Download Local Capital Market Development

The World Bank Group
Infrastructure Economics and Finance Department
Capital Markets Instruments : Financing
Infrastructure Development
IDB Business Seminar Series 2004, Capital Markets for
Development,The Role of the Private Sector, Washington DC,
June 4th, 2004
Infrastructure Economics and Finance Department (IEF)
Contents
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Overview of Bond Markets
Capital Markets and Infrastructure Development
Infrastructure Needs
Local capital markets
Local currency debt instruments
Guarantees
Definition
Options under Consideration
Guarantee Liquidity Facility
Capital Markets in the Region
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Infrastructure Economics and Finance Department (IEF)
Size & Structure of the Bond Markets (LATAM)
Institutional Investor Assets for Larger LAC markets, 2001
Local Currency (equivalent US$ billions)
Country
Argentina
Brazil
Chile
Mexico
Peru
Otherse
TOTAL
Pension
Funds
Insurance
Co.
Mutual
Funds
Total
1999
Total
2001(e)
14.0
53.0
33.0
8.5
2.5
16.7
2.0
11.0
10.0
2.4
.4
3.9
7.5
44.0
4.0
13.0
.5
10.4
23.5
108.0
47.0
23.9
3.4
31.0
29.5
135.0
58.7
29.9
4.2
38.7
127.7
29.7
79.4
236.8
297.0
Source: Internal PRI (IDB) market research
Capital Markets still represent a very small % of GDP (except Chile) : average 11%
(est. 2001).
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Average holdings of sovereign risk by investors is relatively high (70 % to 85%)
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Infrastructure Economics and Finance Department (IEF)
Relative Size of local Capital Markets
Table 2: Capital Markets Capitalization as a % of GDP for selected countries, Year 2001[1]
(equity and bond markets)
Country
Stock Market as
% GDP
Bond Markets as %
GDP
Public Bond Market %
GDP
Private Bond Market %
GDP
Bond Markets as % GDP
(1991)
Argentina
12.42
15.86
10.83
05.03
05.00
Brazil
27.58
61.26
51.25
10.01
13.20
Chile
74.56
52.72
30. 40
22.32
30.10
Colombia
07.30
N.A.
N.A.
N.A.
N.A.
Mexico
9.25
15.89
10.83
05.04
05.60
Peru
16.32
07.16
02.96
04.20
00.70
USA
123.0
149.31
41.51
107.80
122.0
U.K.
144.0
64.42
29.70
34.72
48.15
France
85.65
81.16
46.12
35.04
73.25
Japan
55.93
145.11
95.52
49.59
87.53
[1]
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Infrastructure Economics and Finance Department (IEF)
Infrastructure Needs : LATAM (2005-2010)
New Investments
Maintenance
Total
(000 US$)
(000 US$)
(000 US$)
Electricity (power)
15,034.00
10,593.00
25,627.00
Basic Telephone
Mobile
Sub-Total
3,276.00
4,175.00
7,451.00
15,049.00
10,015.00
25,064.00
18,325.00
14,190.00
32,515.00
2,791.00
4,198.00
6,989.00
0.00
733.00
733.00
1,792.00
3,234.00
5,026.00
37,942.00
32,948.00
70,890.00
Roads
Railway
Water & Sanitation
Total
Source : World Bank, Working Paper 3102, Fay-Yepes, 2003
Note : /1 Does not include rehabilitation, deferred past maintenance and upgrades
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/1
Infrastructure Economics and Finance Department (IEF)
Infrastructure Needs : LATAM (2005-2010)
LATAM infrastructure needs are estimated at US$ 71 billion per year (it was close to
US$ 60 back in 1995). Of this close to 45% is represented by maintenance.
The most demanding sector in the Region will appear to be the Telecom Sector (US$
32.5 billion per year or 46% of the total), with the mobile sub-sector alone
demanding US$ 25 billion annually. Following Telecom will be Electricity (mainly
generation) with US$ 25 billion per year, and toll roads with US$ 7 billion per year.
