62459 IFC Advisory Services in Public-Private Partnerships LESSONS FROM OUR WORK IN INFRASTRUCTURE, HEALTH AND EDUCATION In partnership with Australia, Austria, Brazil, Canada, France, Ireland, Italy, Japan, Kuwait, the Netherlands, Norway, Spain, Sweden, Switzerland, the United Kingdom, the United States, the Public-Private Infrastructure Advisory Facility, the Global Partnership on Output-Based Aid, the Private Infrastructure Development Group, the African Development Bank, the Asian Development Bank, the Brazilian Development Bank, the Caribbean Development Bank, the Central American Bank for Economic Integration, the European Investment Bank, the European Bank for Reconstruction and Development, the Inter-American Development Bank, the Infrastructure Consortium for Africa, and the Islamic Development Bank. Disclaimer IFC SmartLessons is an awards program to share lessons learned in development-oriented advisory services and investment operations. The findings, interpretations, and conclusions expressed in these papers are those of the authors and do not necessarily reflect the views of IFC or its partner organizations, the Executive Directors of the World Bank or the governments they represent. IFC does not assume any responsibility for the completeness or accuracy of the information contained in this document. This publication is printed using New Leaf Reincarnation matte, and Ecoprint inks and process. Printing 2500 copies saved: 2693 pounds of virgin wood, 1335 pounds of greenhouse gases, 422 pounds of solid waste, 3961 gallons of liquid waste, 3 pounds of harmful chemicals, 1 cubic yard of landfill space, and 606 kWh of electricity. International Finance Corporation Copyright © 2010 - All rights reserved Message from the Director Access to electricity, clean water, sanitation services, a transportation network, basic health care, and education are critical to improved living standards and economic development. In developing countries, the public sector alone cannot deliver the resources needed to increase access to these basic public services. Analysts estimate that investments in infrastructure should be seven to nine percent of GDP to sustain broader economic growth and reduce poverty. Yet, on average, developing countries invest less than four percent of their GDP in infrastructure each year. Private sector engagement is necessary to close that gap. IFC Advisory Services in Public-Private Partnerships helps governments implement public-private partnership transactions and expand private-sector participation to increase the quality and quantity of investments in infrastructure, health, and education, while limiting public sector funding and risk. IFC is the only multilateral agency that offers direct advisory services to governments on private- sector participation in these sectors. Our impact is enhanced by our strong partnerships with donors, regional and national development banks, and other international organizations. This publication highlights some of our experiences and lessons learned in working on more than 277 projects in 88 countries over the past 21 years. The SmartLessons that follow demonstrate the business case for private sector investment and show what worked and what should be done differently. We hope that you find this publication useful and welcome your comments. July 2010 Laurence Carter, Director IFC Advisory Services in Public-Private Partnerships SMARTLESSONS Index GENERAL LESSONS Mission Difficult, but Not Impossible… Making Public-Private Partnerships Work for the Poor - Robert Taylor .................................................................................................... 1 The Value of the “Value for Money” Approach When There’s No Money Juan Luis Flores ..................................................................................................................... 7 Delivering the Goods: Multi-Donor Approaches to Project Development and Funding John Hodges ......................................................................................................................... 15 LESSONS IN POWER Bringing Reliable Electricity to Rural Areas of the Philippines William Trant Beloe, Art Cariaga, Marianna Fernando-Pacua and Jed A. Sevilla ......................21 Five Keys to Powering Up a Private-Sector Participation Transaction: The Albanian Experience - Ariana Progri .................................................................................................... 25 Ashta Hydropower: Turning a Doubtful Concept into a Technological Trailblazer Martin Sobek........................................................................................................................ 31 LESSONS IN WATER A First for IFC! Desalination Project at King Abdulaziz Airport in Jeddah, Saudi Arabia Muneer Ferozie .................................................................................................................... 39 Never Test the Depth of the Water with Both Feet—Lessons from the Sinking of the Bangalore Water Project - Neeraj Gupta and Neha Mehra ...................................................... 45 Scaling Up Rural Water Supply Service in Benin: A Programmatic Approach and Budget Support - Sylvestre Bea, Claude Leroy-Themeze and Christophe Prevost .................................... 51 LESSONS IN TRANSPORT Dare to Fail—Counterintuitive Lessons from Mergers and Acquisitions Experience in the Airline Sector - James Morley .......................................................................................... 59 LESSONS IN HEALTH AND EDUCATION Breaking New Ground: Lesotho Hospital Public-Private Partnership—A Model for Integrated Health Services Delivery - Carla Faustino Coelho and Catherine O’Farrell ............. 67 Reappraisal of the Private Schools Support Programs in Ghana, Kenya, and Rwanda Brigid Amoako and Jane Onoka ............................................................................................ 73 SMARTLESSONS Mission Difficult…but Not Impossible Making Public-Private Partnerships Work for the Poor Public-private partnerships (PPPs) hold great promise for improving public services for the poor in emerging markets. But charting the political waters; balancing the needs of governments, consumers, investors, and lenders; and making the transaction transparent and sustainable are challenging tasks and not for the faint of heart. This SmartLesson summarizes 10 years of lessons of IFC’s Advisory Services in Public-Private Partnerships in its role as transaction advisor to governments on more than 100 mandates. PPPs involve a government contracting with a private mandates (including 43 active mandates) and successfully sector company for delivery of infrastructure and/ completed 36 mandates. Recent highlights include or services. As transaction advisor, IFC enters into a the Lesotho Hospital PPP, power generation and formal transaction mandate with a government client distribution PPPs in Albania, small independent power to structure and implement a PPP-type transaction. projects in rural Philippines, and a new airport terminal IFC’s work typically involves: in Amman, Jordan. Roughly 40 percent of current advisory mandates are in International Development t analyzing the project’s fundamentals; Association (IDA) countries. t reviewing PPP options and recommending a transac- tion structure; Transactions typically take 18–24 months to complete, and IFC’s success rate is about 40–50 percent (excluding t providing financial modeling of the PPP project; active mandates still under way). Delays and failure to t promoting the project to investors and getting their complete a transaction have an opportunity and morale feedback; cost on staff, so the department makes a considerable t preparing the PPP contract and tender procedures; effort to glean lessons that will increase the success and rate and speed up implementation. t assisting in conducting the tender and selecting the winner. LESSONS LEARNED IFC seeks to focus on first-of-a-kind transactions Lesson 1: Politics is (and will always be) the with high developmental impact in frontier sectors main cause of death for transactions. (such as health) and regions or countries that often present difficult challenges and so are of less interest It may be vested interests who would lose from a to commercial advisors and investment banks. transaction (especially a privatization) that eventually sabotage it. Or a government realizes that the project may not be acceptable to the public at the necessary RESULTS tariffs. Or the transaction simply runs out of time to Over the past 10 years, IFC’s Advisory Services in be completed before elections. Public-Private Partnerships has signed 112 advisory 1 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Political factors are the single most important privatizations, Queen Alia International Airport in impediment to success. Yet this is an area that IFC tends Jordan, Kenya-Uganda Rail, Kenya Airways, South to pay less attention to, since most staff are primarily African national parks, Polynesian Blue, and our technicians. But ignore it at your peril. Here is some small-power projects in the Philippines. In contrast, practical guidance to minimize political risk: we had a failed airline privatization and a failed airport concession transaction due to the lack of t Avoid taking on mandates within 12 (maybe even high-level political support. 18) months before elections, since most governments avoid anything potentially controversial close to t Identify and assess vested interests who would elections (and some countries actually have laws lose from the transaction. Several of our projects that prohibit major new contractual obligations in different sectors—electricity, water, transport, within a specified period before elections). Two of and health—never reached tender, primarily for our successful mandates (Romania dialysis, Kenya this reason. telecom) completed tenders just two days before t Check in advance to determine whether provincial national elections. And the Moatize mining PPP was or local-level transactions need national buy-in. In signed one month before elections. But one municipal one of our municipal service projects, we needed client stopped a water project, citing concerns about approvals at the municipal and national levels—an water tariffs, just ahead of elections. extremely lengthy process because governments t Assess top-level political commitment before signing a kept changing. When we finally got approval of mandate. Best if there is also a project champion with the bidding documents at both levels, the municipal status and clout. Many of our successful transactions government got cold feet due to upcoming elections have had strong client champions and top politi- and stopped the process. cal support, such as the Panama and Lima power SONEL power utility, Cameroon. Transaction closed in 2001. SMARTLESSONS 2 t Work closely with the World Bank to provide the simply unrealistic. In two Middle East and North broader necessary perspective on country politics Africa countries, we were asked by governments and economics. (unrealistically) to find PPP operators for new public hospitals that had been built (with external loans) Lesson 2: Project fundamentals should be but lacked funding for operations. Fortunately, we sound. discovered this before signing a mandate and were able to back out gracefully. Is the project needed (by the public), affordable (for consumers and the government), attractive (to investors), t Seeing whether it can be done under existing laws. and legal (without new laws)? These questions seem If not, try for a decree, regulation, or government obvious but can easily be overlooked in the rush to decision, but don’t count on new laws being passed respond to a government request. It doesn’t require a to get it done. The absence of enabling legislation huge, lengthy analysis before signing a mandate, but stopped our work on water PPPs in three different some quick answers can be gleaned by: countries, though for different legal reasons in each case. Polynesian Airlines, Samoa. Transaction closed in 2003. t Doing some quick analysis on whether the project t Checking investor (and lender) interest informally (service type, level, and location) is really needed by with a few local and international players. the public. Avoid the “white elephant” syndrome, t Doing quick back-of-the envelope calculations driven by politics, not need. And check for other to see the project’s impact on consumer prices or more cost-effective measures such as improving the government budget. We have rejected several throughput (for example, ports) or efficiency in requests from governments for airport concession consumption (for example, water metering) or transactions due to low passenger volume (in one buying the service from existing private providers case, fewer than 12,000 passengers annually). In (for example, hospitals). two water projects in Africa and Latin America, The scope of the PPP project is also important. In we recommended against proceeding with the principle, the greater the risk and responsibility transaction after our preliminary analysis showed transferred to the private sector, the greater the that the tariffs required for project viability were 3 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS potential gains in efficiency and service quality (if The global/local approach is crucial to success—both well structured). Don’t use PPPs solely as a financing in signing transaction mandates and in successfully technique to avoid public capital expenditures. But be implementing the transactions. IFC’s Advisory Services aware that increased private sector participation and in Public-Private Partnerships was at the forefront of responsibility also tend to generate more opposition the global/local movement, setting up regional-based from public sector employees. managers and local staff starting in the early 2000s. The results have been clear: many more mandates Lesson 3: Plan and manage your team and signed and better productivity (more mandates per consultants for maximum efficiency and staff). Being close to clients (in this case, governments) results. is absolutely essential for success. In many cases, an IFC local presence can help keep a transaction on Transactions typically require a diverse team of financial track and moving quickly. and transaction experts (usually IFC staff); technical and sector specialists who can best determine project Lesson 4: Make the contract bankable and needs, sizing, and specifications; and transaction lawyers sustainable. to vet the legal framework and put the project into proper contracts. There are really two hurdles in this business. The first is getting to a successful transaction. The second—and But getting the team in place, funded, and functioning more important—is having it last. In practice, keep as an efficient unit is not straightforward. Often the in mind several things: technical consultants and lawyers are funded in part through donor funds, which may take time to arrange. t Check and recheck the risk allocation matrix with And hiring the consultants requires adherence to IFC investors and lenders to get their reaction and identify procurement guidelines, which also takes time. any deal breakers early on. Don’t stray too far from accepted international practices. The data and information that IFC requires from its consultants for transactions are very specific and t Governments often have an unrealistic view of what transaction-driven. So it is imperative to ask for only they can get from investors and what they have to give what is needed for the transaction analysis and contract up in return. Although it is the transaction advisor’s documents. We’re not here to do studies. job to communicate the concerns of investors or lenders (and identify unrealistic assumptions of the You can accelerate the transaction preparation and client), it helps to have investors tell the govern- get effective results by: ment directly. Nothing has the same impact as a major investor telling the government why it won’t t Obtaining donor funds before signing the trans- participate. The art in this business is separating the action mandate (or in parallel with mandate real deal breakers from the desirable-but-not-essential negotiations); list. But, sometimes, clients don’t take our advice. t Compiling available client and project data before In a municipal water PPP in Latin America, we the consultants are on board, so they don’t waste experienced two failed tenders due to unrealistic time searching for it; and expectations of the municipality about what it could t Having a joint kick-off session with the team, the get from the market. consultants, and the client team to set everybody t Pay particular attention to the pricing and PPP off on the same track. payment structure and adjustment formulae. They SMARTLESSONS 4 may well be the most important element of the the decision on the precise prequalification criteria is contract for incentivizing performance and efficiency. the government’s, not IFC’s, but it is our job to advise t A balanced contract and good regulation are the the client on right-sizing the criteria for the project most effective tools for sustainability (and yet the and on the implications of different criteria for who hardest to achieve in many client countries). If a will prequalify and who won’t. deal is too good to be true (for one side or the Despite our best efforts to set quantifiable and other), chances are it won’t last. And if it depends verifiable criteria that will not be subject to dispute on big price increases for consumers, it is probably in interpretation, we often face interpretation disputes doomed to failure. A major reason for the success over such issues as accounting standards applied to and sustainability of some of our power and water financial criteria, the definition of an affiliate (and transactions was our ability to close the transaction whether its experience counts), and so on. You can never with the same, or even reduced, consumer tariffs (for completely eliminate the possibility of a complaint, but example, the Panama power privatization resulted you can go a long way toward removing the possibility in an immediate 10 percent reduction in consumer of interpretation disputes. tariffs). In the bidding, we have tended to favor price-only Lesson 5: Be sure there is transparency bids, with sealed envelopes opened and read in a public throughout the process. ceremony. This means no business plans, no technical proposals, and no other documents that could be In all these transactions, IFC’s reputation is most subjectively evaluated (and hence prone to disputes) at risk if investors or the government believe that or later prove to be a hollow promise. there has been favoritism or a lack of neutrality or transparency, particularly in structuring and implementing prequalification and bidding. Such a perception can result in lawsuits, negative press, and a tarnished reputation. Transparency sounds easy, but in fact there are decisions throughout a transaction that affect the perception of transparency. Traditionally, IFC has followed a somewhat rigid approach that favors objectivity and simplicity over subjectivity and complexity. How does this work? Typically, where there is a prequalification process as a precursor to bidding, we favor quantifiable and verifiable technical and financial criteria, such as “at least five years’ experience as an operator of a water distribution company serving at least two million customers,” or “net worth of at least $300 million as of year-end 2008.” But setting these criteria necessarily involves some degree of arbitrariness and can cause complaints, generally from local firms that are not big enough to prequalify on their own. True, Suape TECON, Brazil. Transaction closed in 2001. 5 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS This approach works best for straightforward projects transaction goes beyond a specified time frame (for that are not very conducive to innovative technical factors beyond IFC’s control). This signals at the solutions or major differences in approaches by bidders. time of mandate negotiations that time has a cost The possibility for complaints and corruption is and we are not prepared to work on a transaction minimized, but at the cost of rigidity. indefinitely. Increasingly, we are faced with complex projects t We are now including more explicit exit clauses where bidders may have valid differences in design in our transaction mandates; this allows IFC to and approach that should be considered and cannot terminate a mandate if it becomes clear that the be readily standardized into a price-only bid. It may transaction is not advancing or has little chance be for a new airport (for example, Amman) or a new of success. hospital (for example, Lesotho). In these cases, we recommended a set of criteria for evaluating technical CONCLUSION proposals, which may be either pass/fail or weighted with When many of these factors go in our favor, we can the financial proposals. It’s not perfect or completely have quick successes. One of our largest transactions—a objective, but rather a recognition that some projects $950 million privatization of the electricity distribution are just too complex or innovative to suit a price-only company in Ceara State (Brazil)—was also one of bid procedure. the fastest: eight months from mandate signing to closing. Top political support, excellent counterparts, Lesson 6: Exiting—is there ever a graceful good tariff levels, and a sound legal environment all way? contributed. But when the negatives start piling up, mandates can drag on mercilessly for years without Our experience clearly demonstrates that the longer relief. Applying our lessons in mandate selection and it takes to sign a mandate, and the longer it takes to execution can reduce—but probably not completely implement a transaction once a mandate has been eliminate—these poor-performing mandates and signed, the less likely it is that it will result in a successful increase our overall hit rate. transaction. And, as noted earlier, mandates that drag on will waste resources and hurt staff morale. Staff don’t want to work on projects that take a long time and are not ultimately successful. But it may be hard for IFC to abandon a mandate if the government still wants to pursue it, since the government is also an ABOUT THE AUTHOR IFC shareholder. Robert Taylor, IFC Advisory Services in Public-Private We have introduced three actions to address this Partnerships, has 24 years of experience in the World problem: Bank and IFC, working on private sector delivery of public services. t We spend more time on due diligence of a project’s Approved by Laurence Carter, Director, IFC Advisory political risk and fundamentals before signing a Services in Public-Private Partnerships. transaction mandate. If a project has little chance of success, it is better to find out before signing the February 2009 mandate (and therefore not sign it). t We try to include additional monthly fees if the SMARTLESSONS 6 The Value of the “Value for Money” Approach When There’s No Money Value for Money (VfM) is a technique used by advisors during the design phase of an infrastructure project with private participation to identify whether the participation of the private sector creates enough value for governments to offset the incremental cost of private financing. Primarily used in developed or middle-income countries—where there is more money and more options—a central question is this: Should we also use this tool for projects in low- income countries? I believe so, and in this SmartLesson, I will try to explain the use of this tool, using the experience gained during the design of a health project in Mexico, to show the benefits of the VfM tool regardless of the country. INTRODUCTION a PPP structure was better than simply building two new hospitals with public debt. The VfM exercise Starting from the beginning, why does a government was thus developed in conjunction with specialized look for a public-private partnership (PPP) to provide consultants, different entities of the client, and the infrastructure? MONEY, either in the form of private IFC advisory team. financing or as savings created by the use of private management. PPPs are used on the basis of creating value from combining the strengths of the public VALUE FOR MONEY: THE TOOL and private sectors to provide a more efficient public VfM is based on a simple concept: Compare how service for the population (the ultimate goal). much it would cost the government to build and run such an infrastructure facility if completed by the Because of the limited resources and the current public sector (the reference project), versus the cost financial crisis, it is more important than ever to have under a PPP scheme. solid transactions based on value creation instead of only using private financing. Because the VfM tool Costs for the reference project are compared to the specifically helps to identify the value created for costs of the PPP project, as follows. governments from private-sector participation, VfM can be particularly useful for low-income countries, Reference project (amounts should include VAT if applicable) such as those that receive assistance from the