This is the first of a series of case studies called ‘Financing the Global Recovery.’ The series is based on interviews with ACCA members and aims to share their first-hand experiences of raising finance across borders and the lessons they’ve learned over the past few years.
With the exception of the World Bank Group and its subsidiaries, the names of all companies involved in this particular case study, as well as the locations in which they are active, have been altered to protect the identity of the interviewee.
About the project
Mr P (an ACCA member) was until recently Finance Manager at KB Power Ltd, a special purpose vehicle (SPV) created by BW Energy Company (BWEC) to support a World Bank-funded hydropower project in a landlocked frontier market in South Asia (the Host Country).
The KBA project aims to create a capacity of 37.6 MW or 201 GWhs of energy generation per year; it involves diverting a nearby river through a 4.3m tunnel at a significant elevation above sea level. Following approval by the Host Country’s government in October 2009, the contract for KBA was awarded to BWEC and a project development agreement (PDA) was signed in January 2010. Energy production is expected to begin in September 2015.
Financing a project of this magnitude requires a great deal of expertise, and KBA has from the beginning involved different parts of the World Bank Group; most notably the International Finance Corporation (IFC) and International Development Association (IDA). However, it is ultimately KB Power Ltd that has executed the Project Development Agreement with the Host Country Government, promising to develop the project on a Build-Own-Operate-Transfer (BOOT) basis.
To deliver the project, KB Power requires ca. $78m of debt and equity at a ratio of 77.5:22.5 respectively, with the World Bank providing about $50m of the credit required. KB Power therefore approached local commercial banks to form a financial consortium that would provide the remaining $10.5m, while also looking into the possibility of raising quasi-equity funding from the IFC. In addition to a much needed injection of funds and expertise, either of these financing options would provide a strong external signal: the IFC only invests in for-profit projects and typically requires an exit mechanism, hence its involvement would provide a vote of confidence; domestic banks, on the other hand, could signal their maturity and their involvement would instil confidence in the Host Country’s financial services sector.
Although the Host Country is still in all respects a frontier market, Mr. P notes that its private commercial banks are innovative and highly customer-focused, with a strong drive to provide value-added services. In recent years, they have rolled out innovative products such as targeted sector loans, as well as a number of foreign deals to simplify remittances and worldwide banking facilities for Host Country citizens working abroad. Local banks, he notes, would also stand to gain substantially by providing trade finance and Letters of Credit to facilitate the import of huge amounts of high value-added technology equipment for the purposes of KBA. Nonetheless, the current political deadlock has made the formation of a consortium of local banks impossible.
Easier said than done
As with any internationally-funded power project, KBA involves substantial risk. However, most problematic is the fact that all funding will be channelled through the Host Country’s Government, which essentially borrows the funds from the World Bank to lend on to KB Power.
Crucially, it is up to the Host Country’s Government to finalise the transaction, after which the World Bank should start to disburse its share of the funds within as little as six months. Funds will be released on a proportionate basis and subject to both monitoring of each phase of construction and evaluation by a panel of experts.
Interest on the World Bank’s loan to the Government is 4%, a very good rate keeping in mind the Host Country’s poor repayment record, the Government’s fiscal constraints and what Mr. P calls a ‘dire’ need for hydropower generation in the Host Country. But the interest charged to BWEC/KB was originally at 10.5% and likely to rise further under a revised Power Purchase Agreement between the two. This has made the financing of the project very expensive and made the rate of return unattractive to promoters.
However, the cost of capital is just one of a number of ways in which reliance on Government is complicating the financing of KBA, which remains only partially funded as of July 2013.
During 2012 and 2013, the Host Country faced a constitutional crisis as the Constituent Assembly was dismissed in June 2012, having failed to ratify a new constitution in what international stakeholders called ‘a serious setback’ for the country’s economy. Subsequently, elections for a new Constituent assembly were repeatedly delayed, leaving a caretaker government in charge. Moreover, as agreement on a detailed full-year budget for 2012/13 remained elusive, the Host Country headed into its very own ‘fiscal cliffl,’ unable to mobilise public spending.
Mr. P noted that this pattern of political instability in the country had created substantial delays in the design and financing of the project; “the many slow-working faces of bureaucracy and political intervention” have held back what promises to be a valuable investment.
There will be a next time
Thinking of potential future projects, Mr P’s suggestion would be to reduce reliance on government funding – direct private investment, whether local or foreign would have reduced the level of intervention and avoided bottlenecks.
The World Bank and IFC, he says, should consider channelling their loans through more accessible means, while insisting on transparency, proper internal controls, audit, due diligence and expert advice at each phase of the project. In particular, he notes that using high quality local expertise can prevent substantial repatriations of money out of the Host Country.