The SBP deserves appreciation for preparing guidelines on 'non-recourse finance' or 'limited-recourse finance' considered difficult to handle even in many developed societies


Dec 06 - 12, 2004





The State Bank of Pakistan (SBP) has placed on its website the Draft Guidelines for Infrastructure Project Financing (IPF) and invited suggestions by 30th November 2004. The Director, Banking Policy Department, SBP, has introduced the Guidelines to facilitate the banks/DFIs (the banks) develop expertise for undertaking IPF and enable the private sector funding of infrastructure projects, especially those under long-term government concession agreements. Under the traditional corporate finance, primary source of repayment is the borrowing company backed by its entire balance sheet whereas, the IPF ideally requires 'non-recourse financing', wherein the lenders look solely to the cash flows of the project for debt service. However, in the context of Pakistan 'limited-recourse financing' is preferable, wherein lenders in addition to the cash flows generating ability of the project for debt repayment also have access to the sponsor's credit and legal security for debt servicing. Infrastructure projects (IPs), by their nature and design, require relatively large investment, besides needing longer gestation period with large transaction costs for structuring. The Guidelines are fairly detailed and cover main areas of project finance such as appraisal, risk coverage, security, monitoring, exposure, regulatory compliance, etc.

The SBP deserves appreciation for preparing guidelines on 'non-recourse finance' or 'limited-recourse finance' considered difficult to handle even in many developed societies. The introduction of IPF guidelines is timely as presently Pakistan is embarking on developing its infrastructure with private sector resources jointly with the local and foreign banks. Augmenting local authorities' resources with bank loans can improve infrastructure situation on fast track provided all stakeholders play their due roles efficiently and wisely. The IPF would be a big challenge to the creditor banks but would also offer lot of opportunities for investing their funds. As a student of Project Finance, I feel, SBP after considering suggestions from different stakeholders, would place, the revised draft on its website for final comments. Suggestions on main areas covered in the draft Guidelines are briefly given below.

The Guidelines, for promoting 'limited recourse financing', essential for IPF in the private sector, encourage the banks to accept a "Concession Agreement/License" (CAL) issued by a Government Agency as a collateral, in the overall collateral arrangements, if CAL is free of all encumbrances, is irrevocable, is not detrimental to interest of the lenders and is assignable to lenders in the event of default. Further, the Government Agency issuing CAL to undertake to facilitate lenders in CAL transfer to them in case of default and that the banks are satisfied regarding the secure nature of CAL. It may be mentioned that CAL is one of the many inter-linked agreements/contracts to be carefully negotiated and executed between different counterparties before the loan is effective.

The Guidelines require that the banks, while undertaking IPF under 'limited recourse financing' to prudently secure their interest by a combination of Primary Security/Collateral, such as: (i) First charge on all receivables and different Project/Company Accounts; (ii) Mortgage over all assets of project company and that of the contractors; (iii) Assignment of all insurance policies to cover risks including political and force-majeure; (iv) Pledge of sponsor's share in project company, (v) Assignment by way of security of all government approvals/undertakings and the implementation agreement; (vi) Assignment of company's rights under project agreements (vii) First charge/assignment of corporate/bank guarantees furnished by the contractors to the project company.

The Guidelines, in my view, are sort of a blue-print to the banks for properly starting IPF. However, at present most local banks reportedly do not find it easy to successfully handle traditional long term corporate finance and prefer short term credit including consumer finance. For the local banks to confidently and expertly handle IPF work will be an uphill task, at least in the initial few years. For that the banks might have to commit/train their best human resources with ample financial support for many years. For early initiating of IPF, it is suggested that the Long Term Credit Fund (originally known as PSEDF) presently managed by the National Bank of Pakistan, is developed into a full-fledged Municipal and Infrastructure Bank for lead financing the infrastructure projects in the country. The banks might also expeditiously develop and improve their expertise for traditional corporate finance and the non-recourse project finance.

From definitions of 'License' and the 'Borrower', it is clear that IPF is not meant for providing bank loans for the financing/construction of IPs in the public sector. Local and relatively small infrastructure projects within municipal limits of towns and cities, though unattractive for recovery of user charges, are important for the welfare of the people and for all-round development. Such projects might not qualify under IFP but otherwise might be justified and should be implemented. The SBP might allow the banks to finance such projects in the public sector. If need be the present Guidelines may be suitably amended or a new set of guidelines for financing of municipal projects in the public sector might be issued. The International Financing Institutions (IFIs) have been financing IPs in the public sector. This sector might also be opened for local banks. The IFIs have reportedly offered support to the government as well as the City District Government Karachi for improving physical infrastructure.

The Guidelines list 16 categories of IPs, which fall into four main sectors as under: (i) Communication: roads, mass transit, urban rail, rail-bed, station system, telecommunication, airports, ports, shipping, channel dredging, container terminals, inland waterways; (ii) Energy: Power generation, transmission and distribution network, natural gas, LPG, LPG import terminals, Petroleum, extraction, refinery, pipeline; (iii) Water: Dam, barrage, canal primary and secondary irrigation, tertiary irrigation; and (iv) Municipal: water supply, irrigation, water treatment system, sanitation and sewerage system, solid waste management system project.