World Bank’s International Development Association (IDA), Risks assumed $ which provides financing for the poorest countries. In Operating expenses $ such countries, it is even more important to ensure Financial cost $ that scarce resources will be used under the most Equipment cost $ efficient structure (including public works). Construction expenses $ This SmartLesson is based on our experience in providing Construction cost $ advisory services to the Institute of State Employees of the State of Mexico. VfM was used to justify why Total Cost of Reference Project $ 7 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Public-Private Partnership project investment (including expenses) to finance construction (amounts should include VAT if applicable) and equipment of the infrastructure, this number is the NPV of the interest payments for that bond issue. Risks retained $ As an option, you can take the total cost of the last Operating expenses retained $ bond issued (including fees) and use that number. NPV of PPP payments $ Equipment cost: This is the cost of the equipment. In Transaction expenses $ most cases, there is a component in foreign currency, so you should use the most appropriate exchange rate. Total cost of PPP project $ This exchange rate should be the same for the PPP project. And don’t forget about VAT, if applicable. The VfM is calculated by subtracting the total cost of Construction cost: This is tricky. Here’s my preferred the PPP project from the cost of the reference project; approach to get this number: in this section, I put if the result is a positive number, then there are benefits the “efficient” cost of building this facility; and for to bringing in private participation. “efficient” I use the cost that a private-sector company under private contract would charge. Inefficiencies VALUE FOR MONEY: EXPLAINING EACH due to public procurement should then go to the risk CONCEPT matrix. This approach is simple, and the number will be the same under the PPP project. Another approach Both the reference project and the PPP project are is to include the inefficiencies of public procurement in based on the same assumption: cash flow from the this calculation. The construction cost will be different government perspective. under the PPP project and should include the cost of insurance for risks transferred. This approach obviously The Reference Project is more complex. The calculation for the reference project asks how One note: The numbers that are net present valued much the government will pay if the project is done should be discounted at the real discount rate of as a public works project (including contingencies the project. However, this number is always under and risks associated). discussion. For example, projects done in Mexico at Risks assumed: This number comes from the risk the federal level are discounted at a 10 percent real rate, matrix and reflects the net present value (NPV) of all while projects at the sub-national level are discounted the possible contingencies weighted by a probability at a 12 percent real rate. that they may occur during the construction and operational phases. THE PPP PROJECT Operating expenses: This is the net present value of The calculation for the PPP project is based on the running the facility. In a hospital, for example, this estimated total amount that the government will either would include staff salaries, the cost of medicine and pay or assume the risk to pay under a PPP scenario. treatments, building and equipment maintenance, etc., Risks retained: This is the net present value of the as well as the value-added tax (VAT), if applicable. risks that the government retains (also include VAT, Financial cost: Based on the assumption that the if applicable). The calculation comes from the risk government will issue a bond for 100 percent of the allocation portion of the risk matrix. SMARTLESSONS 8 Operating expenses retained: Depending on the t What is the probability of the risks occurring? services transferred to the private sector, this calculation t If the risks do occur, how frequently would this includes the net present value of the operating expenses happen (daily, monthly, annually, etc.)? that the government will be funding. This is where most of the value can be created. Allowing the private In countries where we usually work, there are no sector to use its creativity, long-term vision, private formal data to use, so we have to rely on people’s management expertise, and smart investments, likely knowledge and experience. Therefore, to answer these creates savings in the long run. questions, the IFC team held a number of workshops with the client, external consultants, and those inside NPV of PPP payments: From the government’s the government who could provide their knowledge perspective, there are two kinds of payments that related to public works, finance, planning, etc. should be considered here: (1) payments that the government makes directly to the private sector, such The first workshop was about defining the risks. We as availability payments and public funds to reduce prepared an initial document with what we thought private investments; and (2) payments made by the were the risks associated with the project. Preparation users of the service that are not directly received by of this document helped us to be more efficient because the government because of the PPP structure (e.g. toll at the workshop we were all on the same page. By payments). In the case of availability payments, please going down the list, we asked the different people be sure to include VAT, if applicable. Also, the data for involved for their thoughts, and the ensuing discussion availability payments come from the financial model. helped us to identify additional risks or omit those Such amounts should be calculated to cover the debt we had originally included. The key here is to ensure payment, operating expenses, taxes, insurances, and representation from all the relevant stakeholders and profitability of the private sector. Debt conditions be sure to make a clear summary of the discussion. usually vary depending on the financial situation; For the hospital example, we categorized the risks for example, for the hospital, we are assuming a 60 into different groups to help ensure that we covered percent debt structure. most of them: Transaction expenses: Because it is using a PPP t design risks; structure, the government incurs expenses that under a public works structure would not occur—for t construction risks that could cause a cost overrun; example, the cost of advisors (such as IFC), specialized t construction risks that could cause a delay; consultants, lawyers, etc. Therefore, such expenses are t risks associated with the equipment that could cause considered transaction expenses. a cost overrun; t risks associated with the equipment that could cause BUILDING THE RISK MATRIX a delay; Creating the risk matrix to calculate the “total risks t operating risks. assumed” is perhaps the most challenging task, as it requires careful understanding of the project and the The second workshop was about determining the players involved. Building a risk matrix is based on impact, probability, and timing of the risks. This four questions: was more complex than the first workshop because people had to be as honest as possible, since this is t What are the risks associated with the project? where inefficiencies were presented and measured. To t What will be the impact if such risks happen? encourage honesty, it is very important to let people 9 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS know that such inefficiencies are mostly because of the NPV of the risks, and then allocated the risks borne government’s way of working and not because of the by the private sector. To allocate these risks, try to people. During this workshop, the discussion is about use 0 percent and 100 percent as much as possible. magnitude and not about exact numbers. Because For example, in our project, the public sector decided the magnitude must be translated into numbers, it to keep doctors and nurses under the government’s is good to set up a standard way of translating this. control (hired by the Institute of State Employees of For example, something that “always happens” means the State of Mexico), therefore bearing 100 percent a 90 percent probability, while something not likely of the risk and the cost if, for any reason, one of the to happen is a 10 percent probability. It is also good doctors did not show up for work that day. to avoid the extreme situations of 100 percent and 0 percent because if a risk is identified as something that See Table 2 in the annex for a partial view of the risk could happen, a 0 percent probability assumes than allocation matrix for the hospital project. it will never happen. If something is 100 percent or 0 percent, then it is not a risk; it is a fact. THE VALUE FOR MONEY TABLE During the discussion, it is important to constantly go When we had all the different elements, the VfM table back to the participants and review the probabilities. (see page 10) was completed showing our project with Ask them if, given these numbers, such risk should a positive value for money. During the exercise, the remain with the given probability. In most cases, you will find that the group will adjust the numbers. Value for Money for the hospital project For consistency of the numbers, it is important to Reference project finish this workshop in one session and with the same people. Ask for two to three hours of discussion, Risks assumed (VAT incl.) $968,139.50 and don’t let the session end without finishing the Operating expenses (NPV) $3,481,930.72 exercise. Although this exercise is not about getting Financial cost (NPV) $297,893.25 exact numbers, it is important that there are consistent Equipment cost $205,620,17 numbers in magnitude. To calculate the “total risks Construction expenses $183,024.46 assumed,” you will need the NPV of the risks involved Construction costs $324,000.00 in the project and the time frame of when people Total Reference Project $5,460,608.11 think it might occur. To answer this question, we defined “moments”(which are at the beginning of the Public-private project construction period, the end, and sometimes in the Risks retained $321,278.60 middle) by a percentage. For the operation phase, we Operating expenses retained $1,635,501.99 did the same thing and defined moments either on NPV of PPP payments (incl. VAT) $2,142,518.07 a monthly or an annual basis, in a certain year, etc. Transaction expenses $3,225.0 See Table 1 in the annex for a partial view of the risk Total PPP $4,102,523.66 matrix that we developed at the end of the first and second workshops. Total Reference Project (a) $5,460,608.11 TOTAL PPP (b) $4,102,523.66 The third workshop was about determining the risk Value for Money (a-b) $1,358,084.44 allocation to calculate the “risks retained” number on the PPP project analysis. We started by reviewing the *Numbers were modified SMARTLESSONS 10 client realized that having doctors and nurses under members of the Ministry of Finance to participate in the government’s control represented over 40 percent the workshops to allow them to take part in creating of the risks retained ($103,697). However, the client solutions and give them confidence that the VfM decided to go ahead with this project keeping doctors exercise was properly done. and nurses under government control. CONCLUSION LESSONS LEARNED The VfM tool helps both the clients and ourselves to Lesson 1: The VfM tool helps to identify where have a clear vision of which risks can be transferred value is created, but all the calculations must to the private sector and which will be retained by the be inside the financial model to really help in public sector. Having this information serves as an easy the decision-making process. checklist when writing the legal contract, to ensure that all the transferred risks are really transferred and While doing the exercise, the client realized how much to help the public sector start thinking about measures money it was losing because of the poor system for to mitigate the effects of the retained risks—e.g. in the medicine control and limitations due to the union. It case of the cost of medicines, the client started to work was at this juncture that the client decided to contract on a structure to allow them to “share” pharmacies out administration of the medications to a private party with their other hospitals to reduce inventory costs. even if the cost of the medicines was to be absorbed by the Institute of State Employees. To make this In addition, the VfM tool proved very useful in giving decision and adjustment, it was important to keep all confidence to the client about the use of a PPP. Even the elements within the financial model and have them though the state of Mexico had the resources, it linked to the basic assumptions, as this helps keep the was trying to improve its credit rating and still had numbers updated and make it easier to manage the considerable financial needs. With a limited capacity different scenarios of risk allocation. to take on new debt, the Minister of Finance needed to be confident that the best structure was used to Lesson 2: Political consensus is critical. Having build the two new hospitals. different stakeholders participate in the workshops helps to build it. One of the main criticisms of VfM is that the tool is extremely easy to manipulate. However, the value Workshop activities are based on identifying areas of the VfM tool is based on the confidence in its in which the private sector is more efficient than the numbers. Having different stakeholders participate public sector; therefore, if discussions are not managed in the analysis workshops helps to ensure confidence appropriately, they can become awkward. Worse yet, about the numbers. Moreover, having participants some stakeholders could block the project. To address from the Ministry of Finance gives total transparency. this issue, the project team stated from the beginning Ultimately, the use of this tool was important to the (and repeated often) that inefficiencies on the public state of Mexico to ensure that its money would be side are usually caused by the way the government works well spent—a concern shared by other countries and (e.g. annual budgets, changes in priorities, changes in particular by poor countries, where resources are due to political interference, etc.). Because the team very limited. framed the challenges as a problem in the process and not caused by the people, the stakeholders were more confident in telling us the real numbers and supporting the project. In another example, we invited 11 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Annex Table 1: Partial view of the risk matrix for the hospital project, developed after the first and second workshops. Description Probability Impact Base Timing NPV (% base) (when could it happen?) Construction risk Change of design 70% 10% Construction cost 75% Construction 18,360 Increase of scope 30% 20% Construction cost 75% Construction 15,737 Lack of budget 10% 20% Construction cost 65% Construction 5,341 Materials price increase 20% 15% Construction cost 50% Construction 8,229 Equipment risk Exchange rate 20% 15% Equipment cost 65% Construction 5,074 Delivery delays due to purchase order 30% 1 Monthly budget 65% Start 2,038 Installation works not ready 20% 2 Monthly budget 65% Start 2,717 Operation risk Failure to get certifications/permits 40% 10% Annual budget Start 13,376 Delay on having staff hired 20% 5% Annual budget Start 3,344 Delay on having staff trained 20% 5% Annual budget Annual 3,344 Availability of medical staff 40% 10% Annual budget Annual 103,697 Availability of support staff 10% 3% Annual budget Annual 7,777 Availability of medicines (pharmacy) 30% 10% Annual budget Annual 77,773 Pharmacy losses 50% 3% Annual budget Annual 38,886 Lack of maintenance of equipment 20% 5% Annual budget Annual 25,924 Lack of medical equipment 15% 5% Annual budget Annual 19,443 Obsolete medical equipment 20% 7% Equipment cost Annual 17,240 Note: numbers were modified SMARTLESSONS 12 Table 2: Partial view of the risk allocation for the hospital project, developed after the third workshop. Risk Distribution NPV Distribution (%) Description NPV Public Private Public Private Construction risk Change of design 18,360 100% 0% 18,360 - Increase of scope 15,737 100% 0% 15,737 - Lack of budget 5,341 0% 100% - 5,341 Materials price increase 8,229 0% 100% - 8,229 Equipment risk Exchange rate 5,074 0% 100% - 5,074 Delivery delays due to purchase order 2,038 0% 100% - 2,038 Installation works not ready 2,717 0% 100% - 2,717 Operation risk Failure to get certifications/permits 13,376 50% 50% 6,688 6,688 Delay on having staff hired 3,344 65% 35% 2,174 1,170 Delay on having staff trained 3,344 65% 35% 2,174 1,170 Availability of medical staff 103,697 100% 0% 103,697 - Availability of support staff 7,777 0% 100% - 7,777 Availability of medicines (pharmacy) 77,773 100% 0% 77,773 - Pharmacy losses 38,886 0% 100% - 38,886 Lack of maintenance of equipment 25,924 0% 100% - 25,924 Lack of medical equipment 19,443 15% 85% 2,916 16,527 Obsolete medical equipment 17,240 20% 80% 3,448 13,792 Note: numbers were modified ABOUT THE AUTHOR Juan Luis Flores joined IFC in 2007 and is currently a Senior Investment Officer for IFC’s Advisory Services in Public- Private Partnerships, responsible for Mexico and Central America. Prior to joining IFC, Juan Luis was the Structured Finance Director for a Mexican commercial bank. Approved by Richard Cabello, Regional Manager for Latin America and the Caribbean, IFC Advisory Services in Public-Private Partnerships. May 2009 13 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Centro Médico entrance, Mexico. SMARTLESSONS 14 Delivering the Goods: Multi-Donor Approaches to Project Development and Funding Getting several bilateral and multilateral donors to collaborate on the development and funding of partnerships with the private sector can be a daunting task. IFC has, however, participated in such a partnership—the Private Infrastructure Development Group—which has successfully delivered results on the ground. BACKGROUND adopted that sought to draw on available private-sector In 2000, the UK government, through the Department expertise and experience with project development and for International Development (DFID), reached the investment. At the same time, PIDG donors retain conclusion that it made sense to use aid financing control of overall policy in order to ensure maximum to help mitigate risks that constrained private-sector developmental value and to limit any “subsidy” element investment in badly needed infrastructure development, to the absolute minimum necessary to mitigate risks improvement, and expansion in developing countries. that constrain private-sector investment. All donor In seeking to develop an approach, DFID decided to members have a say on whether or not a new facility bring in as many like-minded donors as possible so should be established under the PIDG umbrella, but as to provide a single interface for both governments those donors contributing to a specific facility lead and potential private investors for the development the more detailed operational criteria for that facility. and financing of infrastructure projects. The model that was developed was based on a standard As a result, the Private Infrastructure Development commercial company approach, with donors setting Group (PIDG) was launched in 2002. The World Bank investment policy and country/sector limits and the Group has been a member since its inception, first company’s board of directors making the decisions on through the International Bank for Reconstruction individual investments within those policy parameters. and Development (IBRD) window and, since 2007, Company equity is held by a trust fund established through IFC. Current members are Austria, Ireland, by the PIDG specifically for this purpose, and board the Netherlands, Sweden, Switzerland, the UK, and members are selected and appointed by a nominated IFC. committee representing participating donors. Project identification and day-to-day company management functions are contracted out to commercial management THE APPROACH companies recruited by open competition. Realizing that the in-house capacity in the capital markets sector ranged from limited to nonexistent on In order to have a single interface with which the the part of most of the PIDG members, an approach was board could interact at the donor level, and to ensure that all parties abide by the governing principles, the 15 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS participating donors convene biannually as a Governing In addition, the PIDG provides direct grant funding Council, which is serviced by a program management support to IFC’s Advisory Services in Public-Private unit tasked with day-to-day management of the PIDG Partnerships through a specially established trust and the implementation of council decisions. The fund at IFC (the DevCo trust fund), which is used diagram below illustrates the overall approach. to pay for consultants who develop and take forward IFC advisory mandates. The PIDG also has its own OUTCOMES TO DATE technical assistance fund for local capacity building for both the private and public sectors in association Using the above-mentioned approach, the PIDG with PIDG projects. has to date established three companies: Emerging Africa Infrastructure Fund Limited (EAIF) to provide long-term hard currency debt; GuarantCo Limited to RESULTS provide local currency guarantees; and InfraCo Limited, As of July 2009, the PIDG donors had jointly invested a developer of greenfield investment opportunities. a total of $334 million in all the PIDG’s facilities and operations. There were 30 projects to which loans/ PARTICIPATING DONORS Grants/Interest free loans PIDG TRUST Equity  FUND MANAGEMENT Mgmt PIDG COMPANY LTD Debt COMPANY  BY SUBSCRIPTION  PRIVATE INVESTORS Commercial Commercial Commercial funding funding funding    PROJECT A PROJECT B PROJECT C    Equity/Debt Equity/Debt Equity/Debt PRIVATE INVESTORS SMARTLESSONS 16 guarantees had been issued by EAIF and GuarantCo, In contrast, the next PIDG facility to be developed plus 15 projects developed by InfraCo and DevCo that (GuarantCo) was initially developed jointly by two had been successfully concluded with private-sector PIDG donors. After three years, however, the joint investors. These projects have included investment development approach was abandoned because working commitments of $9.5 billion by the private sector, with two governments—each with different rules, i.e. approximately 30 times the expenditure to date regulations, and drivers—proved difficult. GuarantCo by the PIDG donors. (It also needs to be borne in was eventually taken forward by a single PIDG donor, mind that most of the PIDG donors’ investment is with others “buying in” on completion, and was then in the form of equity through the PIDG trust fund, fully operational within a year. which is itself making a return.) Lesson 2: Manage donor expectations with LESSONS LEARNED care: It’s best to under-promise and over- deliver. Over the seven years since the PIDG established its first company, a number of lessons have been learned In taking forward a new initiative, the project officer as to what approaches work in setting up donor-funded has an understandable tendency to use the most private companies in the development sector, and the optimistic assumptions (often without fully spelling pitfalls that await those seeking to establish similar out the potential downside) in order to gain interest multi-donor mechanisms. and investment from the donors. The project officer is faced with the twin problems of needing to forecast Lesson 1: Nominate a single donor to be tangible results within the time scale of funding horizons responsible for developing a facility or (usually three years for bilateral donors) while operating company. within what is practical for a complex, innovative, and often untested initiative. EAIF was the first PIDG facility established (and therefore would generally be expected to take longer In the case of the PIDG, the first initiative (EAIF) to develop). EAIF was initially developed and taken got off to a good start because of a backlog of projects forward by DFID, with other interested donors “buying seeking long-term debt, but then it stalled from a in” once the company was up and running. EAIF was predictable lack of suitable bankable projects. EAIF launched in two years, from inception to full operation. made no new loans for almost a year while efforts were made to identify new investment opportunities. This led to donors’ disillusionment, which was difficult to overcome once business picked up and further equity was required. In retrospect, it would probably have been better to highlight this potential problem from the outset, but this was not done in order to encourage initial investment commitments. In the case of InfraCo, donors made it clear from the outset that they would be seeking high developmental returns from the initiative. In response, a concept was adopted that specifically targeted a number of projects Infraco Chanyanya Irrigation, Zambia that would