In the golden years of infrastructure finance in the Region (1996), total amount of
financing raised was closed to US$ 30 billion. This figure is probably now in the US$ 8
to US$ 10 billion at best. These demand figures do not include a stock of deferred
investments and maintenance. If we add the weak foreign capital flows into LATAM
infrastructure during the last years (and immediate future), the outcome is a
pressing need for new financing options:
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Redesign of the government role (from regulator to partner, PPPs)
Development of risk mitigation products that can addressed the FX risk
Development of local currency debt instruments
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Infrastructure Economics and Finance Department (IEF)
Real Investment in Infrastructure Projects with
Private Participation in Developing Countries(1990-2002)
US$Bn
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
All low and middle income countries
Source: PPI Data Base (IEF, WBG)
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Low income countries
Infrastructure Economics and Finance Department (IEF)
New Agenda : Connect Infrastructure with private
financial markets
Transparent and efficient rules to determine future returns and risks
with clear enforcement and dispute resolution mechanisms
(economic regulation, judicial reform,investment climate)
Development of local capital market development (local currency
financing) and hedging instruments against currency risk.
Development of risk-mitigation products to support financing
instruments capable of dealing with credit, fx, contractual and
regulatory risks.
Enable and support access of municipal governments, sub-sovereign
entities and public utilities to private financial markets via
improvement of corporate governance, credit worthiness, and initial
financial backing.
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Infrastructure Economics and Finance Department (IEF)
Local Capital Market Development
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Financial des-intermediation is a key component of a sustainable
economic development strategy.
Support of good quality credit rating private sector instruments as a way
to diversify investors portfolio (e.g., pension fund development in LATAM
– increased sovereign risk cases of Argentina, Uruguay, Brazil, Colombia)
Develop local currency funding instruments that could mitigate crossborder risk (FX risk). Projects that are typically local currency
generators Water & sanitation, toll roads, irrigation, etc. will have a
tough time getting finance in the US$ markets (even with the best buildin contracting clauses for US$ tariff based there is a tolerance to FX
adjustments in a particular economy)
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Infrastructure Economics and Finance Department (IEF)
Development of local currency debt instruments
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Matching of revenue generation (productive assets) and
liabilities for private corporations.
Mitigation of economic regulation framework under volatility
scenarios (I.e., US$ based tariffs in utilities – public services)
Development of local savings capacities (I.e., diversification
from investments in government related securities).
Incorporation of local debt holders as stake holders in
infrastructure projects (mitigate regulatory risk)
Introduce market performance benchmarks to improve risk &
return remuneration for local savings (domestic investment)
10
Infrastructure Economics and Finance Department (IEF)
Guarantees: Overview
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Political Risk Guarantees (US$ debt instruments)
sovereign (transfer & convertibility) and selected noncommercial risks (contract frustration) for infrastructure
development in the Region. Streamlined approval process
(3 months).
Could include selected non-commercial risk [regulatory
risks] such as breach of contract by the grantor of the
concession (e.g., San Pedro de Macoris, IPP, Republica
Dominicana).
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Infrastructure Economics and Finance Department (IEF)
Guarantees: Overview
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Financial Guarantees, partial credit guarantees (local currency debt
instruments) :
credit enhancements to improve credit risk profiles of local issuers to
enable them to access market financing under better conditions (tenor
and pricing).
Instruments [mechanism] that cover or protect debt service payments
to institutional investors (bondholders).
Products can be structured to guarantee an specific layer of credit
risk,in order to elevate the risk profile of the overall transaction and
thereby attract investors. By guaranteeing an intermediate part of the
debt (I.e., guaranteeing to pay a portion of the obligation after the
internal cash reserves or sponsor support has been exhausted) the local
investor maybe more willing to put its capital at risk for the remaining
exposure.
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Infrastructure Economics and Finance Department (IEF)
Guarantees: Extending tenors for required longer
maturities.
