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p. 7 of 21 BACK | NEXT I. Introduction II. An Overview of the Political Risk Insurance (PRI) Market III. Review of ADB's Partial Risk Guarantee (PRG) Program A. Existing Policy Framework for PRGs B. Review of Experience IV. Recommendation for Changes to ADB's PRG V. Potential Benefits of the Proposed PRJ Program VI. Conclusion

Review of the Partial Risk Guarantee of the Asian Development Bank : III. Review of ADB's Partial Risk Guarantee (PRG) Program

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A. Existing Policy Framework for PRGs

1. Coverage of PRG

30. The PRG covers part (or all) of a lender’s outstanding debt service against specific risks.¹⁰ Coverage of equity risks is not authorized under ADB’s Charter. Risks that are specifically mentioned in the 1995 review (footnote 1) include breach of contract and currency inconvertibility under build-own-operate (BOO) and build-own-transfer (BOT) projects. The guarantee is to cover mainly principal and base interest. Interest spread cover, although allowed, is discouraged.

2. Nonaccelerable Coverage

31. ADB’s obligations under the PRG may not be accelerated by the lenders covered by a PRG. Under Article 15.1 of ADB’s Charter, however, ADB must reserve the right to terminate its liability with respect to interest (also referred to as the “buyout option”) by offering to purchase the guaranteed obligation at par plus interest accrued from the date of default to the date ADB exercises its buyout option.

3. Trigger Events

32. The 1995 review states that the PRG would be callable under two conditions:

1. noncompliance with one or more obligations of the host government is established, as specified in the guarantee agreement; and

2. such noncompliance has resulted in a debt-service default to the lenders.

33. The 1995 review states that ADB will generally seek to include dispute settlement and/or arbitration provisions in the guarantee agreement. However, the review also notes that lenders may be reluctant to purchase coverage that requires lengthy dispute resolution procedures before calling on ADB’s guarantees. Whether or not to include such dispute resolution mechanisms is, therefore, to be decided for each transaction on the basis of business judgment and negotiation.

4. Counterguarantees

34. The 1995 review contemplated extending a PRG without a counterguarantee from the host government. While it is stated that a counterguarantee “will generally be sought,” it allows extending a PRG without a counterguarantee under ADB’s Private Sector Operations (PSO). PRGs without counterguarantees are subject to the same criteria and procedures as nonguaranteed private sector loans and equity investments (the maximum exposure per project is limited to the lesser of 25 percent of project cost or $50 million). PRGs are to be included in the overall PSO allocation as well as the country-specific exposure.¹¹

5. Participation Requirement

35. Article 11(iv) of the Charter enables ADB to guarantee loans “for economic development participated in by the Bank.” This provision of the Charter requires that ADB’s guarantees, including PRGs, can only be extended in respect of projects or programs in which ADB has some other form of participation, such as a direct loan, an equity investment, or bond subscription.¹² As a result, ADB is unable to offer stand-alone PRGs, unlike World Bank, MIGA, and IADB, whose charters were drafted in a consciously different manner.

6. Pricing

36. For PRGs with a government counterguarantee, the 1995 review recommends market-based pricing determined by the extent of the coverage, the nature of the risks covered, and individual and country circumstances. However, while the guarantee is market-determined, ADB will refund to the developing member country (DMC) government the excess between the 40 basis points per annum guarantee fee and the market-determined overall fee. The guarantee fee is charged on the face value of the guaranteed loan, and may be paid up front or on a periodic basis.

37. In the case of PRGs without a government counterguarantee, the 1995 review recommends market-based pricing and no fee sharing with the host government. This is analogous to the determination of interest rate charges for ADB’s nonguaranteed private sector loans.

38. ADB’s Guarantee Committee, which was established under the 1995 review, is responsible for determining applicable fees for specific guarantee transactions, reviewing the structure of specific guarantees, and (if required) providing guidance on conformity with ADB policies and procedures. The Guarantee Committee is composed of representatives of the Office of Cofinancing Operations (Chair), the Treasurer’s Department, the Office of the General Counsel, the Private Sector Group, and the relevant project departments.

7. ADB Financial Policies for PRGs

39. In accordance with the current application of Article 12.1 of the Charter, ADB must ensure, at all times, that its capital base is sufficient to meet future obligations arising from loans and guarantees. Since PRGs may be called at any point in time—as opposed to PCGs, which are callable mainly in relation to later maturities—ADB’s financial policies require that the PRGs be charged against ADB’s lending authority at the nominal value of the guaranteed obligations, as compared to the discounted value used for PCGs.¹³

40. The 1995 review recommends that, in determining capital allocation requirements for PRGs, due consideration is placed on ADB’s right to terminate its guarantee liability under the buyout option built into each guarantee (para. 31). In the case of PRGs generally, it is reasonable to assume that ADB will exercise its buyout rights at an early juncture, in order to minimize its liability with respect to interest coverage. Furthermore, the buyout option would most likely be exercised once it has been determined that the default has been caused by a political event,¹⁴ and there is no reasonable prospect of the Government curing the default.

41. On this basis, the 1995 review indicates that from the date of effectiveness of the PRG the capital backing for PRGs should be set at a level equivalent to the guaranteed principal outstanding, plus the interest that will accrue for the succeeding interest period.¹⁵ The capital backing is then adjusted periodically, to take into account the decline in the outstanding principal of the underlying guaranteed loan following amortization, as well as any possible changes in the base interest covered under the PRG.¹⁶

42. Should a payment default under a PRG-supported loan lead to a dispute or arbitration between the host government and the beneficiary of the guarantee¹⁷ and, under the PRG, ADB is obligated to cover interest that will accrue during the dispute,¹⁸ then, for purposes of the lending and guarantee limit calculations, ADB would reflect the principal outstanding under the guaranteed loan, and the face value of all future interest payments thereon, for the remainder of the life of the guaranteed loan.¹⁹

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