generate high direct developmental returns (as 17 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS opposed to indirect returns through increased growth). felt compelled to ask detailed questions about each In practice, such projects have been difficult to develop, and every project if they were to give their approval, have taken longer than anticipated to bring to the and the 10 days became many weeks. point of sale, and are proving difficult to sell under current capital market constraints. The consequence The donors were eventually persuaded to abandon the is that donors are loath to increase equity inputs to 10-day consultation period and to trust the decisions InfraCo at a time when this is sorely needed, saying on project selection made by the boards, limiting donor that they want to see results before making further (shareholder) inputs to holding the boards accountable investment. In retrospect, it would have been better to for complying with the investment policy set by the have made it clear to donors that, in order to achieve donors. Much friction and many delays would have some early wins and thus demonstrate success, more been avoided if such a policy had been put in place straightforward projects (which would demonstrably from the outset. bring quicker returns to investors) would be appropriate during the early years of the new facility. CONCLUSION There are advantages to all concerned (donors, developing countries, and the private sector) by providing donor support for the development and funding of private- sector projects in infrastructure (and other) sectors in developing countries through multi-donor approaches such as the PIDG. Bilateral donors, particularly those with smaller aid budgets, are able to participate in and guide multi-million dollar investment programs; IFC gains access to significant amounts of grant funding; and recipient-country governments and the private sector have a single interface with an experienced EAIF Safel Roofing Project, Kenya investment professional and a quick, non-bureaucratic decision on an investment request. Lesson 3: Make it clear from the outset that it is the company’s board and not the donors who have the responsibility for project selection. ABOUT THE AUTHOR During the early days, the PIDG was “feeling its way” John Hodges was Head of DFID’s Infrastructure Department until his retirement in 2002, and Program with the donors, trying to take forward a concept (grant Manager of the Private Infrastructure Development investment from aid donors in private development/ Group (PIDG) until June 2009. investment companies) that was completely new to all involved. As a consequence, an arrangement was September 2009 initially put in place under which all projects being presented to the companies’ investment committees would be submitted to participating donors on a 10- day “no objection” basis. This system soon became a DFID constraint to project development because the donors SMARTLESSONS 18 Bringing Reliable Electricity to Rural Areas of the Philippines Electric cooperatives (ECs) in the Philippines are generally undercapitalized and their operational performance is poor. As a result, the supply of electricity in rural areas is unstable, with frequent outages and fluctuating voltages. IFC Advisory Services in Philippines found that a principal reason was the ECs’ lack of sound capital expenditure (capex) plans and introduced a new product to address the issue. The results from the pilot training of six ECs in post-conflict areas of Mindanao will be replicated in all ECs in the country and will ultimately bring an estimated $274 million worth of investments in capex and power generation, and reduce greenhouse gas emissions by 600,000 metric tons per year starting in 2015. To get to this point, IFC learned five key lessons about the importance of building strong relationships to “sell” ownership of the program to clients and pivotal stakeholders and to ensure program sustainability through local consultants and partner organizations. BACKGROUND program that systematically lines up projects to improve the operating efficiency of the ECs. The capex plan, Securing a reliable supply of electricity for rural homes a key element of the ECs’ broader business planning, and small and medium enterprises (SMEs) is a key incorporates a financing and rate impact study. Such ingredient in bringing economic opportunities to the plans match demand with supply and distribution and country’s least well off. In rural parts of the Philippines, present requests for rate enhancements before regulatory electricity is delivered through a network of 119 ECs agencies. The realistic rates justify new investments that account for seven million electricity connections, to make ECs improve their operations. or 75 percent of total connections. The ECs’ poor operational performance caused 10 percent productivity Initially, six ECs participated in six months of training, losses for SMEs. These inefficiencies contribute to the which resulted in identifying the need for $26.59 million high cost of electricity, which, at $14 per kilowatt in new capex investments in five years in these pilot hour, is one of the most expensive in Asia. ECs’ electricity distribution areas. The capex plans so impressed the Energy Regulatory Commission (ERC) Under its Rural Electrification program, IFC’s Advisory and the National Electrification Administration (NEA), Services partnered with the Association of Mindanao which had met with little success in getting ECs to Rural Electric Cooperatives (AMRECO), one of submit realistic capex plans, that they mandated the the country’s biggest groupings of ECs. The Rural replication of the program in all of the 119 ECs that Electrification program aimed to strengthen the capacity make up two of every three electricity connections of AMRECO’s 33 member ECs to plan and manage in the country. The ERC promptly approved the six their operations in a financially sustainable manner, ECs’ capex plans, whereupon another group of 16 particularly through capex investments. ECs began similar training, with AMRECO acting The ECs are now trained to write sound capex plans as project leader. Thirteen of the ECs are paying the that include demand forecasting and operational full cost. improvements. Capex planning refers to a five-year 21 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS On August 5, 2009, the heads of the NEA and ERC In PHILRECA, the general manager was the one signed a memorandum of agreement with IFC Advisory who had to be convinced first of a proposal’s merits. Services, the Philippine Rural Electric Cooperatives Association (PHILRECA), the National Association After a thorough study of why ECs were not delivering of General Managers of Electric Cooperatives, and stable and lower-priced electricity to rural areas, IFC AMRECO to adopt the “Electric Cooperatives determined that ECs lacked the expertise, particularly Distribution Utility Planning Manual” based on in engineering analysis and system planning, to come IFC-developed templates for capex plans submitted up with appropriate capex plans. This, together with for ERC’s approval and as a vital document in the the ECs’ inability to perform appropriate tariff analysis NEA’s supervision of the ECs. and their inexperience in justifying proposals for rate increases, prevented them from recovering legitimate At the request of the NEA and ERC, the IFC Rural costs. Electrification team is scaling up its capex planning workshops to the rest of the country. IFC has agreed The ECs were ill-positioned to secure long-term to train 30 of 86 rural ECs in Luzon and Visayas, the financing for their capex needs. Commercial banks two other island groups that, together with Mindanao, had little understanding of ECs, and the ECs could form the Philippine archipelago. IFC will partner with neither package their requests with adequate feasibility PHILRECA, the “mother” association of Philippine support nor describe to the banks the true nature of ECs, and ensure its capability to train the ECs. The ECs EC credit risks and strengths. are paying the full cost, as they expect the gains to far The key, therefore, was to train the ECs in capex outweigh the costs. As a result of systems improvement planning and in remedies for other critical deficiencies. from the training, the ECs’ total systems losses alone IFC, however, took care not to impose the solution on could be reduced by two percent, saving them $28 the prospective client ECs. It searched for a competent million per year. trainer and found the ideal “relationship builder” in The following five lessons from the project may help Jed Sevilla, who would later organize and manage the facilitate capacity-building projects in other areas. capex planning workshops and guide the ECs, step by step, through the process. Sevilla was previously the general manager of an EC in Sultan Kudarat province in LESSONS LEARNED central Mindanao. His technical expertise and relevant experience were known to the clients and earned their Lesson 1: Find a project leader who can secure confidence. He also had close relationships with the client buy-in. relevant NEA and ERC officials. More critically, he Understanding the problem and coming up with the got AMRECO and its member ECs to attend and correct solution are essential to any intervention, but produce masterful results that won the endorsement they are not enough. In rural settings, where decision of the NEA and ERC. He also prepared AMRECO making originates from or revolves around the dominant to become the subsequent trainer of other Mindanao personality of one person, finding that particular opinion ECs. leader is paramount. In AMRECO, for instance, the views of the president carried so much weight in decision Lesson 2: Give clients a voice in the selection making that the Rural Electrification team made sure of consultants. that he was briefed first and his suggestions heeded before a proposal would be made to the entire board. IFC knows the right type of consultants for specific projects, usually better than the clients do, so IFC brings SMARTLESSONS 22 this value as it makes the final choice of consultants. and they were better off departing the next morning. But it is helpful for IFC to shortlist the consultants Often, the EC manager would say, “I will dig up those and get the clients’ input confidentially before making papers and sign them tomorrow; what’s the hurry?” So the final choice. The clients will then feel they have a the Rural Electrification team would work beforehand bigger stake in the consultants’ success and exert more with his staff to prepare the papers and present them effort to work harmoniously with them. to the manager at the right moment, and he would sign them. “No problem. Let’s go have dinner,” the Contrary to initial beliefs that, if they were given a manager would say. greater voice in choosing consultants, the ECs would be likely to choose those who were more congenial In some ECs, the managers have close kinship or long- than technically competent, this did not happen. The standing personal ties with one another. This colors ECs preferred consultants whose technical capabilities decision making and requires consultants who know they were familiar with, having met them at the NEA- how to work in this “family” environment. sponsored competency training for ECs conducted by the University of the Philippines College of Engineering. Local consultants also provide the advantage of being available to work with the clients for a longer time In another IFC business line, a foreign consultant was than the IFC intervention. This helps ensure the chosen by IFC for his specific expertise, but he and sustainability of the program and its benefits. the clients could not work harmoniously with one another, and a replacement had to be found. Lesson 4: Identify pivotal stakeholders and give them a sense of “ownership” of the Lesson 3: Choose consultants and partner project. organizations that know the clients’ specific culture and can be more accessible to them The two regulatory agencies supervising ECs, the NEA over the long term. and ERC, were pivotal. For some time, they had been trying with limited success to get the ECs to submit The Rural Electrification team’s work with the ECs sound five-year comprehensive capex plans. Knowing proved that it is critical for consultants to have a good these past attempts, the Rural Electrification team understanding of the cultural makeup and dynamics made sure that both agencies, as well as all previous of clients. People from the West have a rather strict players who had been helping the ECs, remained on interpretation of time. Filipinos, on the other hand, board during the implementation of the project. have a more fluid concept of time. Local managers, particularly those from rural environments, often IFC presented the two agencies with the project design, appear to be prognosticating or even negligent when, objectives, and benefits and gave top officials regular in fact, they are operating on a different psychological updates, while seeking their suggestions and active clock. Knowing this, IFC adjusted project time frames participation. When the capex plans were completed, to factor this in. If they wanted the EC trainees to they were presented during an “ERC Engagement come in at 8 o’clock in the morning, the program had Workshop” to the ERC commissioners as well as to to say it would begin at 7 o’clock because attendees the NEA administrator and senior managers. Their would habitually come in an hour late, with the senior inputs were sought and incorporated into the plans, managers arriving even later. IFC staff from Manila giving the officials “ownership” of the project. This would avoid booking a night flight for the return facilitated their approval of the ECs’ capex plans and home; they knew the proceedings would be delayed, their adoption of the training outputs as the official template for training all 119 ECs. 23 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Another major improvement, which the regulatory either are connected to the main grid or are off-grid. officials appreciated, was the fact that the capex plans A number of the ECs in the SPUG areas also took the were made comprehensive to cover five years, unlike capex plan training so they could become reliable and the dozens of individual capex decisions that the ECs creditworthy distributors of rural electricity, which used to submit year after year for the ERC’s approval. in turn provides an incentive for generators under Before the IFC-supported templates, each EC submitted SPUG to operate in remote areas. individual projects in various styles for every year. The ERC commissioners and technical staff had to pore IT’S ALL ABOUT RELATIONSHIPS over the submissions of 119 ECs, and this resulted in all sorts of regulatory delays and disapprovals. Relationships are seen almost everywhere as being critical to the success of IFC programs. But the diversity of cultures and country situations requires Lesson 5: Synergies with other IFC programs that IFC choose program leaders and consultants who can extend the development impact and are sensitive, adaptable, and accessible in working sustainability of projects. with clients. Relationships also help in identifying The Electric Power Industry Reform Act was passed in synergies among IFC programs that would greatly 2001 to end government dominance of the industry contribute to their combined development impact. in favor of the private sector. The law sought to ensure As IFC moves on to create other opportunities, the adequate power supply so as to bring down the cost of good, productive relationships it creates along the way electricity. Incentives were given to independent power ensure the sustainability of intended program benefits. producers, but for years there was little private-sector investment in establishing more independent power producers or improving their generation because the main off-takers for the electricity supply, the ECs, were seen as poor financial risks. The Rural Electrification team synergized with the ABOUT THE AUTHORS Sustainable Energy Finance team to create a two- William Trant Beloe is Head of IFC’s Advisory Services pronged approach to bring a stable electric supply to in Philippines and manages the Sustainable Energy rural areas and, in the process, to mitigate the effects Finance Program. on climate change. As the Rural Electrification team was helping the ECs prepare sound capex plans, the Art Cariaga is a Communications Officer. Sustainable Energy Finance team was supporting a Marianna Fernando-Pacua is a Program Assistant, leading bank in its plan to provide financing to the Sustainable Energy Finance Program. ECs’ capex requirements. With these capex plans being Jed A. Sevilla is an Associate Operations Officer approved by ERC, it would be easier for the bank to heading IFC’s Advisory Services in Rural Electrification establish the risk profile or creditworthiness of the program. ECs’ loan applications. In the case of the Philippine archipelago’s island groups November 2009 and remote villages, the Small Power Utility Group (SPUG) of the National Power Corporation provides them electricity through small generating units that SMARTLESSONS 24 Five Keys to Powering Up a Private-Sector Participation Transaction: The Albanian Experience Privatizing electricity utilities while policy and regulatory reforms are still ongoing may not always be advisable. However, IFC’s experience with privatization of electricity distribution in Albania shows that when there is strong political will and commitment, when the process of privatization is well integrated with other reform initiatives, and when a fair public-private balance is maintained, it is possible to successfully introduce private-sector participation. BACKGROUND electricity utility and establishing new market operators. Privatization also called for a number of Albania was a net power exporter at the beginning of policy and regulatory reforms to allow for a competitive the economic transition in the early 1990s, but growing electricity market, consistent with European Union demand turned the country into a net importer by (EU) requirements, and for a sound regulatory regime 1998. Heavy reliance on hydroelectric production; the with proper energy pricing and tariff policies. Such government’s inability to mobilize adequate investments; reforms were far from being complete when the mismanagement of the state-owned electricity utility privatization process started. However, this offered Korporata Energjitike Shqiptare (KESH); and inadequate an opportunity to introduce the right public-private tariff levels made it impossible for the sector to keep balance in the newly drafted regulatory framework. up with the demand. Large-scale expensive imports The coordination among ongoing electricity reform further constrained the sector’s financial stability. As initiatives and the integration of privatization with a result, the country suffered from major electricity regulatory and legislative review helped structure the supply shortages associated with extensive and regular electricity market and the transaction in such a way load sheds of 400 to 900 gigawatt hours per year. as to increase potential investors’ interest. To address the electricity sector’s shortcomings, the The strong political commitment and the partnership government of Albania decided to undertake a series that IFC built with the government helped bring of initiatives that aimed to improve constraints in all stakeholders on board and accelerate the reform generation and interconnection, reduce dependence on implementation process, without which the transaction hydroelectric production, and liberalize the electricity would have never closed successfully. market. The government also decided to unbundle and privatize the electricity distribution sector, and The excellent cooperation between IFC and the World in January 2007 retained IFC as its lead advisor in Bank also proved critical in achieving donor community the process. consensus on major regulatory issues and in structuring an attractive transaction. The partial risk guarantee, Privatization of the electricity distribution sector a World Bank financial instrument designed to help in Albania required restructuring the state-owned governments mitigate political and regulatory risks, 25 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS helped to increase and maintain investors’ interest in the discussions with power companies that had recently process of privatization. Also of paramount importance privatized distribution utilities in the region made it to the success of the transaction were coordinating efforts clear that under the current situation, the private sector by the U.S. Agency for International Development would not be prepared to take on the risk of securing (USAID), which was heavily involved with electricity electricity supplies to satisfy customers’ demands. All regulatory reform and market liberalization. potential investors who attended privatization events in Tirana invariably confirmed that such a risk was The transaction was completed successfully in May 2009 unaffordable and unacceptable to the private sector. when the CEZ Group paid €102 million for the purchase The uncertainties were many: volatile hydrology, of 76 percent of the Albanian electricity distribution fluctuating energy market prices, and doubts about the company, Operatori i Sistemit te Shperndarjes (OSSH). government’s ability to complete the ongoing initiatives CEZ is an electricity utility based in the Czech Republic. and undertake new ones to increase generation and In the past decade CEZ has become a leader in the interconnection capacities. electricity market in Central Europe and one of the most profitable power companies in Europe, with Under such circumstance, the second-best option a proven track record of turning around distressed was to divide the supply function into wholesale and power utilities. retail. The risk of securing electricity supplies to satisfy customers’ demands was allocated to the wholesale LESSONS LEARNED public supplier, which remained under government ownership. The retail public supplier, responsible for Lesson 1: When the optimum privatization purchasing electricity from the wholesale public supplier structure is not feasible, it may be advisable to at a regulated price and selling it to end consumers, settle for second-best options. was privatized together with the distribution system operator. This model was applauded by all power Privatization of electricity distribution utilities in companies that met with the Minister of Economy developing and transition economies is often intended and the IFC team in April 2009. to improve the supply of electricity and service quality, reduce losses, and expand the distribution network by Lesson 2: To ensure economic, social, and securing adequate investment that the public sector political sustainability of the transaction, has failed to provide. However, some of the objectives establish a fair balance between the public of privatization may not be achieved in full when they and private share of interest and risk. are perceived by the private sector as unaffordable and unacceptable. In such cases, instead of striving When structuring a private-sector participation (PSP) to achieve the optimum results and risk transaction transaction, allocation of risk among parties must be failure, second-best options should be adopted to secure done in such a way as to ensure an increase in efficiency a long-term partnership with a strategic investor and at the lowest possible cost. The process is not quite address all other privatization objectives. straightforward, as it is often difficult to determine which party can cover certain risks at the lowest costs; The privatization package in Albania included the and occasionally portions of the same risk must be electricity public supply function, together with the allocated to different parties. To achieve the desired distribution network, while the responsibility of increase in efficiency, the performance of the private securing an electricity supply to satisfy tariff customers’ operator is generally benchmarked against performance demands was allocated to the private sector. However, standards or indicators. In addition, a fair return on SMARTLESSONS 26 investment is essential in order to secure the private be both politically and economically unsustainable if sector’s interest in the transaction. tariffs are set at unaffordable levels. The adverse effect of unaffordable tariffs would also increase private- In the electricity distribution business, the private sector costs. Therefore, designing and implementing a operator is typically expected to improve efficiencies satisfactory mechanism to protect vulnerable consumers by reducing distribution losses, expanding distribution is beneficial to all. In Albania, a deferred revenue networks, and increasing cash collections. To ensure compensation mechanism was introduced to prevent the private sector’s commitment and reduce the risk tariffs from reaching unaffordable levels. of renegotiations, reasonable performance standards must be specified in the regulatory and/or transaction Lesson 3: Restore investors’ confidence