The importance of International Financial Institutions in emerging market project finance

International Financial Institutions (IFIs) are established by more than one country and subject to international law.  Owners and shareholders are generally governments or other international institutions.

IFIs can refer to members of the World Bank Group such as International Finance Corporation (IFC); regional development banks such as Asian Development Bank (ADB) and European Bank for Reconstruction and Development (EBRD); and export credit agencies of individual country governments, such as US Export Import Bank (EXIM).

IFIs are important in project finance because they play a significant role in supporting large scale infrastructure projects in emerging markets.  They can provide critical capital and catalyse the participation of other players.

The involvement of IFIs in emerging market project finance is important for the following reasons:

Political dimension

IFI’s provide a political risk umbrella for other lenders.  Accordingly, it may give comfort to commercial lenders who invest alongside IFIs, that political channels exist whereby the IFI is able to speak directly to the Member Country should any unforeseen problems or difficulties arise during the life of the investment.

Greater risk appetite

IFIs take a long-term view with respect to an investment and have a stronger appetite for risk. They are prepared to finance projects which commercial lenders are not. 

Different mandate to commercial lenders

IFIs have been set up for different reasons compared to commercial lenders.  Although certain IFIs are mandated to lend based on “sound banking principles”, other considerations are relevant.

EBRD and IFC invest only where it can provide “added value”, by investing in projects that could not otherwise attract private capital on similar or reasonable terms.

A/B loan structure may be beneficial to commercial lenders

EBRD and IFC use an A/B loan structure when lending.  This means:

  • the A loan is for the own account of the IFI;

  • the B loan is the portion which is syndicated to commercial lenders; and

  • the difference to a normal syndication is that the IFI remains the lender of record and the B loan participants do not appear as direct lenders.

The benefits of the A/B loan structure which may attract commercial lenders include:

  • in the event of political occurrences in the Member Country, such as a moratorium on foreign currency payments, the IFI is able to rely on certain “preferred creditor status” to be repaid.  Any benefits which the IFI obtains are indirectly passed on to the B loan participants; and

  • commercial lenders may rely on the IFI conducting thorough due diligence of the proposed project, negotiating the financing documentation and addressing all legal and regulatory issues associated with the investment.

IFIs are often prepared to provide longer tenors of loans

Country and sectoral expertise

Commercial lenders may rely on the IFIs’ country and sectoral expertise in deciding to participate in the project and may see it as beneficial to be able to diversify their portfolio without the need to fund expensive investment in a new territory.

Local currency lending

One very crucial problem of cross-border lending has been that of currency mismatching for projects or companies that borrow in foreign currency and have revenues in local currency.

Where local currency funding is not available (or is too expensive or too short-term) IFIs can help to develop such a market either through local currency loans or guarantees.

International best practice through institutional policies

IFIs will often have stringent lending requirements which are codified as Institutional Policies that are adopted and followed in day to day operations.

Such Institutional Policies and lending terms include:

  • Procurement and Concessions Policy

    IFIs have well developed Procurement Policies and Rules to be followed in bank-financed operations.  An IFI may require that regular information reporting is made on a quarterly basis detailing contracts awarded or goods purchased so it can monitor procurement procedures.

  • Environmental and Social Policy

    When a project is proposed for financing, the IFI will conduct a social and environmental review of the project as part of its overall due diligence.  As a result of the social and environmental review of the project, an Environmental and Social Action Plan is developed which the client is expected to adhere to.

  • Anti-corruption Guidelines and Prohibited Practices

    All EBRD and IFC financed projects require the client(s) to covenant in the legal documentation that they shall not engage in any coercive, collusive, corrupt or fraudulent practice.

Lavan Legal comment

Emerging markets continue to require extensive investment in infrastructure.  Given the size of most infrastructure projects, the challenge still remains as to how to secure financing for these mega projects.  The willingness of IFIs to lend in challenging commercial and political environments is significant and accordingly the importance of IFIs in emerging market project finance should not be underestimated.