Development Finance Institutions – catalysing private sector investment in Africa

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By Frances Okosi, Partner in the Banking & Finance Practice at Baker McKenzie in Johannesburg

If the gap between the quality and quantity of Sub-Saharan Africa’s infrastructure and the infrastructure in the rest of the developing world could be narrowed, the growth of GDP per capita for the region would be increased by around 1.7% per year. This is according to the latest edition of the World Bank report –  Africa’s Pulse.

It has been estimated that development of Africa’s infrastructure will require investment of $93 billion per year for the next decade. As noted in the World Bank’s report, to-date less than half that amount is being invested annually, with only 50% of the amount invested being provided by regional governments. This leaves a funding gap of $48 billion a year and an increasing need for the private sector to play a significant role.

Incentivising the private sector to invest in Africa’s infrastructure is proving challenging. Amongst the most oft-cited obstacles to increasing private sector participation are (i) whether real or perceived, elevated levels of risk, particularly political risk driven by macroeconomic instability in many African countries (ii) in the power sector, poor credit utility off-takers, (iii) inadequate institutional and regulatory frameworks, particularly for public private partnership arrangements and (iv) a lack of “bankable” projects.

Many development finance institutions (DFIs) are at the forefront of addressing these and other risks that deter investment across the continent and are making it their mission to catalyse investment from institutional investors, commercial banks and other private sector participants.

Guarantees and insurance provided by DFIs and export credit agencies (ECAs) are the most obvious example of explicit risk mitigation available to support infrastructure projects across the region. For example, the financing for the construction of the 450 megawatts Azura-Edo independent power plant in Nigeria was supported by $237 million World Bank partial risk guarantees. These guarantees served to leverage a total investment in the Azura power plant of more than $900 million, made by a set of 20 international banks and equity finance institutions that are drawn from nine different countries. Obtaining the World Bank guarantees was crucial to the success of the financing.

The presence of DFIs and ECAs also provides implicit risk mitigation through the so-called “umbrella effect”: DFIs have influence and leverage that makes it more likely that governments and state-owned entities will ensure that debt repayment and other terms and conditions associated with a project are met.

Beyond providing direct lending or credit support, DFIs are also actively engaged in creating enabling environments to address regulatory and institutional challenges to private sector investment. The IFC’s Scaling Solar programme in Zambia, Senegal, Madagascar and Ethiopia is a good example. Under the Scaling Solar programmes, not only does the IFC provide financing support, but it has developed a package of bankable project documentation and a simplified tendering process all designed to increase transparency, reduce transaction risk and speed negotiations, thereby providing an incentive to international developers to invest in smaller scale solar projects.

Key to developing an enabling environment is capacity building within the public sector. For example, many governments in emerging markets have limited capacity to manage, structure and negotiate private power concessions and can find themselves up against deep-pocketed, international investors that have the experience and the resources to take the upper hand in negotiations. Here again, DFIs are playing a major role. The African Legal Support Facility (ASLF), hosted by the African Development Bank (AfDB), is an organization established to provide legal advice and technical assistance to African countries to redress these negotiating imbalances. The ASLF provides support to regional governments involved in complex commercial transactions (particularly in the natural resources sector) through training, funding engagement of top legal counsel and assisting with negotiations.

To help increase the number of “bankable” projects across the continent, NEPAD’s Infrastructure Project Preparation Facility (IPPF), again hosted by the AfDB, provides grants to African governments, Regional Economic Communities and African infrastructure-related institutions to prepare high-quality viable transboundary projects in energy, transboundary water resources, transport and ICT. However, attendees at a recent roundtable hosted by Baker McKenzie in conjunction with the Development Bank of Southern Africa and AfDB queried whether such complex, cross-border transactions would ever be truly “bankable” from a commercial bank perspective, notwithstanding the technical and financial assistance provided by the IPPF.

Beyond DFIs, other stakeholders are lending support to leveraging private sector investment across the Continent. The London Stock Exchange (LSE) is working with exchanges across Africa to help develop their capital markets. The aim is to tap into the local institutional investor base to offer an additional funding source for local businesses across Africa through supporting the development of robust regulatory frameworks as well as raising investor awareness and understanding.

DFIs are also playing an active role in encouraging impact investments. Impact investments are a recent innovation designed to attract private sector funding into infrastructure projects that have social or environmental benefits. In Introducing the Impact Investment Benchmark, by the Global Impact Investing Network and Cambridge Associates, impact investments are described as, “investments made into companies, organisations and funds with the intention to generate social and environmental impact alongside a financial return.” In contrast with “socially responsible investments”, impact investments are intended to proactively create positive social or environmental benefit, rather than just seeking to minimise negative impact.

Here too DFIs are playing an active role. A recent example is the US$152 million Forest Bond issued by IFC to support the Kasigau Corridor REDD Project in Kenya. Baker McKenzie advised BHP Billiton on the IFC first-in-kind bond instrument that raises funds from institutional investors to invest in threatened rainforests and forests, and under which the annual coupon can be repaid in carbon credits or cash.

If the private sector can successfully be incentivised to invest in infrastructure projects in Africa, the continent will take a major step forwards in reducing poverty and improving African lives.