by documentation. Such standards must be clearly defined effectively mitigating the regulatory risk. and easy to monitor by the regulator or contracting authority. To allow for a fair return on investment In recent years, private investors have shown reduced and provide further incentives to the private operator interest in the distribution utilities of developing to reduce distribution losses and increase collections, countries. The number of bidders and, consequently, the performance standards must be measured against the degree of competition in similar transactions in the elements of the distribution and retail tariff calculation sector have been limited. The reasons for this include formula. a weak institutional and administrative framework in the electricity sector, incomplete regulatory regimes In Albania, the new tariff methodologies, drafted under and tariff policies, and the poor performance record the privatization framework, allow the distribution of regulatory institutions. operator to make sufficient revenue to cover operating costs and investments, including the cost of energy To add to this, privatization of the electricity distribution purchased to cover technical and nontechnical company in Albania was initiated soon after privatization distribution losses. The private operator was asked of the electricity distribution company in neighboring to commit to a loss reduction schedule as part of the Macedonia. Continuous disputes over regulatory privatization offer (see chart below). and contractual issues between the government of Macedonia and the Austrian electricity company (EVN), While allowing a fair return on investment is important which had recently purchased the majority of the to attracting the private sector, the deal may prove to Figure 1: Distribution losses before and after privatization Distribution losses before privatization Distribution losses after privatization 38.5% 37.2% 36.4% 36.0% 38.3% 39.8% 35.4% 32.0% 32.0% 28.0% 24.0% 21.0% 18.0% 15.0% '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 27 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Macedonian electricity distribution utility, increased private investors. Potential investors’ feedback may investors’ sensitivity to regulatory and political risks be as constructive as that of any other stakeholders, in the region. and will especially help with assessing how much risk the private sector is prepared to take. To restore investors’ confidence, privatization efforts in Albania focused on establishing a sound regulatory To achieve this, traditional activities used for the framework, with proper energy pricing and tariff recruitment of potential investors, such as market policies, and effectively mitigating the regulatory risk. sounding or pre-bid conferences, are also used to The latter was achieved by introducing contractual discuss and get investors’ feedback on major transaction political commitment and proper dispute resolution and regulatory issues. As an example, an Investors’ mechanisms. To this extent, the Regulatory Statement, Roundtable, sponsored by USAID and organized by IFC a document that specifies tariff calculation formulas and in April 2008, not only informed potential investors key performance indicators, was attached to the share about the transaction and the process, but also presented purchase agreement that was signed by the Albanian them with the new regulatory framework and asked government and the winning bidder and then ratified for their feedback on key issues and risks. by the Albanian Parliament. To further help mitigate the regulatory risk and backstop the government’s All of the comments and recommendations received commitment to the pre-agreed regulatory framework, the during this process highlighted some of the major World Bank offered a partial risk guarantee (PRG). issues that the government and the regulator needed to address in order to improve the regulatory framework The PRG is a financial instrument the World Bank and enhance attractiveness of the transaction. The designed a few years ago to help countries mitigate interesting fact was that comments were provided not political and regulatory risk in order to enhance investor only from the companies that later participated in the interest and reinforce confidence in newly established tender process, but also from those that didn’t. They regulatory frameworks and institutions. It must be gave disinterested, free-of-charge advice and shared noted that the PRG cannot be put in place until the their knowledge, views, and concerns on the electricity privatization agreement has been signed. The process market model and distribution tariff methodologies. of structuring the PRG and finalizing the necessary Making potential investors part of the regulation review contractual agreements among the parties involved— helped strengthen their confidence in a transparent the World Bank, the government, the investors, and and professionally run process. the commercial bank issuing the letter of credit—may add to the time and costs of the transaction. This is Lesson 5: Resist government pressure to why, if a PRG is needed to support the privatization achieve rapid closure, and focus instead on of a distribution utility, it is best if the World Bank the need to address all major issues. is involved as early as possible in the process. Governments in developing countries are often in a hurry to privatize and off-load loss-making, debt-ridden Lesson 4: Involve the private sector early in the electricity utilities. In addition, political pressure from process of policy and regulatory reform. upcoming elections usually adds to the governments’ Involving the private sector in the process of electricity desire to close transactions rapidly. For this reason, it is policy and regulatory reform may help increase the important to constantly assess and, where possible, resist chances of drafting an impartial regulation and the pressure by governments to achieve rapid closure structuring a PSP transaction that is attractive to by making them aware of the high risks associated SMARTLESSONS 28 with offering a transaction that may not be ready independent auditors selected by both CEZ Group for the market or rushing investors to submit their and the regulator. proposals before they have had an opportunity to properly assess all of the issues and risks. CONCLUSION To comply with clients’ request for rapid closure and IFC’s experience in Albania shows that integration of still address all major issues, it is often necessary to the privatization process with reform implementation implement in parallel as many processes as possible initiatives is of paramount importance in the effectiveness and also to use synergies with other ongoing initiatives. of transaction advisory work. From the beginning of However, the closer you get to election day, the more an advisory mandate, it is important to obtain donor difficult it becomes to find the right balance between support as well as the commitment of the highest government pressure to speed up the process and the political levels in the country. This commitment and need to address outstanding issues. support must be maintained throughout the project to ensure successful implementation of the transaction As an example, despite everybody’s efforts during and a long-term partnership with a strategic investor. the privatization process in Albania, there were still outstanding issues that could not be resolved by the However, the long-term success of the privatization is bid submission deadline at the end of September still to be tested. It will take a few years before we know 2008. The government was not prepared to move the whether CEZ will be able to turn OSSH around. A deadline because of the general elections scheduled in major concern remains the regulator’s ability to monitor June 2009. To overcome this obstacle, the IFC team OSSH performance effectively with regard to reduction identified the five most critical issues and convinced of losses, increase of collections, and adequacy of the the government that potential bidders be allowed to investment to upgrade the distribution network and make comments on them. improve the quality of service. It is imperative that donors such as USAID and the World Bank remain Introducing changes in the process and allowing for involved—the former with providing assistance to conditional bids at that stage was quite risky, but it the regulator in implementing the new regulatory was the only way to maintain bidders’ interest in the framework, and the latter with making sure that all process and satisfy the government’s request to close parties follow the terms agreed to in the regulatory the bidding process by the preferred date. framework and privatization agreement as defined in The five issues—the level of return on equity, the the partial risk guarantee documentation. initial level of distribution losses, the purchase price adjustment mechanism, the property title, and long- term debt—were negotiated with the winning bidder ABOUT THE AUTHOR and included in the share purchase agreement and the regulatory statement. Some items, such as the initial Ariana Progri is an Investment Officer with IFC Advisory Services in Public-Private Partnerships in level of losses and the current level of bad debt, both Southern Europe. of which needed extensive work and study, could not be defined during the negotiations. As a solution, Approved by Georgi Petrov, Regional Manager, IFC Advisory Services in Public-Private Partnerships, the private operator was given the responsibility to Southern Europe and Central Asia. complete, within the first year of operation, one study on the level of losses and one study on the age of November 2009 the receivables. The two studies will be audited by 29 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Power lines bring electricity to rural areas of Albania. SMARTLESSONS 30 Ashta Hydropower: Turning a Doubtful Concept into a Technological Trailblazer IFC played a key role in helping the Republic of Albania structure and implement its first large public-private partnership (PPP) transaction in the energy sector, which brought a strong and reliable international investor into the country. Verbund, Austria’s largest electricity company, won a 35-year concession to build and operate the Ashta plant—the first major hydropower plant built in Albania in 30 years. Verbund will invest more than $220 million in the project, resulting in an expected savings on Albania’s electricity imports in excess of $45 million during the first five years of the plant’s operation. But the project has not been without its challenges! From design to bidding to contracts, we learned what it means to persevere—as described in the SmartLesson below. BACKGROUND well as riparian-rights issues for the two neighboring countries. Some 30 years ago, Albania not only satisfied its own domestic electricity needs but also exported its In August 2001, the government suspended the CWE surplus to neighboring countries. In contrast, it now contract so that the German engineering firm Lahmeyer experiences frequent power outages that affect the International (LI) could conduct an independent country’s economic development and require it to rely assessment of the plan’s technical, environmental, on costly energy imports. Albania’s power-generation financial, and economic feasibility. One of LI’s suggested system is based almost entirely on hydroelectric plants, approaches envisaged reducing the tailrace channel the most important of which exploit the Drin River length so as to discharge the powerhouse outflow back basin. into the Drin River upstream of the Buna confluence, slightly decreasing the available head but eliminating In February 2001, Albania’s power utility, Korporata most of the project’s adverse environmental and social Elektroenergjetike Shqiptare, contracted the China impacts, and avoiding riparian issues. Water & Electricity Corporation (CWE) to build a hydropower plant on the lowest reach of the Drin River, The LI study took only a few months, but there was at Bushati, on a turnkey basis. The CWE plan featured no forward movement on the project until the fall a diversion weir, a headrace canal, an aboveground of 2006, when the Albanian Ministry of Economy, powerhouse, and a tailrace channel conveying the Trade, and Energy (METE) retained IFC to: turbine-design discharge of 540 cubic meters per second to the Buna River, some 4.5 kilometers downstream t create a legislative framework that would be conducive of its confluence with the Drin. However, this plan to PPPs and reflect best international practice; would affect the levels of Lake Shkodra (an important t help establish a PPP unit within METE; and wildlife refuge shared by Albania and Montenegro), t identify, structure, and implement a pilot PPP raising environmental and socioeconomic questions as transaction in the hydropower sector. 31 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS IFC drafted a new Concession Law, adopted in early stage, the government’s reluctance to assume or share 2007, and helped establish a PPP unit within METE. any of the project risks became evident. Besides the Afterwards, IFC studied the technical and financial hydrological, geological, environmental, and land- viability of a number of potential hydropower projects, acquisition risks typically associated with hydropower and concluded that a modified version of the original developments, Ashta is totally dependent on the water Bushati project, incorporating LI’s approach to discharge releases from state-owned upstream hydropower plants the powerhouse outflow back into the Drin River and subject to a rudimentary regulatory framework upstream of the Buna confluence, offered the best (regulations on minimum ecological flows, water off- prospect for a pilot PPP project in hydropower. However, takes for irrigation, cascade operation rules, potential there is no such thing as an easy hydropower project. liabilities associated with existing structures, and so on)—factors that constituted an obstacle to potential It took a lot of effort on IFC’s part to persuade the participants, several of whom abstained from bidding. government to move from the old design to the new Those bidders that did not withdraw expressed concerns design with a reduced capacity. To avoid confusion with these uncertainties and with the government’s with the original CWE plan, the new project was reluctance to address them during the discussion named Ashta, after the village where the powerhouse phase. would be situated under the new project design. In May 2007, the government approved the new concept In June 2008, two international investor groups as the first pilot PPP transaction to be implemented (Verbund of Austria and a consortium of Electrabel under the new concession law. of Belgium and Compagnie Nationale du Rhône of France) submitted technical and financial bids. In early Between July and September 2007, IFC reviewed all July 2008, Verbund was selected as the winning bidder, previous studies and design work, refined the overall and the contract was signed two months later. concept, and prepared a baseline design that could be realized on the Ashta site. This baseline design specified some elements of the plan as essential to LESSONS LEARNED its viability, leaving sufficient flexibility for private Lesson 1: Projects require definition—and investors to present sound and innovative technical sometimes redefinition. solutions within these clearly defined boundaries. Next came an Environmental, Social, Health, and Hydropower plans are extremely location- and Safety Screening Study, in line with IFC standards design-sensitive. Consequently, unless the project to and Equator principles, and several rounds of public be developed has already been defined to a degree consultations with the affected communities. sufficient to estimate with some accuracy its costs— including the expenses required to mitigate its social In January 2008, the prequalification phase began, and environmental impacts—as well as its predicted resulting in 12 submissions, 10 of which met the benefits, it becomes impossible to consider a PPP prescribed criteria. Nine international companies approach until its engineering, economic, social, took part in a bidders conference in April 2008 and environmental, and other features have been properly performed extensive technical and legal due diligence. established. In the case of Ashta, the concept had already In the following months, the IFC team pre-negotiated been well studied, but it still was necessary to review the tender documents with potential investors in a previous findings by means of technical due diligence. transparent and nondiscriminatory manner, incorporating As a result, IFC proposed a design that avoided the some of their most substantial comments. During this environmental and social flaws of the original Bushati SMARTLESSONS 32 design. We also proposed renaming the project “Ashta” Lesson 3: Don’t forget about the bidders: so as to provide it with a new “face” and cut links with understand their concerns and work with your the past environmental and social issues. This turned client to address possible issues. out to be a very good move and a great example of Being the most downstream plant on the Drin how proper marketing and management of public cascade, the Ashta plant is totally dependent on water attitude can play a key role in making a project with releases from the plants upstream. So the winning a difficult history happen. bidder was understandably concerned that the state- owned generation company might retain water in Lesson 2: Something’s gotta give…. We have its reservoirs for extended periods and release it at to understand the client’s objectives—and times when it would be most advantageous for energy help the client understand what is realistic. trading purposes (for example, at peak power times). Initially, the government wanted the entire output Since Ashta has almost no storage, extreme water of the new hydropower plant to be subject to an off- releases upstream would spill over the weir without take agreement between the future operator and the producing any electricity—negatively affecting the state-owned generation company. The government project’s economic performance and potentially causing also insisted on having the highest possible installed extensive flooding of neighboring villages. capacity—in the 60 to 70 megawatt range—at the The IFC team assisted in drafting a Cascade Coordination lowest possible tariff. Agreement between the winning bidder, Verbund, The reality in the case of a run-of-river plant, such as and the state-owned generation company, to ensure Ashta, is that there is usually a tradeoff between the fair and transparent rules for cascade regulation and maximum installed capacity and the minimum tariff safety management. The agreement provides for regular level, since these plants lack a storage reservoir that water releases under normal flow, and sets clear rules would allow regular water releases and ensure optimal for information sharing and crisis management in energy outputs. In practice, such plants benefit from case of extraordinary events such as floods. Verbund economies of scale only up to a point: once the plant considered this issue a deal breaker and wouldn’t have reaches the size at which it has the lowest production signed without the agreement. cost per kilowatt-hour, installing additional capacity simply increases the project cost without achieving Lesson 4: It is extremely difficult to pre- correspondingly higher benefits. negotiate a perfect contract that will fit all possible scenarios. The IFC team analyzed various alternatives and explained their advantages and drawbacks to the relevant In IFC Advisory Services, we usually try to pre-negotiate stakeholders. Our estimates indicated that the lowest concession contracts with interested investors to the production costs per kilowatt-hour would be achieved maximum possible extent prior to the bid submission with an installed capacity of 40 to 50 megawatts. date, so as to ensure transparency and avoid lengthy METE finally agreed to have the off-take price as the post-award negotiations (during which the granting most important evaluation criterion, so long as the authority is in a less favorable bargaining position). All total installed capacity was not allowed to fall below prequalified investors are invited to submit comments 40 megawatts. IFC’s assumptions turned out to be to the contractual documents, which are then reviewed right, since the winning bid offered the lowest tariff and accepted (or rejected) by the client and its advisers. at the installed capacity of 48.2 megawatts. This iterative process is usually done in two rounds, 33 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS combined with the bidders conference, where such evaluation criteria. Since you never know exactly what comments are discussed with all prequalified investors technical solution investors will come up with, a certain in a transparent manner. degree of contractual flexibility is desirable, provided it’s fair to all parties. Details stemming from different In the case of Ashta, many investors were reluctant technologies can (and in some cases must) be hammered to comment on certain technical aspects of both the out only after the winning project is known. concession agreement and the off-take agreement, fearing that they would disclose confidential information. Lesson 5: Technical and financial bids should As a result, the contractual documentation was fairly be evaluated separately, but if the client insists advanced from the commercial point of view, where all on reviewing them simultaneously, you may investors seemed to be in relative agreement, but was have to get creative to maintain objectivity in very general from the technical side. Technical language the process. (such as metering, scheduled outages, construction process) was based on the baseline project design that When evaluating final bids in an IFC Advisory Services IFC and its consultants prepared for the tender. mandate, we prefer to open the technical part of an offer first, to see whether it is complete, compliant with The winning bid presented by Verbund included an all the essential project requirements, and technically innovative solution based on the StrafloMatrix TM sound. If it is, the technical offer receives a “pass” technology—a new concept for developing hydropower score, and only then is the bidder’s financial offer at low-head sites where dams, weirs, or canals already opened. If a technical offer receives a “fail” score, the exist. Projects that may not be financially viable, based corresponding financial offer is not opened, and the on conventional turbines and generators, may now entire package is returned to the rejected bidder. be developed using this method. The StrafloMatrixTM design relies on a factory-assembled grid, or matrix, However, Albanian legislation required that both of standardized generating units. Complete modules, technical and financial offers be opened simultaneously including all the associated mechanical and electrical and be evaluated using a predetermined set of weighted equipment, are shipped to the project site, where criteria in a comprehensive scoring formula. they can be readily installed into existing structures with minimal civil works required. The advantages To avoid subjectivity in the evaluation of the technical of this concept are its low investment cost, easy and criteria, the IFC team recommended a binary approach inexpensive maintenance, and shorter construction whenever a simple and transparent grading formula periods, compared to conventional plants. Since this could not be established. For example, an investor could approach is new and original, we spent considerable time receive either ten points or zero for “environmental during the final negotiations reviewing and adjusting and social acceptability of the project.” Since such a the project’s technical details and the contractual terms project feature is either acceptable or not acceptable to best reflect the peculiarities of the winning bid. (“pass or fail”), saying that one offer is “more” acceptable than the other and assigning acceptability grades The principal lesson here is: when drafting and pre- for it is inherently subjective. (You can’t be “partly” negotiating contractual documents with investors, married.) rather than getting lost in technical minutiae, the team should focus on the main commercial terms The only financial criterion used was the off-take price of the project, the major risks envisaged, and their per kilowatt-hour of electricity produced, leaving no allocation, as well as on a set of fair and transparent room for ambiguity. But since the legislation required technical and financial offers to be opened at the same SMARTLESSONS 34 time, the evaluation committee started unintentionally regulations), thus essentially saving the deal. However, leaning toward the best financial offer from the first delays in addressing these issues in the early stages of the moment. The IFC team insisted that the evaluation project shifted the timetable and possibly discouraged committee conduct a thorough technical examination some investors