In the context of eligible IPs, following suggestions are offered: (i) The Guidelines are generic in nature covering a broad spectrum of IPs. Comprehensive guidelines specific to different sectors might be more useful; (ii) IPs include highly risky projects such as natural gas exploration and Petroleum/LPG extraction, which are mostly financed through equity and loan funds are rarely used; (iii) Some of the IPs might not be generating enough of cash for debt servicing. Roads, flyovers, bridges, water supply, water treatment system, sanitation and sewerage system or solid waste management system project, etc. Perhaps it would be better if banks are allowed to finance such municipal projects under traditional finance to public sector entities under acceptable securities; (iv) List of IPs include power generation and petroleum refineries for which there exist special policies of the government, to which the Guidelines might be made compatible; (v) Many IPs will be implemented under Public-Private Partnership, for which broad parameters might be developed; and (vi) Compensation to the project company and/or the creditors might be provided for changes in government policies in future or delay in the award of different approvals adversely affecting IPs.



For suitably conducting credit appraisal the Guideline require the banks to obtain comprehensive/detailed Feasibility Report containing information relating to project's anticipated economic conditions, capital investment, and financing. The Guideline requires that the Feasibility Report is endorsed by an Auditing Firm either approved by SBP or on the panel of SBP. The question is whether the Auditing Firm will be held liable if the information or statements in the Feasibility Report are actually found lacking or incorrect and the project had problems? The role and responsibility of the Auditors might be clearly stated. Moreover, for preparation of the Feasibility Report, the Guideline might require the selection and use of reputed independent consultants having experience and expertise in their respective areas. This would add value to the document.

The Guidelines cover activities under different stages of credit-cycle such as Appraisal, Construction, Follow up and Operation. Some ideas have also been offered for joint technical appraisal in case of large projects needing loan financing from a number of banks and DFIs. This aspect might be debated more under legal advice and the actual experience of industrial financing in the past, particularly when the loans went sour and different creditors tried to save their own interest, in many cases disregarding the interest of other institutions. Under consortium or syndication arrangements, the prudent course might be that the banks agree on the detailed outline of the Feasibility Report (FR) and the experienced consultants for its preparation. This FR coupled with required minimum information should form the basis for every bank to appraise the project for financing decision. The banks might share their individual reports among each other but without confirming the viability of the project or assuming any liability whatsoever.

The Guidelines encourage the banks to develop expertise for appraising technical/environment/financial/economic viability and bankability of infrastructure projects, with particular reference to the risk and sensitivity analysis whether the project will be able to generate sufficient cash flows to repay debts and produce a satisfactory rate of equity return. As IPF calls for special appraisal skills and expertise, the banks may consider constituting appropriate screening committees/special Divisions for appraisal of credit proposals and monitoring the progress/performance of the projects. For IPF purposes, each creditor institution shall have to devise detailed guidelines and extensively train the personnel handling appraisal, monitoring and negotiation functions.

The Guideline provide that IPs usually go through development, construction, start-up, and operation stages, all of which should be assessed separately for risk mitigation by the banks during the credit appraisal process. The lenders better avoid funding the development phase, during which the sponsors using their equity assesses the project's scope, seeks regulatory and concession approval from the government or municipal authorities, and attempts to attract financing. The risk during construction/start-up phase is high as the construction may not be completed on time or the project may have large cost overruns or there is failure to meet project specifications. Duration operation stage the risk might reduce. The Guidelines advise the banks to cover their risks by a number of precautionary/contractual measures, some of which are:

1. To encourage the project companies to hedge construction risk by using fixed-price, date-certain construction contracts and to ensuring that the credit is actually utilized for the purpose for which it was approved;

2. To negotiate that the risks during completion phase of the project are the responsibility of the project company, its sponsors, contractors, equipment suppliers, and insurers. Moreover, for mitigating force majeure, the banks have been advised to ascertain that the sponsors purchase the risk insurance;

3. To ensuring that sponsor's holding in the project company does not fall below 51% of equity capital;

4. A new project may reach physical completion but not become financially healthy or self-sustaining for any number of reasons. Project documentation, therefore, may require the sponsors to provide subordinated loans or additional equity backed-up by a letter of credit, bond or guarantee from a creditable third party, to the project until the agreed financial performance is achieved.

5. During operation phase, the premature termination of different project agreements such as concession, management or supply agreements could adversely affect the project and usually a party prematurely terminating or violating provisions of an agreement prematurely pays for the damages caused to the other parties.

The requirements as above are important but the project sponsors might not agree to assume all risks or make commitments for additional financing as the lenders might wish. The guarantees, financial commitments, etc are very costly and therefore might be used sparingly for large IPs only. To protect their interest the private sector can engage the best legal/technical help, which might not be available to the banks and public sector DFIs. It may be noted that very strict requirements from the creditor banks might discourage private sector participation in the financing of IPs and thus the country might not attain the goals of having improved infrastructure within the desired timeframe. A gradual and approach coupled with fair and equitable treatment might be more useful.