Finding the right credit enhancement’s package to support the obligations of a state-utility offtaker (the “Offtaker”) in state-utility Independent Power Projects (“IPPs”) in selected African markets is fundamental for the bankability of those IPPs.
In some markets, the credit rating is below the investment grade, foreign direct investment is hard to flow and the credit worthiness of state utilities is poor.
Sovereign risks play an important role in predicting the number of IPPs for each country as well as the size of investment (debt and equity) commitments.
The risk of non-payment by the sovereign supporting the Offtaker’s obligations under the project documents in some IPPs is not insubstantial. A large percentage of the African countries are considered risky borrowers by international standards.
Multilateral Development Banks (“MDBs”) play an important role by offering risk mitigation tools to unlock financing in African countries such as credit support instruments.
I. Sovereign Guarantees (“SG”) and publicly structured guarantees
1. SG – the “easy fix” solution to attract capital for IPP
Most of the IPPs in Africa over the past years benefited from SGs which were required by lenders (i.e. international financial institutions) and international developers in project finance structures.
In the context of an IPP, a SG is a guarantee from the state that an obligation will be satisfied if the Offtaker (as the primary obligor under the PPA) defaults.
Ideally, SGs from a guarantor with sound credit quality shall be obtained in IPPs. The SG shall rank senior or pari passu with the guarantor’s senior unsecured obligations.
SGs usually cover payment obligations of the offtaker. However, these can also cover all types of obligations and binding commitments.
In African IPPs, and under a fair allocation of risks between the independent power producer, the Offtaker and the state, SGs would typically cover the following risks:
- payment defaults or any other defaults by the Offtaker under the PPA or any other project document;
- state unilateral changes in tax treatment;
- termination of the PPA and other project documents;
- currency inconvertibility and FX transfer restrictions; and
- other political risks that are deemed under the sole control of the state.
States in emerging markets are reluctant to provide SGs due to insufficient fiscal revenues, increasing public indebtedness, macroeconomic deterioration and IMF restrictions. States tend to disfavor providing any guarantees on the top of a state supported PPA or a letter of comfort to support the offtaker’s obligations under the PPA.
2. Publicly structured guarantees
Absent any possibility to obtain a SG to guarantee the offtaker’s obligations, international developers and lenders may pursue the following alternatives to a SG:
- a guarantee from the central bank, national bank or any other state-owned bank such as a public finance institution to guarantee the offtaker’s obligations under the PPA and/or any other project documents.
- a guarantee from a state created fund established by reciprocal guaranteed structure with enough liquidity to be used as collateral. The fund should comply with best international practices in terms of governance and international solvency standards.
II. Alternatives to SGs and publicly structured guarantees
If a SG or a guarantee by a state public entity is not an envisaged option, then the following other instruments developed by the market for IPPs can be explored:
- Partial Risk Guarantees (“PRG”)
The PRG guarantees lenders against debt service payment defaults resulting from the state’s failure to meet its payment obligations as stipulated under selected project documents (e.g concession agreement or government guarantees).
The PRG would cover the risk of debt service arising from events and risks which include the following:
- political force majeure events;
- changes in law and events making the project contractual agreements unenforceable or void, or making the performance of the developer or its EPC contractor unlawful;
- government imposed restrictions on the ability of to be paid or to receive foreign currency or transfer funds abroad;
- transmission line (owned by the government or government entities) and grid interconnection risks;
- failure by the Government to fulfill its payment obligations.
- Political Risk Insurances (“PRI”)
Political risk insurances are solutions that covers (i) risks in connection with commitments on free convertibility of hard currencies and availability of hard currency reserves, (ii) risks in connection with change in law or invalidation of benefits that may adversely affect the project, (iii) risk of withdrawal of permits, licenses or concessions and (iv) risks of expropriation.
- MIGA Political Risk Insurance
MIGA offers political risk insurance cover solutions as follows:
- currency inconvertibility and transfer restriction cover for the risk of inability to convert or transfer dividends or loan payments due to foreign exchange restrictions;
- expropriation cover for the risk of government nationalization or otherwise when it is impossible to operate the project through discriminatory measures;
- war and civil disturbance cover in case of destruction or interruption of business due to political violence; and
- breach of contract cover in case of arbitral award default by government when it is determined through a dispute resolution mechanism that the government has failed to honor obligations under key project documents (e.g. concession agreement, PPA).
- Partial Credit Guarantee (PCG)
PCG is a credit enhancement mechanism for debt instruments (bonds and loans). It is an irrevocable promise by a third-party entity, usually an MDB (i.e. World Bank or AfDB) to pay principal and/or interests up to a pre-fixed amount.
PRGs cover part of the debt service default by the project company.
PRG is a useful tool to reduce the Offtaker’s risks through improving its creditworthiness and promote access to local debt funding.
PRGs address selected risks such as currency transfer and convertibility risks and commercial risks for developers finding it challenging to provide completion or performance guarantees under the project documents.
- Revenues ring-fencing structures
Other structured tools were designed to ring-fence revenues accruing to off-takers and ensure that there is enough cash to meet the Offtaker’s payment obligations under the PPA as follows:
- allocation of power sector revenues which are assigned to the discharge of IPP payment obligations; or
- assignment of bill receivable for a set of large and solvent accounts by the Offtaker into an escrow account managed by the seller (or a third-party manager).
- Guarantees provided by an Export Credit Agency (ECA)
ECAs are financial institutions that offers financing for domestic companies’ international export operation and other activities.
ECAs can underwrite the political risks and commercial risks of overseas investments, including in IPPs.
- Other credit support instruments and liquidity guarantees
Other type of credit support instruments include the following:
- Performance Bond: Letters of Credit (LC) or bank guarantee to the host government.
- Development Bond: for government consent or concession agreements, linked to specified milestones.
- Sponsor Support Agreement for funding shortfall during constructions, small contingency budgets, high-risk of cost over-runs.
- Debt Service Reserve Accounts with up to 12 months of debt service.
- Working Capital LC to fund initial cash shortfall.
- Escrow account (functionally equivalent to a letter of credit). It tackles short-term liquidity concerns. It shall be funded up to an amount equal to a certain number of monthly payments by the offtaker under the PPA.
- Put and Call Option Agreements (“PCOA”) which (i) for the call option, establishes the right of the offtaker or government to require the Project Company (PC) to sell the share of the PC or its assets to the government or the offtaker and (ii) for the Put Option, establishes the right of the government or the offtaker to purchase the shares or the assets of the PC under circumstances that suit the PC.