from bidding. of both offers before making any recommendation to the contracting authority. Several independent experts FINAL WORD: MAKING CHANGE studied both offers in great detail for almost three HAPPEN weeks and, to the great relief of all parties involved, found both offers to be compliant and technically The Ashta hydropower plant is a great example of how feasible. IFC’s involvement can bring about real change by fostering innovative solutions. Our advice, perseverance, and out-of-the-box thinking helped turn an old, Lesson 6: Important issues not addressed environmentally and socially questionable concept in the early stages of the tender can have a into a sustainable project using the latest technology potentially devastating effect later. in hydropower generation. During the transaction-structuring phase, our team made a number of recommendations regarding the risk allocation and the necessary changes to the regulatory framework required to make the transaction more attractive. The government, in an effort to shift project risks to the future concessionaire, initially refused many of the recommendations. Moreover, it also wanted to remove certain events (such as sudden tax increases) from the MAGA (Material Adverse Government Action) clause, putting the overall viability of the ABOUT THE AUTHOR deal at stake. Martin Sobek is an Investment Officer in IFC’s At the same time, certain regulations (minimum Advisory Services in Public-Private Partnerships. He has 10 years of international experience in mergers ecological flow requirements, irrigation use of water, and acquisitions, privatization, and public-private and so on) required further refinement to comply with partnership transactions in Europe, North America commonly accepted standards. IFC warned the client and the Middle East. that investors would need clear “rules of the game” Approved by Angelo Dell’Atti, General Manager, for their financial modeling purposes (for example, IFC Advisory Services in Public-Private Partnerships, a four percent versus an 11 percent residual flow Southern Europe and Central Asia. requirement would have changed the economics of The author would like to acknowledge Georgi Petrov the project completely), but the government did not and Nikola Mihajlovic for their valuable comments focus sufficiently on those concerns in the early stages. and contributions to this SmartLesson. As the tender progressed and the contractual documents May 2009 were pre-negotiated, most of the prequalified investors raised those same issues. After several rounds of investors’ comments, the METE agreed to make changes to the contractual documentation (and to refine existing 35 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS The Ashta run-of-river hydropower plant weir. SMARTLESSONS 36 A First for IFC! Desalination Project at King Abdulaziz Airport in Jeddah, Saudi Arabia The King Abdulaziz Airport (KAIA) Desalination Project is the first-ever transaction that IFC has advised on in the desalination sector. The successful transaction closed in June 2007, and this SmartLesson provides both a summary of the important aspects of the transaction to assist in knowledge management, and a series of lessons learned during the course of executing this mandate. BACKGROUND around KAIA, GACA has relied on its internal (captive) desalination plants and funded and operated these The General Authority for Civil Aviation (GACA) of plants using its own resources. Over the years, GACA Saudi Arabia appointed IFC as lead advisor to structure built three captive desalination plants, with a total and implement a public-private partnership for a new capacity of 33,000 cubic meters per day, out of which desalination project at KAIA, the main international only one plant, with a capacity of 25,000 cubic meters gateway and hub for Saudi Arabian Airlines. KAIA per day, was operational (see Table 1). served over 14 million passengers in 2005, including the religious Hajj and Umrah traffic. It occupies 105 All three desalination plants owned and operated by square kilometers, including four terminals, cargo GACA were nearing the end of their economic life, facilities, a housing compound for employees, an air and although Plant III was relatively new, it was poorly force base, and a dedicated nursery. maintained. This resulted in an unreliable supply to GACA and a very high production cost. Moreover, The city of Jeddah, with a population of about 2.8 water production was insufficient to meet current and million in 2006, faces huge water shortages. Because projected growing demand, as shown in Figure 1. the local municipality was unable to supply water due to a lack of adequate production and network Table 1: Existing capacity and projected demand as of 2005 PLANT OPERATIONAL PLANT I PLANT II PLANT III TOTAL NOT OPERATIONAL 1978-2005 1997-2005 Design capacity m³/day 6,000 25,000 2,000 33,000 Actual capacity m³/day 0 25,000 2,000 27,000 Average production m³/day 0 21,298 0 21,298 Water production m³/day* 0 2.060 0.900 1.975 *Excludes capital costs. 39 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Figure 1: Forecast water production requirements (under different growth scenarios) 40,000 35,000 Annual average daily demand (m3/day) 30,000 25,000 20,000 15,000 05 07 09 11 13 15 17 19 21 23 25 27 29 31 20 20 20 20 20 20 20 20 20 20 20 20 20 20 medium growth high growth low growth PCA forecast 7-year trend Note: The CAA forecast figures are adjusted to remove cooling and boiler water and take into account discussions with CAA. DESALINATION TECHNOLOGIES whereas RO uses pressure for separation, allowing the fresh water to pass through the membrane, There are two major types of desalination technologies: leaving behind the salts. 1. Thermal technologies involve heating seawater and collecting the condensed vapor (distillate) to REFURBISH VERSUS BUILD NEW PLANT produce potable water. They require high energy The choice the IFC-led team faced was whether it for vaporization (phase change) and have a limited was better to refurbish the existing MSF plant, which scale of operation. Examples of thermal desalination had a capacity of 25,000 cubic meters per day, or technologies include multistage flash (MSF), multi- consider building a new plant using potentially a effect distillation (MED), and vapor compression new technology. Based on a comparison of capital distillation (VCD). expenditures, production costs per cubic meter of 2. Membrane-based technologies involve passing water, the requirement of additional future capacity, seawater through membranes to separate the salts, and the environmentally friendly nature of the RO and then adding chemicals to produce potable water. technology, IFC and its technical consultants advised Examples of membrane-based technologies include that building a new RO plant made more sense (see electrodialysis (ED) and reverse osmosis (RO). The Table 2). basic difference between ED and RO is in how the Significant improvements in the RO technology over the membranes are used: ED uses an electric potential last 10 years helped reduce the capital and operating cost to move salts selectively through a membrane, of RO plants, contributing to the growing reputation SMARTLESSONS 40 of RO as the most economical and environmentally with an initial capacity of 30,000 cubic meters per friendly desalination method (see Table 3). day, increasing to 35,000 cubic meters per day in Year Eight, and decommissions the old MSF plant. RO provides the following advantages: t Off-taker commitment is guaranteed through GACA’s t it is energy efficient; reliance on the project for 100 percent of water t it requires lower capital cost; demand. Moreover, a credit enhancement through t it is easier to maintain; an escrow account of $2.5 million is established t it has the flexibility to expand capacity easily to and funded by the purchaser (GACA) to secure meet demand; and payment obligations to the investor. t it requires a smaller footprint. t GACA provides the use and quiet enjoyment of PROJECT STRUCTURE existing infrastructure and project site for the duration of the contract, which is to be transferred back to Figure 2 depicts the project structure, and the following GACA at the end of the contract. points summarize the structure’s key aspects: t GACA is responsible for supplying electricity to t GACA and the investor sign a 20-year take-or-pay the project. water purchase agreement under a build-operate- t The investor is required to rehabilitate the site, since transfer arrangement. The payment structure includes the footprint of the site will be much reduced under an output price and a capacity price (to cover fixed the RO technology. Because the site is in a very nice costs). residential neighborhood right on the Red Sea coast, t The investor finances, designs, constructs, operates, the investor is also obligated to beautify the site so and maintains a new seawater RO desalination plant that it is aesthetically better than before. Table 2: Cost comparison: Refurbishment vs. new plant OPTION CAPACITY CAPITAL COST PRODUCTION COST (m³/day) (millions) (m³)* Refurbish MSF plant 25,000 26,000 $1.95 SAR 93.60** SAR 7.02 Build new plant with RO technology 30,000 $27.50 $0.80 SAR 99.00 SAR 2.88 *Assumes a capital charge equivalent to an internal rate of return of 15 percent. ** Saudi Arabian Riyals. Table 3: Comparison of the economics of the desalination processes MSF MED VCD RO Capital cost (m³/day) $ 1,200-1,500 900-1,000 950-1,000 700-900 SAR 4,320-5,400 3,240-3,600 3,420-3,600 2,520-3,240 Total production cost $ 1.10-1.25 0.75-0.85 0.87-0.95 0.68-0.82 (m³) SAR 3.96-4.50 2.70-3.06 3.13-3.42 2.45-2.95 41 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Figure 2: Diagram of project structure FINANCING PARTY Financing agreement Principal & interest Performance bond Senior debt Payments Water purchase agreement EPC EPC contract PROJECT COMPANY Special purpose company GACA (KAIA) CONTRACTOR [Winning bidder] Power [Off-taker] O&M contract Engineering procurement construction Water SAUDI BANK O&M [Credit enhancement Power Water CONTRACTOR Escrow payment risk] Power account DESALINATION SAUDI WATER Operation & maintenance PLANT OLD RO PLANT & ELECTRICITY [Reverse Osmosis] COMPANY KEY COMMERCIAL RISKS AND GACA payment risk: Mitigating factors MITIGATING FACTORS t Credit enhancement of GACA’s payments through Demand risk: Mitigating factors an escrow account mechanism until GACA acquires sufficient credit standing. t Take-or-Pay Agreement: GACA pays capacity pay- t Credit enhancement mechanism is reinstated ment, regardless of lower demand or consumption, whenever GACA’s credit standing falls below a throughout the 20-year concession period. minimum level. t Initial plant capacity is established based on medium- term, base-case demand; additional capacity installed GACA performance risk: Mitigating factors in future tailored to actual demand growth t GACA’s obligation under Water Purchase Agreement Energy supply and price risk: Mitigating (WPA) to make full payments based on Contracted factors Capacity should act as deterrent. t GACA is responsible for energy supply. Seller performance risk: Mitigating factors t Interruption of energy supply will trigger force t Prolonged underperformance allows GACA to majeure mechanism. terminate and buy the plant at cost of outstanding t Pass-through of energy price changes through tariff debt. indexation SMARTLESSONS 42 Seawater quality risk: Mitigating factors Technical Services S.A. of Greece—in association with Aquatech International Corporation of the United t Contract cost opener for material deviation of States, Haji Abdullah Alireza and Company of Saudi seawater quality (cost consequences to be reflected Arabia, and WTD Srl of Italy—was selected as the in tariff adjustments); dispute resolution through winning bidder. Financial closure occurred in June an independent expert. 2007. With a 21-month construction schedule, the t Force majeure affecting seawater availability will project is expected to become fully operational by trigger force majeure mechanism under WPA. March 2009. BIDDING AND RESULTS The project significantly lowered the cost of water and introduced international best practices to operate the The project proved to be attractive, and ten firms were desalination plant at the airport, leading to a more prequalified from a total 16 applications. Of these ten sustainable and better-quality water supply for the firms, six submitted bids. Bidding was organized as a airport. It is estimated that the price quoted by the two-envelope procedure in which the technical bid was winning bidder will save GACA about $12 million per evaluated first, and only those bidders that passed the year as a result of technical, economic, operational, technical evaluation were invited to the commercial and managerial efficiencies, with a total net present bid opening. The rationale for this procedure was to value fiscal impact of $401 million over the concession ensure that: (a) GACA obtained the best value for the period. Savings are further increased when the capital water from technically capable bidders, and (b) the costs avoided are taken into account. bidding remained as transparent as possible. Since two of the six bids received did not pass the KEY LESSONS FROM THE MANDATE technical criteria, four commercial bids were opened. EXECUTION To select the winning bidder, the commercial bid was then evaluated in a public opening based on the lowest Lesson 1: Risk allocation must be appropriate. price of water quoted. The criterion for contract award It is important that a particular risk be allocated was based on the lowest price of water delivered to to the party best suited to assume it. An open and GACA over the 20-year concession period (lowest transparent dialogue between counterparties helps evaluated bid price), as shown below: achieve appropriate risk allocation. It ensures that Evaluated Bid Price = [Base Capacity Price * Annual all issues and investors’ concerns are brought to the Contracted Capacity (Years 1–20)] + [Base Output surface and taken into consideration when formulating Price * Annual Output (Years 1–20)] the structure of the transaction and the accompanying project agreements. It also reduces the probability of This formula was designed to discourage dishonest post-signing negotiations. bidders from distorting the bid price by loading the capacity payment and not taking the risk on the projected For example, investors—who are used to securing output required by GACA (which was provided to the the counterparty risk, including payment risk and bidders) during each year of the concession. termination risks by sovereign guarantees—wanted GACA to provide such guarantees, which would have Of the four Saudi Arabian and international groups added at least six months to the timetable for approvals. that participated in the commercial bidding process But a fair-risk allocation in the concession agreement in December 2006, the consortium led by SETE avoided the need for sovereign guarantees. With the 43 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS help of open and transparent dialogue and fair-risk have saved four to six months had the client made allocation, we negotiated an acceptable structure that timely decisions. We should build this sort of delay includes an escrow account for payment risks and into our budgets and always try to fast-track as much an implicit undertaking of the Ministry of Finance as possible to help clients avoid excessive deliberation. through its support of GACA for the termination risk. Lesson 5: Consultant selection is extremely Lesson 2: A transparent bidding process is important. vital. Although we did not have any institutional knowledge To avoid any reputational risks for IFC, it is extremely based on past mandates in this sector, the selection of important that the bidding process remain transparent. high-quality technical consultants gave us the necessary The IFC team made sure that all bidders were treated expertise. We were able to understand the technical fairly and that the information was disseminated to all dynamics of the desalination industry fairly quickly, bidders. Due to the public opening of the commercial thanks to the excellent work of our international and bid, the bidders were confident that no particular local technical consultants—a consortium of Nippon bidder would be favored, and the transparency of Koei (Japan), Richard Morris Associates and Chris the process ensured credibility and produced a very Ricketson Associates (UK), and Dar Al Taqnia (Saudi good result for GACA. The losing bidders were all Arabia). complimentary about the process. PROGRESS UPDATE Lesson 3: Commitment by the client is critical. The project started commercial operations in January Client commitment is a key factor and needs to be 2009—two months ahead of schedule. The investors were part of our initial assessment when deciding whether naturally incentivized to start commercial operations to engage in the mandate. All projects require difficult as quickly as possible because that meant they would decisions and can face severe delays, or at worst get paid earlier. may fail, if the counterparty is not committed to a successful outcome. We faced several challenges during the course of executing this mandate, particularly while negotiating the credit enhancement required for the project. However, GACA was committed to the ABOUT THE AUTHOR successful conclusion of the project, so it understood Muneer Ferozie is a Senior Investment Officer in IFC’s Advisory Services in Public-Private Partnerships, the requirements of the private investors and made and has over 15 years of experience in investment commercial decisions. banking in London and IFC. He focuses on origination and execution of privatizations and public- Lesson 4: Timing is key. private partnership projects in infrastructure in the Middle East and North Africa. Government approvals were delayed due to holidays Approved by Moazzam Mekan, Manager, IFC (summer, Hajj, and Christmas) and to the steep learning Advisory Services in Public-Private Partnerships, curve, since it was one of GACA’s first projects of this Middle East and North Africa. kind. Also, all bidders (as usual) asked for extensions February 2009 to the bid date, and the client made some decisions that weren’t timely. Although we completed the project in 18 months (from kick-off to bidding), we could SMARTLESSONS 44 Never Test the Depth of the Water with Both Feet: Lessons from the Sinking of the Bangalore Water Project Water—possibly the most important resource on earth—is also one of the most politically contentious. Public systems account for 90–95 percent of access to water and sanitation services across the world, yet their coverage is not universal, and the quality available is often questionable. Expansion of access to water—through improvement of public distribution networks or through private sector participation (PSP)—is a key component of the World Bank Group’s global strategy, though the project team leader and the policymaker have to tread this field carefully. Given that water is a public good, any suggestion of PSP is likely to raise suspicions in many quarters about its form and intent. In a newly liberalizing and highly unequal market society such as India, the envisaged reforms under the Greater Bangalore Water and Sanitation Project (GBWASP) were scuttled precisely because of the suspicions and fears that PSP in the water sector can stir. The project is a study in how to manage and address these fears; valid or not, the sheer perception of inequity is potent enough to derail a potentially unique and successful project. GREATER BANGALORE WATER & structure a public-private partnership (PPP) project to SANITATION PROJECT: provide water and sewerage services 24/7 to the Greater WATER UNDER THE BRIDGE? Bangalore region. IFC was mandated to oversee the selection of a private firm to operate and manage the Bengaluru—the Silicon Valley of India—is the water distribution and sewerage system for the eight third largest city in the country by population and newly added municipalities serving approximately 1.2 geographic spread, with a population of 5.3 million million people, predominantly urban poor. people in 2001. (Unofficial figures are closer to 10 to 12 million—a decadal growth rate of 61 percent!) The World Bank-managed multidonor facility—Water This growth, spurred by the information technology and Sanitation Program (WSP)—and IFC jointly boom, has inflicted a massive burden on existing public supported this project, which directly addressed issues utilities. The city has grown administratively as well, of access to affordable and good-quality water for the incorporating 110 villages and eight municipalities urban poor. However, toward the completion and to form Greater Bangalore. A 2002 survey of this submission of the transaction structure design, the expanded city by the Bangalore Water Supply and project was suspended in the wake of demonstrations Sewerage Board (BWSSB) revealed that nearly 40 against water-sector privatization generated by a similar percent of urban households did not have access to project in Delhi (circa 2003–05) in which IFC was not water (see Box 1). involved. The project further suffered from slackened political support in the face of these protests, and In 2004, the Government of Karnataka state appointed eventually the traction was lost over time due to a high IFC as Lead Transaction Adviser to the BWSSB to turnover of project champions in the government. 45 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Box 1: Access to water services intrinsically linked to the extreme poverty & disease burden t More than one billion people lack access to safe water. Close to two billion lack access to sanitation. Most live in low- and middle-income countries. t Each year, nearly a billion people suffer from diarrheal illnesses caused by unsafe water. Millions more suffer from other water-related diseases. Poor people, especially the very young and the elderly, tend to be the most at risk. t Safe water is scarce because it is often undervalued and used inefficiently. t As a country’s economy becomes stronger—as its gross national product (GNP) per capita rises—a larger percentage of its people tend to have access to safe water and sanitation. t Thoughtful decision making by all user groups generally leads to improvements in the supply of safe water for all at affordable prices. LESSONS: the primary focus, irrespective of “economic rationality” THE BABY & THE BATH WATER (a practically and theoretically challenged concept, anyway) when structuring such projects, especially Lesson 1: Water wars in the media: Build a when the restructuring of public utilities may result in communication strategy. increased user charges. To wit, solutions proposed must be socially, politically, and economically feasible, apart In a crucial infrastructure sector such as water, it is from being simply technically and financially viable. important to identify the right stakeholders at the right time and at all levels—the organization (engineers at Stakeholder participation workshops and dissemination BWSSB), community, civil society, and government. strategies are paramount. All the media coverage the Policymakers and advisors alike must engage with them GBWASP attracted (see Box 2) indicates that the constantly, anticipate their concerns, and incorporate project team failed to communicate the benefits of the their voices into community outreach efforts and project proposed project. The responsibility of advisors and structures. The GBWASP teaches us that such projects policymakers to educate consumers about the changes not only require commitment from political agencies, that the PPP will bring to their lives exists throughout but must also be supplemented by a concerted, organic, the project cycle. This process can help project teams and targeted dialogue derived from a broad-based sound out the solutions they propose and, ultimately, stakeholder consultation campaign. improve their project structures through feedback from the end user and other stakeholders. As water is a social good that is crucial for individual life and longevity, PSP in the sector sets off alarm bells. If advisors and decision-makers are so convinced of its Lesson 2: Taming the rapids: Be proactive in managing the turnover of key champions. efficacy in improving access, quality, and usage by those without this basic need, then that message must be During an 18–24-month period, including the strategy honestly conveyed to the public. The end user should be phase of the project, there were four sequential chairmen SMARTLESSONS 46 Box 2: The Voice of opposition in the media t “Will the operator be incentivized to provide the last mile to people who can pay little and live in hard-to-reach shanties?”—India Together. t “….When faced with uncertainty, government’s response is to clamp down on information…. These are the old ways of wearing down the opposition, bulldozing people rather than really engaging them in genuine debate.”—Janaagraha Publications: Advocacy Impact. t “International experience shows that privatization of ownership or management of water has led to increase in wastage, decline in water quality, increase in costs, and discontinuation of water supply when people cannot afford to pay the bills. A situation of mismanagement, underinvestment, and carelessness is wished away as a problem of regulation.”