Catalog

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p. 5 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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V. Implementation

A. Pilot Testing

67. The proposed concepts would be for implementation on a pilot basis for an initial period of three years. While the proposed concepts are new to ADB, they have been implemented elsewhere in comparator development banks or in the commercial banking sector. Pilot testing would allow ADB’s Management and Board to monitor and assess their viability, relevance, effectiveness, and uptake (para 76). At the end of this period, their performance, suitability, outcome and impact would be evaluated. Based on this evaluation, Management and the Board can decide to extend them as they are for another pilot period, incorporate them into ADB’s core business model, or discontinue them.⁴⁰ Consequential and specific changes would be incorporated into ADB’s policies and operating procedures then or earlier, as required.

B. Other Reforms

68. The introduction of the new financing concepts requires a number of changes to ADB’s business processes and the establishment of an independent credit risk management function. These conditions must precede work, particularly on subsovereign, refinancing, and local currency nonrecourse or limited recourse lending operations. General business processes reforms are contained in a separate IEI paper which targets changes in the CSP, project processing, approvals, and implementation arrangements. The most important changes needed in relation to nonrecourse and limited recourse finance involve the substantial completion of due diligence on standard project finance areas and term sheet negotiations before Credit Committee and/or Management Review meetings, and Board presentations. An independent CRMU was established on August 2005. Reviews of ADB’s cofinancing strategy as well as ADB’s credit enhancement policies are ongoing. These reviews are aimed at strengthening the framework for financing partnerships, financial syndications and risk sharing arrangements.

C. Organizational, Operational and Resource Implications

69. The pilot concepts will be introduced initially within the existing organizational framework. Further reviews of organizational and skill-mix implications will be undertaken once some experience has been gained with the pilot concepts. The skills base will need to be strengthened over time if the pilot concepts are to be mainstreamed into ADB operations.

70. Traditionally, lending operations in regional departments have been geared towards lending to governments with sovereign guarantees. In recent years, there have been more public-private partnerships as regional departments started to “think private sector development” in public sector operations. Regional departments now have some of the required expertise, though only enough to undertake a limited number of transactions at a time. These departments recognize the need to further develop existing skills and to bring in new and additional expertise. In the meantime, pilot transactions can be processed through the establishment of multidisciplinary teams that combine expertise in public sector operations with nonrecourse and limited recourse financing. It is envisaged that the two sides of ADB (the regional and the private sector operations departments) will increasingly work together to define and deliver sound and unified “ADB brand” financial solutions to clients in areas where neither of the two are currently active. Local government and SOE financing are such areas. Public-private partnerships also could be expanded through this collaboration. In the medium-term, this should also help to improve project quality, as ADB will become more closely involved with the client. The newly established Special Initiatives Group in RSDD will support the project teams in the short term, especially in (i) defining concept papers, (ii) mapping out part or all of the due diligence, (iii) carrying out financial modeling work, and (iv) assisting with final transaction structuring. Due diligence in specialist areas may be outsourced to independent external advisors, as appropriate.⁴¹ While these proposed financial instruments and modalities will not change the character of ADB overnight, they might do so in the medium to longer term.

71. Over the medium term, the pilot concepts might have important resource implications at various levels. At the staffing level, certain activities, such as credit risk management will receive increased attention. New activities will be required to process some of the transactions, including more extensive communications with clients. On the other hand, the MFF will save considerable resources at the processing level, at least over the medium term. These resources can be reallocated to focus on implementation, as well as other transactions. Subsovereign and nonsovereign lending, refinancing, and local currency lending fall in this category. These transactions will need extensive due diligence. The due diligence will be carried out after concept clearance. This means that highlighting key issues, establishing the basis for the formation of joint processing teams, and defining precise terms of reference for external experts will be done at this early stage. Other processing activities currently carried out but supportive of outcomes might be de-emphasized. On the whole, this should not cost more than that associated with current standard public sector operations. Some specific tasks, particularly legal and financial ones, will cost more but project preparation as a whole may not need to be more costly. Rather, it will be different. Over time, project teams will need to be strengthened with more nonrecourse finance skills. This will require not only a change in the recruitment pattern, but also extensive coaching and training of existing staff. How all of this will balance out is not clear yet. The operational and resource implications should be much clearer as initial experience is gained in implementation and following the more detailed demand assessment described in para. 32(ii). To cope with the immediate requirements of the pilot phase, the existing resource framework is expected to be sufficient.

72. The proposed pilot financing instruments and modalities will also have implications on ADB’s reporting framework. The MFF, in particular, will shift year-end reporting away from Board approval towards effective legal commitments and implementation. Consequently, this may result in reporting of lower lending approval figures during the initial phase of the pilot period. Over the medium term, this is expected to provide a more accurate reflection of ADB’s legal financing commitments. For the subsovereign and nonsovereign public sector financing facility, a separate reporting category for lending and guarantees without sovereign guarantee, outside of private sector operations and regional lending with sovereign guarantee, will need to be established to capture the composition of ADB’s exposure in a transparent manner. This new category should be linked to internal incentive structures that encourage teamwork across divisional boundaries, rather then single departments.

73. The head of the Special Initiatives Group of RSDD will provide management advice on the overall interpretation of the pilot concepts and be responsible for their implementation in accordance with this paper. This will be done in close consultation with operational and key support departments and offices, as required.

D. Financial Risk and Income Implications

74. TD has projected that up to $3 billion could be used for non recourse and limited recourse financing under the IEI pilot schemes. This is considered a prudent ceiling from a credit risk exposure perspective, as it would most likely cap ADB’s equity capital exposure to non recourse and limited resource financing (including PSOD lending under reasonable growth assumption) for the next three years to within 10% of ADB's risk bearing capital.⁴² However, it is mandatory that the independent CRMU should introduce a formal exposure limit within one year to replace the temporary guidance.

75. The income impact will to a considerable degree depend on the disbursement pattern and the pricing of non recourse and limited recourse financing in light of prevailing market conditions, as well as whether the pilot financing instruments and modalities result in additional business volumes for ADB or substitute for traditional lending operations. In any case, it is expected that disbursements will be modest during the initial phase and increase only gradually over the pilot period. Thus, the income implication during the pilot phase relative to ADB’s overall income is expected to be small.⁴³ Yet, the objective of the new instruments is not to increase ADB income per se. The aim is to help ADB service its clients in a more efficient and effective manner while safeguarding ADB’s financial integrity.

E. Monitoring and Reporting

76. Finally, the Board will be kept informed of the progress of IEI, as a whole, and the pilot instruments and modalities, in particular. In addition to specific submissions made under each pilot concept, Management also will compile and submit to the Board an annual report on the overall performance of the package. This will be based on the results framework in Appendix 1 and the monitoring indicators given in Appendix 10. Some of these indicators will suggest trends, rather than precise quantitative targets. As such, new yardsticks might be considered during the pilot period to help evaluate the level of success or failure. This report will include a list of the projects being processed or funded in this fashion, the impact that the approaches might have had on ADB’s clients and business plan, the progress made, and problems encountered.

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