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A Partial Credit Guarantee (PCG) can guarantee debt service for
specific periods
$150 million
Example: China
Ertan Power
Project
$50 million
0
3
6
Average financing term for
China without
World Bank Guarantee
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Additional uncovered
risk taken by
commercial banks
13
Total risk assumed by commercial banks
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15
World Bank
Guaranteed
Infrastructure Economics and Finance Department (IEF)
Guarantees: PCG applications under development
Application of Partial Credit Risk Enhancements to potential
PPP projects in infrastructure
Design the “optimal” partial credit enhancement for a given project in order to
improve its credit risk profile enough to capture private capital on adequate
terms & conditions
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Mezzanine Guarantee (local currency instruments)
Pool Guarantee (local currency instruments)
Guarantee Liquidity Facility
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Infrastructure Economics and Finance Department (IEF)
PCG applications under development
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Mezzanine Guarantee
A “credit” loss protection enhancement with the WB
providing a guarantee for a specified mezzanine layer of
credit risk, thereby elevating the overall transaction to
investment grade on the local currency scale.
Illustration: For a project bond supporting PPP
investments in electricity distribution, the WB could
provide a partial credit guarantee to support electricity
payments by government related clients to project.
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Infrastructure Economics and Finance Department (IEF)
Mezzanine Guarantee (energy distribution co.)
Transaction (Receivables
Securitization )
Project Revenues
(High Credit Risk
Quality Layers)
Transaction Reserves

Over-collateralization
Project Debt Service
Reserve Account
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Layer of Lower
Credit Risk Quality
Liquidity Reserve
(sponsors recourse)
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Mitigation of the lower credit risk
quality and improving the
transaction rating attracts
participation of Monoline
Insurers to provide a “wrap” on
the whole transaction,
improving further the
transaction credit rating.
Partial
Guarantee
(a portion of
the credit loss
on the
transaction, -debt service)
Infrastructure Economics and Finance Department (IEF)
PCG applications under development
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Pool Guarantee for Asset-Backed Securities
A partial credit enhancement product with WB providing a PCG for a
portion of principal and interest sufficient to offset potential losses
resulting from non-performing assets within the underlying collateral
pool.
The Pool Guarantee’s amount will be calibrated for each
transaction to improve the project’s credit rating in a manner sufficient
to attract targeted local investors.
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Illustration: A utility company may pledge credit receivables as
collateral to repay a bond issue. Although the collateral enhances
the bond’s credit quality, the information on the collateral in
emerging markets may not be adequate (e.g. incomplete records of
past performance) and as such, the collateral may not be sufficient to
attract local investors to purchase the bond. The WB could further
enhance the bond with a partial credit guarantee in order for the
bond to achieve a credit quality sufficient to interest targeted local
investors.
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Infrastructure Economics and Finance Department (IEF)
Pool Guarantee: CBO, for Illustrative purposes
CBO (Collateralized Bond Obligations) for Emerging Markets (EM) Debt
1. Stressed Default Rates (%)
Col l ater al
Rati ng
Desi r ed CBO Rati ng
BBB
A
AA
AAA
AA
A
BBB
BB+
BB
0.50
1.00
2.00
6.00
22.00
24.00
1.00
1.50
3.00
11.00
30.00
32.00
1.50
2.00
4.50
13.00
40.00
42.00
BB-
30.00
36.00
48.00
Appr oxi mati on to Requi r ed Cr edi t Enhancement
(illustration purposes)
Desired Rating (CBO)
2. Assets Recovery Assum ptions
EM Sov ereign w ithout guarantee
EM Sov ereign w ith guarantee
(principal + 12 m onth interest)
EM Corporate
A
Underlying Credit Quality of Pool (AVERAGE)
Stressed Default Rate for a A rating
Recov ery Rate (AVERAGE)
BB+
30.00%
25.00%
Loss sev erity (1-recov ery rate)
75.00%
Expected Loss
(Default Rate * Loss Sev erity)
22.50%
25%
40%
20%
Minim um Am ount of Credit Enhancem ent = 22.50%
(for bond holders guaranteed paym ent of
interest + principal)
Source: Rating Agencies Methodology (Case Example)
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Infrastructure Economics and Finance Department (IEF)
PCG applications under development
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Liquidity Facility
A form of project support that is funded in a separate escrow
account, or available on a contingent basis from a third party
and that maybe utilized under defined circumstances. Liquidity
Facilities are intended to assist the project in coping with
problems that are believe to be temporary.