— Times of India. of BWSSB and three Principal Secretaries of Urban Lesson 3: Drop by drop, you fill an ocean: Development (from the line ministry responsible for Focus on the promised deliverable! the project). Removal of the initial champions meant As advisors to governments, IFC and the World Bank the project lost political traction over time. should carefully analyze what level of PSP is adequate Both the tumult of coalition politics and the and feasible. In the case of GBWASP, the advisors were unpredictability of bureaucratic assignments exacerbate asked to focus on assisting the client to let a three to the risk of non-completion of projects in India, five-year management contract for the operation of the despite the federal government’s growing level of new periurban distribution system being built through PPP preparedness. donor funding. However, the recommendations of the advisors went beyond what was asked, and instead Alleviation strategies must be in place in the pre- addressed the establishment of the PPP in the context implementation phase, including looking beyond the of a 10-year vision of multistage privatization of the convenient project champion—someone who proposed entire water and sanitation sector in Bangalore. This the project or is not opposed to PSP in general. It was well received, and indeed requested by senior is important to seek out other potential champions bureaucrats and technocrats, but it was unnecessary early on—from the technocracy, civil society, or other and inappropriate in the context of the timing of the government ministries and departments—since they project—when suspicions about PSP in the water will gain greater salience during the implementation sector were particularly rife. phase and ensure the delivery of a well-structured project based on consensus. Before advisors present project structures to their clients, it would be useful to ask: Who is the audience? Not just Building a phalanx of project champions allows to knowing what they want to hear, but also recognizing maintain continuity in the face of inevitable political what they can institutionally manage to implement churnings, and sets in motion a consensus-building with a view toward the securing of maximal benefits process for politically sensitive projects even before for the end user. project commencement. Advisors often face this challenge in cases where government capacity to successfully manage PPP 47 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS contracts is inadequate, or in the case of first attempts 182 shareholder member countries, IFC should strive at unique project structures in unexplored sectors. hard to dispel the myth of its alterity and establish However, the purpose of PPP project advisors is its identity as a multilateral organization where each transaction advisory, and to simply wait around for member country is a stakeholder. Many saw IFC as regulatory institutions to emerge that can set the playing bringing expatriates to India to advise Indians on field right overnight is self-defeating. In the absence how to better serve Indians through the managerial of enabling regulatory and institutional factors, it is expertise of other expatriate firms. Small wonder important to integrate robust contract management that this message was then eagerly disseminated to strategies for clients with core transaction advisory consumers, and IFC was seen as paternalistic and in work. This not only serves the sustainability of projects the service not of the government but rather of the but also demonstrates commitment to ensuring the of the private sector. achievement of the longer-term development objectives that national governments and multilateral agencies Under the GBWASP project structure, international have set for themselves. PSP was proposed, which was not politically acceptable. Looking back, perhaps more time should have been invested in identifying indigenous solutions and Lesson 4: Water, water everywhere: But which capacities. Maybe the relevant expertise did not exist one’s Indian? domestically, but addressing the concern of the various IFC was seen as an “outsider”—a fact that the various stakeholders was imperative, nonetheless. One could protest lobbies also exploited. As an organization with draw a lesson from Manila Water, one of the world’s Boy fetching water from a communal tap in Bangalore. SMARTLESSONS 48 largest water privatizations, where in the absence of time, effort, and money went into what has eventually indigenous private sector capability, the Government of morphed into a difficult legacy for IFC’s Advisory the Philippines imposed the legal requirement that the Services in Public-Private Partnerships operations in concessionaire be 60 percent owned by Filipinos. This India. It begs the question: When is the right time suitably allayed stakeholder groups’ concerns about a to exit, and what is the best strategy? PPP not fostering technology transfer. The legal provison was designed to ensure that domestic capability would A high turnover rate of project champions and a be increased as a result of the concession. tempest of angry anti-privatization voices were not healthy signs to begin with. The Delhi Jal Board project, It would behoove advisors and policymakers to consider with a similar design, had already come under severe a plethora of options and configurations of potential attack, raising the question: Was this a losing battle international and domestic private sector participation. all along? While developing potential investor lists, advisory teams could make a concerted effort to identify regional firms The lesson perhaps is to consider whether multilateral with niche capabilities and identify opportunities for agencies possess enough organizational flexibility to more “South-South” collaborations. know when to throw in the towel. Lesson 5: A ripple widening from a single stone: Think Global-Local. The GBWASP advisors were based out of Washington, ABOUT THE AUTHORS D.C., with no continuous presence in the field. Though Neeraj Gupta is an Investment Officer in IFC’s local consultants were appointed as well, a healthy Advisory Services in Public-Private Partnerships mix of domain-knowledge experts (who could come in South Asia. Prior to joining IFC in 2007, he spent more than two years in the Public-Private in on an as-and-when-needed basis) and project or Infrastructure Advisory Facility at the World Bank. liaison managers in the field were needed. The best Before that, Neeraj had 11 years of private sector composition of a team for a project may mean that consulting experience across various infrastructure sectors. multilaterals distinguish between teams that generate mandates and teams that execute them. Neha Mehra is an Operations Analyst in IFC’s Advisory Services in Public-Private Partnerships in South Asia, IFC’s decentralization initiative is well under way focusing on health sector and aviation infrastructure to counteract the perception of a distant and aloof in the region. Prior to joining IFC almost two years ago, she worked in knowledge transfer management paternalistic organization. Still, the experience of in an Indo-German IT joint venture in Germany and in GBWASP reinforces the need to have projects managed international economic policy research in India. by local teams with essential skills in the field—in Approved by Vipul Bhagat, Manager, IFC Advisory project execution, client relationship management, Services in Public-Private Partnerships, South Asia. and communications management. The authors would like to thank Catherine Revels, Jerome Esmay and George Nugent for their CONCLUSION: EBB TIDE, THE RIGHT comments and support. TIME TO EXIT? May 2009 IFC Advisory support for GBWASP began in December 2004. The project closed in November 2007 without proceeding to the implementation phase. Considerable 49 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Women fetch water from a communal tap. SMARTLESSONS 50 Scaling Up Rural Water Supply Service in Benin: A Programmatic Approach and Budget Support People in rural areas of Benin have a greatly increased access to safe drinking water, thanks to government vision, donor support, and the investment and advisory assistance of the World Bank. In 2000, the government of Benin began preparing the ministries of key sectors for a shift from a project approach to a programmatic approach with enhanced budget support. The World Bank, through Budget Support Operations1 and other donors, has supported Benin’s reforms in budget preparation and management and in implementation of the country’s Poverty Reduction Strategy Paper. The Ministry of Rural Water Supply was part of this move, and Benin is on track to meet the Millennium Development Goals (MDG) target for its rural drinking-water supply. This SmartLesson shares how the World Bank contributed to Benin’s remarkable progress in this sector, and what we learned along the way. BACKGROUND Ministry of Finance; boost reforms of a difficult sector; strengthen harmonization and alignment of donor Initially, the World Bank’s Budget Support Operations interventions; and develop an effective monitoring (BSO) series was intended to support the implementation and evaluation (M&E) system. of Benin’s Poverty Reduction Strategy Paper with concessional financing through the national budget The government RWS reform program included: (i) processes. These operations focus on key policy and implementing a sector-wide approach; (ii) improving institutional reforms in priority areas and are designed budget planning, execution, and monitoring through to assist the government in establishing priorities and a medium-term program budget; (iii) increasing access implementing a rolling core reform program. The to a reliable, affordable, and sustainable provision of program contained policy measures and outcome water services; and (iv) improving the governance indicators for each operation. Then a gradual transition and management practices for the small piped-water toward a consolidated programmatic approach was systems through a local public-private partnership launched at both government and sector levels. (PPP) arrangement. The first reason for including rural water supply (RWS) As a result of all these efforts, Benin is on track to meet in the BSO was to enable the Ministry of Rural Water the MDG target of a 67 percent rate of access to potable Supply to continue to benefit from World Bank support, water by 2015. Since 2001, the government has made since no new project could be prepared. The second significant progress in increasing the rural population’s reason was that all of the sector stakeholders viewed access to potable water (from 33 percent in 2001 to policy dialogue through the BSO as the way to improve 49 percent in 2008), and the sector execution capacity overall planning; strengthen relationships with the has been multiplied fourfold. In 2004, for the first time ever, Benin constructed more than 1,200 water 1 Adjustment Credit (PERAC) and Poverty Reduction Support points, against a target of 700; in 2008 it constructed Credit (PRSC 1–6). more than 2,000. More than 500,000 people gained 51 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS access to safe water in 2008, against fewer than 100,000 facto included in the program budget, discussed, and in 2001—an outstanding performance in scaling up validated by the Directorate of Water and the donors. investment, since over the previous two decades no more than 500 water points were constructed annually. Also, we supported the development of a roadmap Also, the water-facilities functionality rate improved setting out clear annual targets for the acceleration from 77 percent in 2003 to 87 percent in 2006, due of physical service delivery and financial investment/ to better post-construction follow-up (see Figure 1). expenditure to achieve the MDGs in 2015. In Benin, the target was delivery of at least 1,350 new water points per year from 2005 to 2015. This roadmap provided LESSONS LEARNED a clear plan—a critical step toward harnessing the efforts of all sector players and promoting collective Lesson 1: Focus on sector planning first. and coordinated action toward achieving the MDGs. Generally, the rural water-supply sector is heavily Also, involvement of communes and regions in the dependent on external financing and is supported formulation of investment plans and budgets has through multiple donor projects, but coordination increased progressively since 2002. In addition, a and planning are weak. Introducing a medium-term procurement plan and an annual work plan were program budget and MDG roadmap can make a big prepared along with the program budget. difference. Including these new planning tools prior Introducing a planning procedure based on objectives to the second World Bank BSO had a great impact on generates a strong dynamic of responsibility, the sector stakeholders’ practices, and ultimately on the accountability, and results. In Benin, all programs performance of the sector as a whole. The sector program and projects were consistent and aligned with the budget was used as an inclusive planning vehicle for country’s national development strategies, regardless all stakeholders, including the Ministry of Finance. of their modes of financing and implementation. The program budget became the reference framework Donor contributions to capacity building in the for strategic and operational programming and for sector have increased. The program budget has been the monitoring and evaluation of all sector activities. critical in shifting the focus from a project approach All projects or capacity-building activities were de to a programmatic approach in the RWS sector. At Figure 1: Number of additional people served with safe drinking water per year 60,000 160,000 (1997) - 500,000 (2008) 50,000 40,000 30,000 20,000 10,000 97 98 99 00 01 02 03 04 05 06 07 08 19 19 19 20 20 20 20 20 20 20 20 20 people served SMARTLESSONS 52 the same time, it has contributed considerably to sector review with all stakeholders, generally in May, to improved communication and coordination among review progress in national program implementation donors, predictability of funding, harmonization of against the agreed target, exchange best practices, and donor objectives, monitoring, and alignment with discuss the way forward; and (iii) another meeting country systems. And it has optimized the impact of organized in September by the Directorate of Water both government and external financing. to discuss sector budget allocation and the next year’s program. Those meetings have seen the involvement This experience also has had a demonstration effect, of all donors and have led to a greater percentage of with the program budget and the RWS sector roadmap donor funds reported in national budgets since 2005. being introduced in other countries: Burkina Faso, Madagascar, Mali, Mauritania, and Rwanda. The Benin experience is a good example of the need for this sort of framework. Initially, the sector had Lesson 2: Develop an accountability four major sources of external financing: DANIDA framework, including a credible M&E system (Danish International Development Agency), KfW and participatory reviews. (Kreditanstalt für Wiederaufbau, Germany’s development bank), CTB (Coopération Technique Belge, Belgian First, to properly track physical achievement and Technical Cooperation), and JICA (Japan International financial disbursement, it is important to define Cooperation Agency). Since 2004, two more have been performance indicators. But keep it simple—and added: AFD (Agence Française de Développement) make sure there are internal resources and capacity and AfDB (African Development Bank). Funds have to sustain the M&E system. In 2002, the Ministry of been flowing more predictably (from central to local Water put in place an M&E system in Benin which entities) since 2004, thanks to the implementation of has been continually improved over time to capture the program budget and increased donor information the physical and financial progress made by the sector. and coordination. Total funding for the rural water- Indicators were simple and sufficient, and the processes supply sector has increased by 214 percent over the past for gathering and storing information were clearly six years—from $14 million to $44 million. However, defined and easily implemented. The system includes the percentage of project funds flowing through project a central database for water points and an information implementation units has not gone down because system for financial management. Annual program donors would like to see tangible budget-support execution reports were improved over the period and results in the field before shifting completely from produced in time to be presented to the Ministry of the project approach to budget support. Finance and at the joint government/donors annual sector review. Lesson 3: Be smart in using budget-support Second, the participation of all stakeholders is required leverage. in reviewing the progress achieved in implementing a Generally, a ministry’s operating budget is not sufficiently national program. This is an excellent way to ensure robust to handle pure state tasks, such as carrying out transparency and build confidence among partners, proper planning, improving national procedures, and including all donors—non-governmental organizations, ensuring proper post-construction activities. So, in the private sector, and several sector ministries. In order to ensure greater sustainability for the sector, BSO Benin, the process strengthened sector coordination and leverage is necessary to increase the operating budget efficiency. It included three types of sector meetings: (i) and overall domestic funding—a key issue we had to a bimonthly group meeting of donors; (ii) an annual address in Benin. Then, in 2001–02, the operating 53 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS budget increased from $50,000 to $1.5 million, and result, 29 percent of the budget was delegated to the the budget for investment increased from $1 million decentralized level for sector operational expenditures to $5 million, due to intensive discussions between the in 2007, and over 90 percent of contracts are now Ministry of Finance and the Ministry of Rural Water. procured at the local level within 75 days. However, These discussions, directly facilitated by the World continued efforts are needed to speed up the procurement Bank team, constituted a critical step in helping the process and increase the budget execution rate. RWS sector adjust the amount of operational budget for the sector’s needs, and these amounts have been But just fixing the sector bottlenecks is not enough. increasing. Successful implementation of the programmatic approach involves a number of other factors, such Another example of our having to use the leverage as strong government buy-in and ownership, sound provided by the BSO was implementation of budgetary reform, alignment of strategies, effective management reform for the rural piped-water system. donor coordination, and a sound analytical basis. It Introducing a local PPP arrangement for improving should be noted that other reforms and prior actions the management and sustainability of the water-supply included in the World Bank BSO strengthened systems of small towns was one of the most difficult public procurement, improved government financial reforms to achieve in Benin. All of the stakeholders management, and streamlined internal control and talked about it for years, but nothing really moved. audit. All of these improvements had a strong positive Then, a decision to require implementation of the impact and contributed to the achievement of RWS sector reform as a prior action for the third World Bank sector objectives. BSO played a key role in moving the reform process forward. As of 2008, 23 percent of the small-town Lesson 5: If you want to go fast, go alone. If water-supply systems are under PPP arrangements. you want to go far, go together. Moving the reform process forward is not a one- Lesson 4: Review and address quickly the sector bottlenecks—and understand other man show! Every stakeholder has some comparative factors beyond the sector. advantages, and spending time and energy to build alliances is necessary—and pays off. It is also important It is important to thoroughly understand the overall to understand other partners’ constraints, make the best situation. In Benin, a public expenditures review that we conducted with DANIDA revealed a number of critical issues to be addressed. For instance, financial management systems and procurement were flagged as major areas for improvement. So we prepared an action plan that included implementation of a rigorous tracking system of all the contract procurement steps and a strong boost to the decentralization of procurement to the regions. This action definitely led to a progressive increase in sector absorption capacity. This transition toward further decentralization of service delivery, including procurement, was facilitated by the The Small Towns Water Initiative provides potable water introduction of a prior action in the fourth BSO. As a for 500 localities with populations of 2,000-25,000. SMARTLESSONS 54 use of potential synergies, and look ahead. Achieving t management reform of small piped-water systems results takes time. that introduced a new governance framework to ensure sustainable service; and A good illustration of this team approach in Benin is the Small Towns Water Initiative to provide potable t strengthening of decentralization, with a regional water for two million people living in 500 localities with program budget and procurement at the local level, populations between 2,000 and 25,000. This initiative to increase sector absorption capacity and empower was adopted during the 2004 government/donors joint local governments. annual sector review, and the framework agreement Government vision and ownership, planning and for it was signed by the Ministry of Finance and the accountability, analytical work and a results-oriented donors (the European Union, DANIDA, AFD, and approach, stakeholder coordination, as well as a learning- KfW) in February 2007. The World Bank supported by-doing approach are key elements of this success the initiative process through a policy action included story in Benin. in the BSO. Finally, the donors’ pooled fund was established and €20 million committed. Funds are disbursed based on the country system procedures and managed by national capacity. In 2008, 25 small-town water-supply systems were constructed through this ABOUT THE AUTHORS initiative—a good example of working together and Sylvestre Bea, Financial Specialist and Senior Consultant with the Africa Region, coordinates a contributing the best each one can offer. Public Expenditure Review project in Water and Sanitation in five Sub-Saharan Africa countries. Previously, he worked on Subnational Finance, a CONCLUSION Poverty Reduction Support Credit Impact Assessment Results achieved in scaling up investment and in RWS in Benin and Madagascar, and Municipal Finance in Burundi. reforms in the RWS sector in Benin are due to a combination of government vision and ownership of Claude Leroy-Themeze, Senior Economist, joined the the budgetary reform and programmatic approach, World Bank in 2000. She managed various Economic Sector Works and was task team leader of the first and the complementary mix of donor support and four Development Policy Lending (DPL) operations instruments used (sector investment projects, capacity in Benin and other DPLs in Burundi and Congo. She building, and BSO). Donors directly contributed to joined the Independent Evaluation Group in 2007. building national capacity and procedures and to Christophe Prevost, Senior Water and Sanitation financing water-supply infrastructures. Also, sector Specialist, joined the World Bank in 2001. He prior actions and sector policy dialogue, carried out managed RWS projects in Madagascar and Rwanda, through the World Bank BSO with the Ministry of conducted Public Expenditures Reviews in seven West African countries, and participated in 15 Rural Water Supply and other donors, contributed DPL operations in five countries to lead the policy significant support to the government’s efforts to dialogue on Rural Water and Sanitation reforms. He implement major reforms: joined the Water and Sanitation Program in South Asia in 2008. t introduction of a results-oriented medium-term Approved by Jaime Biderman, Sector Manager, Africa program budget that radically improved planning Region, World Bank. and achievements; November 2009 55 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS In 2004, Benin constructed more than 1,200 water points. A water point is a borehole with a hand pump that can serve 250 people. Or it may be a small supply system with communal standpipes—the equivalent of many water points. SMARTLESSONS 56 Dare to Fail: Counterintuitive Lessons from Mergers and Acquisitions Experience in the Airline Sector Warren Buffet famously quipped that by inventing a flying machine, the Wright Brothers did the world’s investors a great disservice. The only modification this SmartLesson would make is to include the world’s taxpayers as well, due to the number of countries that have lost money through government-run airlines. Below are summaries of some lessons learned from airline privatization successes—and (particularly) failures. BACKGROUND A great deal has been written about the troubles of the airline sector, in particular about how bad the IFC’s Advisory Services in Public-Private Partnerships industry has been for investors. The reality is that, provides merger and acquisition (M&A) transaction for a variety of deep-seated structural reasons, airlines advice to clients, specifically governments wishing to have an amazing capacity to lose money. Some of the transfer businesses to private sector ownership and biggest problems include: management. Over the last 20 years, global aviation has followed this privatization path, as a consensus 1. Fixed-cost structure: Airlines tend to build up emerged that governments were not good at managing a legacy-costs base (staff and fleet) that’s difficult airlines1. for a new owner to manage. In addition, fuel costs are beyond management’s control, and during the In the last 20 years, IFC has worked on nearly a recent oil price spike they accounted for as much dozen airline transactions. Unfortunately, many have as 30 percent of the cost base. proved to be difficult projects. However, a couple have become outstanding success stories. The Air Vanuatu 2. Price-sensitive product: Demand for travel is transaction stumbled during the economic turmoil extremely elastic, especially in tourist markets. of 2008 (see Box 1 on the next page). In recessions, people forgo vacations for other consumer goods. Conversely, price reductions LESSONS LEARNED increase passenger numbers dramatically (see Lesson 3). Lesson 1: Equity investment strategy “long airlines”: Think busted flush2. 