have been agreed at the beginning of a project and remained largely static throughout the project period. Counter-guarantees have been limited to sovereign guarantees. Reinsurance, or ‘sell-down’ of risk to bilateral or commercial agencies, has not taken place, even if those agencies operate on a commercial basis and with untied procurement. Recently, commercial financial institutions, from the private sector as well as public sector, have shown increased interest in entering into risk-sharing agreements with ADB. In conjunction with the other proposals formulated in this paper (e.g., public sector lending without sovereign guarantees, local currency financing, and the MFF), the scope for sharing project risks with third parties potentially is significant. This would facilitate more efficient risk allocation among the financing partners with commercial banks focusing on short-term and commercial risk, and ADB on longer-term and political risks. Cofinancing partners clearly value the benefit of ADB’s AAA rating, as well as its privileged relationship with host governments. Some limited experience has already been gained with public-private risk sharing partnerships in ADB’s private sector operations.³⁹

65. Reinsurance and sell downs would reduce and better balance ADB‘s risk profile, and allow ADB to manage its balance sheet more flexibly. These activities would be closely coordinated with the new CRMU. If properly managed, risk-sharing agreements could increase significantly ADB’s role and relevance as a catalyst for development finance, while enhancing ADB’s income position. Appendix 8 provides additional background on the concept, exposure limits, and guidelines for implementation. The proposal would be refined, if needed, during the upcoming review of ADB’s cofinancing strategy and policy review of credit enhancement and guarantee products.

6. Flexibility in Commitment Charges

66. Commitment fees can deter business development across countries and penalize projects vis-à-vis programs, especially those with a limited number of tranches or short implementation periods. However, commitment fees do have an impact on ADB income. This paper does not provide a specific proposal to the Board on the subject. Instead, it suggests that Treasury Department look into the matter and, as appropriate, submit to Management and the Board a separate paper with a specific proposal to achieve greater flexibility. This is currently planned for October 2005. Some options are highlighted in Appendix 9.

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