The liquidity facility will be repaid over a number of years
through: (a) phased tariff adjustments to return tariff to a cost
recovery level, or (b) a special levy on consumers. /1
Foreign Exchange Risk Mitigation for Power and Water projects in Developing Countries, World Bank,
Energy Discussion Papers, Matsukawa, Sheppard and Wright, December 2003
/1
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Infrastructure Economics and Finance Department (IEF)
PCG applications under development

Guarantee Liquidity Facility (GLF)
A partial credit enhancement product with the WB providing a
liquidity guarantee to cover a specified number of interest
and/or principal payments, on a rolling forward basis – i.e. the
guarantee is in place throughout the life of the bond or until
depletion.
The guarantee could be predetermined as an lump sum amount
of the debt service covering a rising share of remaining debt
service (on a mortgage style payment), or the guarantee could
be designed as to cover only a predetermined % of principal
throughout the life of the bond.
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Infrastructure Economics and Finance Department (IEF)
GLF : (transmission and distribution PPPs)
Outstanding Principal
Debt /
Service
Coverage
Ratio
DSCR
1.5
1.0
Guarantee Liquidity Facility
Years
N
N+I
21
Infrastructure Economics and Finance Department (IEF)
Liquidity Facility Guarantee : FX mitigation
Product currently under development
Local
currency
Project
Cash-flows
expressed in
real US$
(going
exchange
rate)
Projected Cash-Flows
Real Cash-Flows
(after FX adjustment)
US$ cash shortfall
US$ cash shortfall
N
N+1
22
N+2
Years
Infrastructure Economics and Finance Department (IEF)
Liquidity Facility Guarantee : FX mitigation
Projected Cash-Flows
Product currently under development
Real Cash-Flows
(after FX adjustment)
Local
currency
Project
Cash-flows
expressed in
real US$
(going
exchange
rate)
DSCR
US$ cash shortfall
to cover DSRA
US$ cash shortfall
to cover DSRA
N
N+1
23
N+2
Years
Infrastructure Economics and Finance Department (IEF)
Liquidity Facility Guarantee : FX mitigation
Projected Cash-Flows
Product currently under development
Real Cash-Flows
(after FX adjustment)
Local
currency
Project
Cash-flows
expressed in
real US$
(going
exchange
rate)
DSCR
Liquidity Facility
covers short fall up
to debt service
payment
Liquidity Facility
covers short fall up
to debt service
payment
N
N+1
24
N+2
Years
Infrastructure Economics and Finance Department (IEF)
Capital Markets in the Region

Local capital markets are not the magic solution to what economists call the original sin (weak currency
environment). They are still limited in size (as a % of GDP), there still far from perfection for a pricing
point-of-view, they need better and speedier enforcement of regulations and so on…

Pool of approximately US$ 350 to 400 billion (assets held by LATAM institutional investors – Brazil,
Mexico, Chile and Argentina representing roughly 60%) and growing at anywhere between 5% to 10%
per year. Of these assets around 75% are held in sovereign related paper. If by offering good credit
quality private instruments this number could be reduced to 50%, it will free resources of up US$ 50
billion to be invested in new infrastructure let’s say. Or if new growth could be ear-marked for private
sector development we will be talking of anywhere between US$ 20 to 40 billion in needed local funding
for private projects.
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