3. Management speak: The bottom line is that “cost leadership” is important—very few airlines 1 The theory goes that by managing airline businesses commer- successfully charge more for a “differentiated” cially the private sector creates efficiencies, saves governments product3. money (often a huge percentage of national income), and boosts the numbers of passengers travelling. 3 As all graduates of business school know, cost leadership and 2 For those unfamiliar with gambling terminology, a busted product differentiation are the two basic strategies for a business. flush refers to something that started out with great potential It really is that simple, which is why all graduates of business but ended up a disappointing failure. That is not to imply that schools know that they have absolutely no need for strategy hedge fund investment strategies bear any resemblance to poker. consultants…. 59 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Box 1: Two landmark deals—and one that didn’t fly Kenya Airways Year the deal closed 1995 Structure Sale of 26% to strategic partner, subsequent 51% IPO on Nairobi Exchange Bidder KLM Cost structure Reduced (but full-service airline remained intact) Results From 1995–2001 Kenya Airways’ frequencies grew by 61%, developing Nairobi into a regional hub. Tourist arrivals increased 42% over this period. A subsequent $15 million IFC investment has funded fleet expansion. The airline has consistently been profitable. Poly Blue Year the deal closed 2005 Structure Sale of 49% to strategic partner, 2% to local business Bidder Virgin Blue, Australian low-cost carrier (LCC) Cost structure LCC Results The $7.5 million government subsidy in 2004—70% of Samoa’s budget deficit— turned into $6.6 million profit in 2007, including $1.2 million cash dividend to government. Tourist numbers have increased 15% annually (historic trend 4%), and tourism revenue, $83 million in 2005, reached $113 million in 2007. Implies 2,000 new jobs created (population of Samoa: 180,000). Air Vanuatu Year the deal closed TBD (as of 2008) Structure Sale of between 40% and 49% to strategic partner Bidder Primarily Australian airlines Cost structure Proposed LCC Results Tender held March to July 2008, over which time fuel prices rose precipitously. Investor interest dwindled; by June only one bidder remained. Terms of the offer would not meet government objectives. Recommendation: Cancel the tender and wait until market conditions improve, which may take some time. 4. Complicated “demand chain”: Customers often will suffer. This is particularly true in tourism- purchase tickets through travel agents, frequently dominated markets such as Vanuatu. in a package with hotel accommodations. Since airlines rely on these other actors for their sales, if 5. Overregulation: Bilateral agreements between there are bottlenecks elsewhere the aviation sector governments, still prevalent in many parts of the world, prevent competition from functioning SMARTLESSONS 60 normally. Open skies are being adopted, but not Lesson 2: Airlines are a political football that in all countries. politicians like to kick around. 6. The twist… leverage: All of the above features Unfortunately, experience has shown that in our markets, contribute to making airlines a fairly risky politicians are prone to protect their national flag business; so the last thing you’d want to do is to carriers. For some reason, they are viewed as national leverage them up like a safe, steady, predicable champions, crown jewel assets that deserve special utility. Unfortunately, due to the massive cost of prestige and a place in a nation’s heart. There are two purchasing aircraft, that’s exactly what happens.4 lessons here. Any deterioration in the operating environment First, we have to figure out the political connections and… managers are on Amazon.com ordering within an airline’s management early and determine “Bankruptcy Legislation for Dummies.” whether there is any chance of control being relinquished. 4 Some clever people figured out a way of hiding these debts off Too many times we have encountered a prime minister’s the balance sheet (through the magic of capital leases). However, the reality is that the terms of an aircraft lease are so inflexible nephew being the chairman of the airline’s board of (returning a 737 early is roughly as difficult as building one from directors, or had our fingers burned by last-minute scratch out of paper) that from a financial perspective, the busi- political decisions to pull out of a transaction—for ness is still highly leveraged. example, with Camair (see Box 2). These factors combine with devastating effect: Periodically the whole sector goes into meltdown, the last being after 9/11, and a current one starting in March 2008 (due to high fuel costs, later combined with softening demand). For example, in 2004, the year before we were engaged to assist with Polynesian Airlines, 70 percent of the Government of Samoa’s total budget deficit was due to the losses at the airline. 61 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Box 2: Some of IFC’s recent airline deals Mandate Country Year Result Comments signed Air Jamaica Jamaica 2008 Ongoing Air Vanuatu Vanuatu 2007 Failed bid Oil price increases during 2008 reduced market interest (see photo caption at left) Rwandair Rwanda 2005 Failed bid Oil price increases during 2008 reduced market interest. Camair Cameroon 2005 Reversed Bid won and airline awarded to SN Brussels; government then decided to cancel process. Royal Tonga Tonga 2003 Liquidation IFC study showed airline was not viable; government liquidated it. Polynesian Blue Samoa 2003 Success See photo caption at left. Air Botswana Botswana 2002 Cancelled Lack of market interest. Air Tanzania Tanzania 2001 Success Bid won by South African ($20 million for 51%). Subsequently, airline went bankrupt and was renationalized. Nigeria Airlines Nigeria 1999 Cancelled Airline eventually liquidated, replaced by Virgin Nigeria. Kenya Airways Kenya 1994 Success See Box 1. Second, the high-profile nature of airlines can sometimes Lesson 3: News flash: Most people choose the work in our favor. With Kenya Airlines, for example, cheapest flight. the original motivation for the restructuring came Although it sounds obvious today, the realization when then-president Daniel Arap Moi’s Kenya of just how price-sensitive the aviation sector is has Airways plane was grounded at Charles de Gaulle taken several decades to emerge. As the first low-cost by the Accounts Receivable department of Airbus carrier (LCC), Southwest Airlines in the United States Industrie. The bankrupt airline had only forgotten to modified the traditional airline business model, which pay the installments for its aircraft. The humiliation has been copied, with minor modifications, around and indignation prompted a top-level decision to put the world. With price cuts, demand for air travel the airline on a sound financial footing—whatever it explodes (often to the chagrin of environmentalists), took. The Kenya Airways transaction is one of our most as has now been proven in almost every region of the successful, and a poster child for airline privatization globe. Empirical evidence suggests that when an LCC around the world. SMARTLESSONS 62 starts up, prices fall by an average of 20 percent over Lesson 4: Slaying an IFC sacred cow?5 the first four years, resulting in a traffic increase of about 50 percent over the same period. So what does When IFC advises a client on selling a company, there this mean for our mandates? is a golden rule that we always make every effort to stick to: force the investors into bidding as part of a Firstly, if our reform package is bringing competition to competitive auction. This proven classic negotiation aviation markets, tourism numbers will grow, creating tactic gives sellers maximum leverage over buyers, and a powerful incentive for government to complete the it generally leads to the best results (on price and other transaction. For a mid-market destination, statistics terms). Typically, we manage the auction by negotiating suggest one tourism job for every four arrivals. In Samoa, all nonprice issues (degree of management control, for example, although several hundred jobs were lost service levels, brand conditions, and so on) with bidders in the restructuring of the airline, an estimated 2,000 in advance, and then hold a bid on price—and winner have been created by the new arrivals—in a country takes all. Basically, “Selling a Company 101” is all with a total population of only 180,000. In three years, about getting buyers to compete with each other 6. our transaction has taken several percentage points off the national unemployment rate—a significant However, in the aviation sector there may be justification impact. A key lesson from the Air Vanuatu transaction for suspending this rule, for the following reasons: is that enlisting the support of other actors in the t Practically speaking, actually getting two bidders tourism sector (hotels, travel operators, and so on) prepared to compete is very difficult; depending on can become an important way of mobilizing public market conditions, it may be impossible. With Air support for our work. Vanuatu we had two bidders—until about a month The second lesson is that if we are going to advise a before the bid date when, with oil prices soaring, government to divest its national airline and encourage we suddenly found that only one remained. competition, we had better be sure that it is doing t More profoundly, what are we trying to achieve? In so in a way that enables the new airline to have some many sectors, getting the highest price or the lowest form of cost leadership. Otherwise, we may complete tariff is a key objective of our transaction. But in the transaction only to see the airline to go bankrupt airlines, the key objective is often simply finding an one or more years down the track as was the case with international investor that will give us access to its Air Tanzania (see box on page 62). cost base. The terms of access to this cost base (the management fees that will be charged, what parts We need to approach cost leadership creatively. Since of the legacy business will be incorporated, and so our mandates usually take place in small, niche markets on) are much more significant in the long run than that lack economies of scale on their own, cost leadership a small nominal payment for shares. can mean adopting the cost base of a larger regional airline. In Africa, it can mean liquidating the old The controversial lesson may be that a competitive airline (with its large liabilities and legacy-cost issues) bidding process brings little value to securing these and starting afresh with an international investor’s 5 No sacred cows were harmed during the preparation of this business model. In other regions, a difficult but proven SmartLesson. approach has been to create a “virtual airline” run by 6 This approach has also been used by IFC when exiting equity an LCC, as was the approach taken in Samoa and investments. A great example is the sale of 6.2 percent of the equity of Asia Commercial Bank of Vietnam, where IFC sold its attempted with Air Vanuatu. stake at twice the price being publicly traded on the market. This outstanding result was achieved through a blind-auction process; JP Morgan advised IFC on this deal. 63 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS terms and conditions. If some form of competitive had made the right recommendation to our client.… negotiation will secure the lowest cost base for our But when we phoned senior management to break client, then maybe this is the process we should advise the news that “actually, guys, we’ve decided to call the our clients to follow. whole thing off,” the line suddenly went dead. Lesson 5: Dare to fail: A discredited theory of management finds a new home7. Sometimes the right advice to our clients is not to do a transaction. This can be a difficult piece of advice to give, especially when the team has worked day and night for over a year to painfully negotiate a transaction with bidders. But sometimes it is the right advice—more frequently with aviation than with our other work. These situations occur for different reasons. For example, governments often resist our advice to allow the reformed airline to pursue a strategy of cost leadership. There can be a natural resistance to allowing a major staff restructuring to take place or to adopting a low-cost model. The danger for us is that if we recommend that the transaction be consummated on these terms, the airline will not be able to compete and will subsequently go bust in the next industry downturn (as happened with Air Tanzania), and as a development institution we are left several years down the track with an unhappy client (who also happens to be a shareholder). Another reason is that if the industry is in the midst of a cyclical downturn, getting a good deal becomes very hard. This is what happened with Air Vanuatu. The aviation industry went into meltdown in early ABOUT THE AUTHOR 2008, just as negotiations with investors were taking place. The result was that the goalposts shifted, and James Morley has worked for several years with IFC’s the broad terms of the deal that we thought were Advisory Services in Public-Private Partnerships in achievable suddenly moved, materially. The cost to Hong Kong and Johannesburg. government of gaining access to the low-cost base of a Approved by Edgar Saravia, IFC Advisory Services in larger regional airline became prohibitively expensive, Public-Private Partnerships, East Asia and Pacific. so our advice to the government was to wait. Although February 2009 fairly frustrating at the time, we at least knew that we 7 The Alan Latchley “Dare to Fail” philosophy was pioneered by the England football team and then adopted by a number of British industries in the period from 1950 to 1990. SMARTLESSONS 64 Lessons in Health and Education Breaking New Ground: Lesotho Hospital Public-Private Partnership—A Model for Integrated Health Services Delivery For many years, Lesotho has urgently needed to replace its main public hospital, Queen Elizabeth II. In 2006, to maximize the use of limited resources and ensure long-term improvement in facilities and services, the government adopted the public-private partnership (PPP) approach for a new hospital. IFC’s Advisory Services in Public-Private Partnerships advised the government in structuring a PPP for the design and construction of a new 425-bed hospital and adjacent gateway clinic, the renovation of three strategic filter clinics, and the management of facilities, equipment, and delivery of all clinical care services for 18 years. The project has a capital value of over $100 million, and the private operator—the Tsepong consortium headed by Netcare, a leading South African health care provider—has significant local ownership: 40 percent of shares held by Lesotho-owned businesses, increasing to 55 percent during the project term. This SmartLesson describes this pioneering project, and shares some lessons we’ve learned from it. WHAT MAKES THIS PROJECT which will operate as the national referral hospital as DIFFERENT well as the district hospital for the greater Maseru area, PPPs in the health sector typically range from simple Tsepong will be responsible for the refurbishment, outsourcing of support services (such as catering or re-equipping, and operation of three primary health laundry) to the more complex design, construction, and care clinics at Qoaling, Mabote, and Likotsi in the facilities management of hospitals. To our knowledge, greater Maseru area, allowing it to manage a mini– the Lesotho PPP structure is a first for Africa—and health care network, and filter and treat less severe one of only a handful of similar projects worldwide. In cases at the clinic level, freeing up as much hospital addition to the design, construction, and full operation capacity as possible. of the hospital and associated health care facilities, the Tsepong consortium will deliver all clinical services, 2. Service Payment. with the objective of providing vastly improved, high- quality health care services at an affordable cost. Here The private operator delivers budget certainty as well as are some key differences from other hospital PPPs: patient-centered care, assuming full patient risk from project inception and agreeing to treat all patients who present at the hospital and filter clinics, regardless of 1. Complete Health Care Services Delivery. the type of condition, up to a maximum of 20,000 Tsepong is responsible for delivery of all clinical inpatients and 310,000 outpatients per annum—with services—including recruitment of doctors, nurses, very few clinical exceptions. The government provides and other health professionals—and provision of all Tsepong an annual fixed service payment for delivery medical equipment and all pharmaceuticals necessary for of all services, escalated only by inflation annually. clinical services delivery. In addition to the new facility, We know of only one similar full PPP project in a 67 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS The 100-year-old Queen Elizabeth II Hospital, an aging facility functioning at a minimal level, will be replaced by a new hospital. developing country, and that private operator opted t The Lesotho agreement includes a detailed list of for a direct-cost-plus-margin payment basis for the first both clinical and facilities performance indicators few years (until patient profiles and disease patterns that the private operator must meet in order to could be studied) before committing to a fixed cost receive full payment from the government. Failure for clinical care. to meet a performance indicator will result in a severe penalty deduction (a percentage of the total 3. Performance Monitoring. service payment). The relative importance of clinical versus facilities performance indicators is reflected The Lesotho PPP agreement includes typical performance in the percentages deducted. For example, failure to monitoring—such as payment and penalty mechanisms comply with the infection-control measures (clinical related to facilities management, equipment, and other indicator) draws a 1.00 percent penalty; whereas nonclinical service outcomes—as well as independent failure to comply with linen and laundry service certification of delivery of facilities and equipment. standards (facilities indicator) brings only a 0.25 But it also requires additional monitoring: percent penalty. A ratchet mechanism for repeated SMARTLESSONS 68 service failure for the same problem increases the vastly improved services. However, there were many penalty deduction for each repeated failure, and questions as to whether the country (and the average service failure that is not remedied can result in patient) could afford new facilities and better public termination of the agreement. care. What services would be offered? Could service t The Lesotho project has an independent monitor— delivery by a private operator be affordable? a unique role specifically created for this project To answer these questions, IFC produced a detailed and jointly appointed by the government and the baseline study of health care costs and services at the private operator—to perform a quarterly audit existing Queen Elizabeth II hospital and the related of the private operator’s performance against the filter clinics. The baseline significantly shaped the contractual performance indicators (clinical and project design, helped set the performance indicators nonclinical) and, where performance has not been in the PPP agreement, and improved the government’s achieved, determine the penalty deduction that understanding of what was currently being delivered applies. The independent monitor is a consortium and what improvements the PPP could bring. The of companies with specialized experience in PPPs, performance indicators are also aligned with the clinical services, hospital operation and management, Millennium Development Goals (MDGs) for Lesotho. medical and nonmedical equipment, information The baseline study will also be useful for IFC’s own management and technology, and soft and hard monitoring and evaluation work on the project going facilities management. forward. t The private operator is required to obtain and maintain accreditation from the Council for Health Services Lesson 2: Evaluation of bids serves to enhance Accreditation of Southern Africa; failure to do so outcomes and affordability. can result in termination of the agreement. The challenge was to come up with a bid evaluation t The project provides for a Joint Services Committee, structure to accommodate three competing objectives: established by the government and the private opera- tor, to review performance and discuss and develop 1. to procure as many services for as many people at mechanisms, procedures, or protocols to improve the hospital and filter clinics as possible; the services at the hospital and filter clinics. Given the long-term nature of the project, this committee 2. to improve the quality of services; and provides a mechanism for altering the hospital’s 3. to do so within the government’s affordability services, by agreement, to address new disease pat- limit. terns, new technologies, or new national priorities, thereby ensuring that the project remains relevant The best structure we could devise to balance these for the country. objectives involved dividing the technical evaluation into three areas: LESSONS LEARNED Service Coverage: Bidders were required to confirm Lesson 1: The baseline study is important which services they could feasibly provide within the throughout the project. service payment, taking into consideration patient volumes. Services listed by the government in the bidding During project preparation, IFC realized that the documents included “mandatory” and “optional.” For expectations of the government and general public example, orthopedic surgery (general and trauma) was were high: a new facility with better equipment and a minimum requirement, but bidders who also offered 69 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS hip-joint replacements within the service payment agreement on the minimum types of services believed received additional points. Similarly, diagnostic imaging to be deliverable within the affordability limit by any (radiology, digital X-ray, CT, mammography) was private operator. a minimum requirement, but bidders who offered magnetic resonance imaging (MRI) services received To progress smoothly, such a highly visible, important additional points. The winning bidder agreed to provide national project had to be seen as having the support all mandatory services, plus 95 percent of all additional of all key stakeholders. Wide support would not have optional services, within the service payment. been possible without the consultative process. A key to getting agreement was finding a balance between Patient Volumes: The government stipulated services to a services perceived to be essential versus services that minimum of 16,500 inpatients and 258,000 outpatients would be good to have but not essential—plus a constant at the hospital and filter clinics. Bidders had to commit reference to affordability. A bidding structure that to a maximum number of inpatient and outpatient allowed bidders to include optional extras was also visits, and the bidder offering the highest number of helpful in reaching agreement. patients received the maximum points. The winning bidder committed to delivery of services to 20,000 Lesson 4: Integrated service delivery is inpatients and 310,000 outpatients per annum. essential at every level. Service Delivery Plan: Bidders were evaluated on their Since the private operator is responsible for complete approach to quality, effectiveness, and efficiency of health care service delivery at the hospital and filter the services to be provided; compliance with service clinics, it was important to ensure that it could actually standards; and how realistic their plans were. This deliver all services—pharmaceuticals, for example. element was evaluated by a multidisciplinary team The current national referral hospital is a significant from the Ministry of Health and Social Welfare, the client of the National Drug Supply Organisation Ministry of Finance and Development Planning, and (NDSO), the central pharmaceutical and medical- IFC. supplies procurement entity for the government. On the one hand, if the private operator were no longer The technical and financial offers were submitted required to use NDSO as a pharmaceuticals supplier, separately, with the financial offers opened only after NDSO would lose significant bargaining leverage for the technical evaluation was completed. the country. On the other hand, if the government forced the private operator to use NDSO, and NDSO Lesson 3: Defining clinical services is necessary, failed to deliver the right drugs on time, the private even if it has to be a highly consultative operator could claim cause for failure to treat a patient. process. Solution: The private operator entered into a service- The service coverage list developed for the bidding level agreement with NDSO, as well as a capacity- documents was a key element of the bid evaluation, building initiative that will enhance NDSO supply but the definition of that list was a highly consultative and logistics capability, thereby ensuring better service process, including Ministry of Health staff, clinicians at delivery not only to the PPP but also to the broader the Queen Elizabeth II hospital, private practitioners in public health system. Lesotho, and IFC’s technical experts. These discussions were complicated by the inevitable need to balance affordability and expansion of services currently not provided in Lesotho. The parties eventually reached SMARTLESSONS 70 Lesson 5: Value for money is about more than any other public health facility in Lesotho. The project just project cost and risk transfer. has also ensured maximum risk transfer to the private operator, protecting the government from most of PPPs generally focus on the concept of value for money, the financial, operational, and legal risks inherent in which typically assesses the affordability and risk transfer a project of this nature. of a project. By this standard, the Lesotho project is affordable for the government. On an operational Other significant value-added elements include: cost comparison, the government will not pay much more for the PPP than it currently spends on the t Development of human resources: Lesotho, like Queen Elizabeth II, yet it will receive vastly improved many other developing countries, struggles to attract facilities, medical services, and patient care. From a and retain professional health staff. In this project, patient perspective, services at the new hospital and the private operator is responsible for recruitment of filter clinics are affordable and will cost the same as at all staff at the new hospital and filter clinics and has The new clinics getting ready to open their doors to the public. 71 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS greater freedom to pay the staff salaries that reflect the investors, expands services to more people, and has scarcity of their skills, without being constrained by the potential to deliver high-quality health services government salary policies. This project also allows that address MDGs and the critical shortage of health the private operator to create a platform for doctors professionals—key constraints for many developing to serve both the private and public sectors in a countries. controlled manner. The project will also create a working environment that encourages high-quality, Although the project is still in its early stages and the patient-centered treatment with the use of modern expectation of success is high, there will certainly be equipment and greatly improved facilities—one of challenges and obstacles for the private operator and the key factors in retaining health sector staff. the government to overcome. A key risk is the high probability that the hospital will reach maximum t Training: The new referral hospital will be the coun- capacity very early in the project term, requiring the try’s main teaching hospital for physicians undergoing government to rapidly improve the service offering at postgraduate training, medical students, nurses and other hospitals to relieve the pressure on the national other health professionals, and staff from other public referral hospital. Another risk is whether the private health facilities. These students will have access to operator will be successful in attracting and retaining equipment and facilities not previously available in the numbers of doctors and nurses necessary to ensure Lesotho. This training component is also expected effective service delivery. The key factor for the success to assist in retaining qualified health sector staff. of this project is the commitment and support of t Referrals: The government currently refers most the government demonstrated throughout the project complicated cases outside the country, since the process, from procurement, during negotiations, and current facilities at Queen Elizabeth II cannot ac- to financial close. The government firmly believes commodate them. The new hospital will address this project will deliver meaningful results for the many of these cases. country. Human resources (HR) and training costs are built into the financial model, and the private operator commits to spending the amounts allocated to HR and training annually—making these elements part of the overall cost of the project. ABOUT THE AUTHORS Carla Faustino Coelho, an Investment Officer in IFC’s Advisory Services in Public-Private Partnerships, works CONCLUSION on health, education, and water sector projects in Sub-Saharan Africa. The PPP agreement for this project was signed by the government and the private operator on October 27, Catherine O’Farrell, a Senior Investment Officer in 2008. Financial close occurred on March 20, 2009, IFC’s Advisory Services in Public-Private Partnerships, works on health and education projects in Sub- and construction began on March 23, 2009. The filter Saharan Africa and other regions. clinics are expected to be operational at the end of 2009, and the new hospital in July 2011. Approved by Robert Taylor, Principal Financial Analyst, IFC Advisory Services in Public-Private Partnerships. The Lesotho Hospital PPP has demonstrated that it July 2009 is possible, in a low-income country, to embark on a very ambitious project that is affordable for the country and patients, is attractive to top-quality private SMARTLESSONS 72 Reappraisal of the Private Schools Support Programs in Ghana, Kenya, and Rwanda Private schools serve a critical role in the education system in many developing countries. However, they often remain limited in their ability to provide quality education services, due to inadequate access to finance and advisory services. In 2005, IFC piloted a model in Ghana— which it replicated in Kenya (2007) and Rwanda (2008)—that encourages local financial institutions to expand their lending to schools, with a parallel advisory program that helps schools create viable business plans and improve their operations through management/staff training and systems. This SmartLesson discusses what worked well in the program and what did not, and what can be done if IFC is to have a greater impact with the Africa Schools Program. BACKGROUND IFC supports the banks by providing risk-sharing facilities and advisory services. These products With public funds for education in Sub-Saharan Africa simultaneously help to reduce the risk of private school limited, governmental efforts alone are insufficient to loans going bad, afford bank officers the opportunity meet the demand for quality education spaces. Hence, to better originate schools’ loans, and ultimately enable there is a need for private schools to fill the gap. Private the banks to expand their lending to the education schools, especially at the primary and junior secondary sector. Under the risk-sharing facility, IFC shares the level, are essentially small and medium enterprises risk on defaulting loans on a portfolio of private schools (SMEs) with the usual less-than-optimal formality in originated by the partner bank to an expanded and their operations. For this reason, few banks understand defined maximum portfolio limit. IFC does this by the risks involved in lending to private schools, and agreeing to underwrite a percentage (40 to 60 percent) those that venture to do so generally lend on the short of loans in the portfolio that default and are written term. Thus, even if schools are able to secure bank off (in line with local central bank requirements). financing, the tenor of that financing in most cases is inappropriately matched to infrastructure expansion This risk is defined as junior risk, as it kicks in after or school modernization needs. the partner bank has absorbed the senior risk, or what is called the first loss: usually five to ten percent. Managed by IFC’s Private Enterprise Partnership for The first loss and IFC’s percentage participation are Africa (PEP Africa), in cooperation with IFC’s Health determined at appraisal and are based on the target and Education Department (CHE), the Africa Schools bank’s portfolio quality, including historical indicators Program is designed to leverage IFC’s experience in like the nonperforming loans ratio, credit policies and project financing and advisory services for SMEs. It procedures, and the bank’s general financial health. consists of an integrated offering of access to finance By design, the risk-sharing facilities are unfunded, and tailored business development services to schools. and most of the banks have come back to ask for funded lines of credit to assist them in meeting the 73 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS asset-liability mismatch for lending to schools over the banks, especially The Trust Bank and BRD, has proved medium to long term. Most of these banks typically that this is a profitable lending sector and that banks do not have access to long-term funding—relying are willing to do more if the liquidity issues can be mostly on demand deposits—and so they are more addressed. inclined to lend on a short-term basis. In all countries of operation, the program also provided various advisory services to the schools, mostly focusing RESULTS TO DATE on delivery of business and education management Under the risk-sharing agreements with partner banks workshops and developing customized business plans (The Trust Bank in Ghana, KREP in Kenya, and BRD to access finance from the partner banks. in Rwanda), a total of 75 schools and three hostels have accessed a cumulative loan total of $12.33 million LESSONS LEARNED from the banks. Utilization levels of the risk-sharing facilities across the three banks are as follows: Lesson 1: Private schools are not for the rich only. Therefore, we need to adjust our product 1. Ghana: The facility has utilized about 75 percent, to better serve low-income schools, especially or $3.45 million of the $4.58 million (current in frontier markets. equivalent) risk-sharing loan. In most African countries, private-education institutions 2. Rwanda: The facility has used 69 percent, or $8.45 range from those serving low-income groups to those million of the $12 million risk-sharing loan. serving high-income groups. In fact, in some areas, the 3. Kenya: The facility is at 25 percent utilization, poor state of public schools means that the only real at $0.43 million of the $1.7 million risk-sharing option for parents is the private school. However, the loan after the first two years of the program. Africa Schools Program, as currently designed, is not able to meet the needs of schools serving low-income In Ghana, only one school out of the 25 schools in groups. Such schools have the following characteristics the portfolio has had problems with repayment. In that effectively exclude them from the program: Rwanda, the schools portfolio is the BRD bank’s best, with not a single non-performing loan. In Kenya, t Marginal profitability: They have very low fee of the 30 schools in KREP’s portfolio, seven were levels, and most of their students do not pay fees nonperforming as of December 31, 2008. The Kenya on time, if they do pay at all. situation was brought about by the post-election violence that rocked the country in January 2008 and resulted A partner school in Ghana. in some of the schools losing students and revenue, which affected their ability to repay the loans. In addition, the KREP bank faced liquidity constraints attributed to the global financial crisis, which made the situation even worse. To support the bank in addressing this problem, the Africa Schools Kenya program conducted an audit of the nonperforming portfolio and advised the bank on how to restructure the portfolio. The portfolio is currently performing. The experience of the participating SMARTLESSONS 74 t No security/collateral for accessing loans: the disbursement to ensure that these schools are These schools are often on rented premises and embracing sustainable business principles. We could in temporary structures that cannot be used as also reconsider pricing levels and first-loss provisions collateral (especially in the case of Kenya). for the partner banks that serve such schools, and leverage partnerships with development partners to t Lack of basic necessities: Despite the fact that provide first-loss funding. they desperately need advisory services, the schools cannot afford a contribution in time and cash, In our experience, banks target different segments of as they continuously struggle to remain afloat. the market. It is therefore important to engage a variety of banks (with a variety of financial products) to ensure As a result, the current program has worked quite that all market segments are reached. Otherwise, the well serving mostly the middle and upper range of program ends up excluding certain groups of schools the private school market. If we want to expand the that may not be part of the partner bank’s target. Low- program’s benefits to low-income schools, we need to income schools will need to be served by microfinance make several important adjustments. Specific advisory banks, and middle- to high-income schools need to be services and financial products need to be developed served by SME and larger banks, with a commensurate for the different segments. higher return to both IFC and the partner banks on Eligibility criteria, like a minimum number of students the latter. Having more than one bank also ensures and 130 percent coverage ratio on loan security, should that the program does not stall if there are challenges be reevaluated to maintain portfolio quality but enable with any of the partner banks, as was the case in Kenya low-income schools to qualify for loans under the with the KREP bank, and currently with The Trust program. IFC should also seek third-party “impact Bank in Ghana. investors” to reduce the collateral requirements for However, getting other partner banks on board is schools and to reduce the pricing of the facilities to the proving to be tough, especially in view of the current potential partner banks. All three current partner banks global financial crisis and the pricing of IFC products. have complained of the high quarterly fees charged To put this in context: IFC’s Board approved the $50 by IFC for this unfunded risk-sharing facility as well million program in June 2007. This meant that the as the level of first loss/senior risk. It is also quite Africa Schools Program through CHE investment telling that several other banks in Ghana, South Africa, officers could sign up different banks across Africa to an Uganda, and other countries have rejected the facility, based mostly on the price/fees. Profitability levels of the private schools, and hence the ability to pay off commercial loans, will vary, and IFC needs a product that recognizes this. For example, the lower-end schools could be targeted with a product that first sets out to bring them to a sustainable level—for example, loans with extended moratorium periods of up to two years. Such a product might require partnerships with other development organizations, including foundations and donor agencies that are interested in education to provide funding Kenyan school constructed with a program loan. for advisory services not only prior to but also after 75 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS aggregate total of $50 million. So far, the aggregate of line with IFC’s Advisory Services pricing guidelines. the investments in the three countries is $3.5 million Pricing is usually determined by market surveys and in Ghana, $1.7 million in Kenya, and $4.8 million in feedback from schools during pre-implementation Rwanda—a total of $10 million, or 20 percent of the workshops. original $50 million approved. If the program is to go beyond the current 20 percent, there is a need for The starting point is the school’s diagnostic and CHE and the Global Financial Markets Department business plan, delivered directly to schools through to diversify the financial products and their pricing, local consultants. These schools are also able to access as well as the levels of first loss required of partner other direct advisory services as needed. Other schools banks, in order to attract more banks to the program. that do not access loans but meet the eligibility criteria The current risk-sharing facilities require banks to use (enrollment levels, number of years in operation, their own funding to lend, and most of the banks are registration/licensing by the relevant authorities) can asking, “When are we likely to call on IFC’s guarantee?” also qualify for advisory services. The terms of the agreement do not enable the banks Experience in delivering this program in Ghana and to take on additional risky projects, so the likelihood Kenya has shown that the direct services that include of default is low. self-diagnostics and business plan development cannot In particular, Liberia and Sierra Leone represent be delivered as “en masse” workshops. Most schools challenges for the Africa Schools Program. Whereas lack a basic understanding of what a business plan demand from frontier country governments, IFC entails and its usefulness. It therefore becomes critical country staff, and potential private schools at all levels to coach them on a step-by-step basis. This is best is high, the appetite for a low-margin investment by achieved by local consultants, who not only understand IFC in a local bank is almost nonexistent. We need a the market within which the schools operate but also financial product directed at frontier markets where are stationed in the country and therefore are able to IFC recognizes that, due to marginal profitability but commit ample time to the assignments. a strong social need, a suitable partner bank can be The exit strategy is for the cost-share by IFC to decrease engaged on less pricey terms. over the implementation period of the program and for the local consultants to be sufficiently exposed to Lesson 2: Use local consultants for delivery of the business opportunity to take this up on their own. the Advisory Services Program, tailored to the needs of individual schools The Advisory Services component has been well attended by the targeted schools as well as by the partner banks in Ghana, Kenya, and Rwanda. Advisory services are targeted at schools in two main ways: directly at each potential school that requests a loan, and broadly at groups of schools through workshops. IFC raises funds from donors to pay for the cost of delivering these advisory services through external consultants or firms, and the schools are obliged to cost-share at various levels of up to 40 percent, in Beneficiaries of the programs in Kenya. SMARTLESSONS 76 Ideally, IFC’s continued investment engagements with local banks on private schools will create a “pull factor” ABOUT THE AUTHORS for commercial and sustainable advisory services. Brigid Amoako, Operations Analyst in Ghana, has more than eight years of experience in business Lesson 3: Carefully segment, profile, and development working with IFC. Prior to joining the screen the schools during pre-implementation Africa Schools Program in November 2008, she was activities. part of the SME Entrepreneurship Development Initiative in Accra, managing the provision of advisory services for SMEs. To be able to pitch the program at the right level, profiling and screening of schools must be part of Jane Onoka, Associate Operations Officer in Kenya, pre-implementation activities. This can be achieved joined IFC in February 2007 to manage the Africa through a mini-survey or recruitment exercise to Schools Kenya program. Her role has since expanded to include managing the Africa Schools Rwanda determine their broad cost structure, revenue history, program, as well as leading the development of new and estimated recurring surplus in order to indicate programs in other East African countries. Jane has realistic payback of commercial loans. more than 10 years of experience in education and development. The screening and profiling should be done based on Approved by Colin Shepherd, Infrastructure and the income category of the target schools agreed on Corporate Advice Business Line Leader, Sub-Saharan with the bank. As mentioned in the first lesson, it is Africa; and Sam Akyianu, Program Manager, Africa necessary to design products that will specifically help Schools Program. low- and middle-income schools reach a sustainable May 2009 level for them to benefit from this program. We also find that preparation of the schools for advisory services can be significant, depending on their business readiness, and this takes up part of the implementation time. Pre-implementation activities should therefore be carried out over an extended period of 6 to 12 months prior to the formal program launch and the engagement of the partner bank(s). Low-income schools especially require long and heavy “hand-holding.” For example, where we identify low management skills, it may be necessary to start up the advisory program about a half year before the financial program is implemented, in order to give the schools time to understand the basics of business borrowing for expansion. This also ensures that there is a pipeline of schools ready to take up loans by using prequalification criteria, once the agreement with partner banks is signed. This will also serve to attract banks to the program. 77 IFC ADVISORY SERVICES IN PUBLIC-PRIVATE PARTNERSHIPS Credits PHOTOS Cover page © Javier Calvo/IFC Page across from index © Apa Nova Bucharest Page 2 © Paul Nickson/World Bank Page 3 © Morris Biondi Page 5 © Marcelo Lessa/IFC Page 14 © IFC Pages 17, 18 © PIDG Page 19, 20 © Simone D. McCourtie/World Bank Page 30 © Jeanine Delay Page 36 © Angelo Del’Atti/IFC Pages 37, 38 © Edwin Huffman/World Bank Page 48 © Perumal Venkatesan/Flickr Page 50 © Manish Bansal/Flickr Page 54 © Sylvain Adokpo-Migan Page 56 © Eric Miller/World Bank Pages 57, 58, 61 © Phillip Capper/Flickr Page 64 © Javier Calvo/IFC Pages 65, 66 © Veronica Donnelly/iStockPhoto Page 68, 71, 74, 75, 76 © IFC Page 77 © Trevor Samson/World Bank DESIGN Jeanine Delay PRINTING Ecoprint IFC Advisory Services in Public-Private Partnerships around the world HEADQUARTERS Washington DC, USA 2121 Pennsylvania Avenue NW T: +1 202 473 1000 EAST ASIA & THE PACIFIC EUROPE & CENTRAL ASIA SOUTH ASIA Hong Kong, China Belgrade, Serbia New Delhi, India 14/F, One Pacific Place Bulevar Kralja Aleksandra 86-90 50-M, Shanti Path, Gate No. 3 88 Queensway Road 11000 Niti Marg, Chanakyapuri 110 021 T: +852 2509 8100 T: +381 11 302 3750 T: +91 11 4111 1000 LATIN AMERICA & CARIBBEAN MIDDLE EAST & NORTH AFRICA SUB-SAHARAN AFRICA Rio de Janeiro, Brazil Dubai, United Arab Emirates Johannesburg, South Africa Rua Redentor, 14 The Gate - DIFC 14 Fricker Road, Illovo, 2196 Ipanema 22421-030 West 10th Floor, Sheikh Zayed Road T: +27 11 731 3000 T: +55 21 2525 5879 T: +971 4 360 1004 SmartLessons is a World Bank awards program to enable development practitioners to share lessons learned in advisory services and investment and financial operations. This SmartLessons brochure presents first-hand and straightforward project stories with pragmatic useful analysis, written by professionals for professionals. Through the prism of their own experience—positive and negative—these authors aim to capture practical insights and lessons that could help advance development-related operations for private sector-led growth across the globe. July 2010