Report No. P-336 Public Disclosure Authorized This report was prepared for use within te k and its affiliated organizations. They do not accept responsibility for its accu'racy or completeness. The report may not be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL FINANCE CORPORATION Public Disclosure Authorized

REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS OF THE BANK AND THE BOARD OF THE IFC ON A PROPOSED LOAN BY THE BANK TO, Public Disclosure Authorized AND INVESTMENT BY THE IFC IN, THE INDUSTRIALIZATION FUND OF FINLAND (TEOLLISTAMISRAHASTO OY)

August Z9, 1963 Public Disclosure Authorized INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVJELOPIENT

INTERNATIONAL FINANCE CORPORATION

REPORT AND RECOWtiENDATIONS OF THE PRESIDENTI TO THE EXECUTIVE DIRECTORS OF THE BANK AND THE BOARD OF THE IFC ON A PROPOSED LOAN BY THE BANK TO, AND INVESTIENT BY THE IFC IN, THE INDUSTRIALIZATION FUND CF FINLAND (TLOLLISTAMISRARASTO oY)

1, I submit herewith the following report and recommendations with respect to a proposed Bank loan to, and a proposed IFO investment in TEOLLISTA;1IISHAHASTO OY, The Industrialization Fund, hereinafter called the Fund, of Finland. The Bank loan would be in various currencies amounting to the equivalent of US $7 million and the IFC investment would be in the amount of Fnlk 510,000 to Fmik 1,020,00C (equivalent to US $159,375 to US i318,750).

PART I - HISTORICAL

2. Following discussions in Washington with the Finnish delegation during 1tho 1%*2 Annual Meeting, missions visited Finland in November 1c962 and in April 1963 to consider the financial needs of Finnish in- dustxy arld to review the Finnish proposal for the reorganization of the Fund, for which financial assistance of the Bank and IFG was being sought.

3. Negotiations with the Fund and the Finnish Government took place in July 1963.

4. The Bank has already made the following loans in Finland: -2-

Amount, less Cancellations No. Borrower Purpose As of July 31, 1963 (US $ million)

16Fi Bank of Finland Power, wood processing and limestone 12.5 21FI Republic of Finland Equipment for timber production 2.1 61FI Bank of Finland Power, wood processing and limestone 20.0 70FI Bank of Finland Wood processing 3.5 112FI Bank of Finland Power and wood processing 12.0 142FI Mortgage Bank of Finland Oy Electric power 15.0 222FI Miortgage Bank of Finland Oy Wood processing 37.0 291FI Mortgage Bank of Finland Oy W-food processing 25.0 319FI Mortgage Bank of Finland Oy Electric power 25.0

Total: 152.1 Of which has been repaid: 32.5

Total now outstanding: 119.6

Amount sold: 34.3 Of which has been repaid: 17.0 17.3

Net amount held by Bank: 102.3

The total loans outstanding include $25.9 million not yet disbursed on July 31, 19(3.

5. IFC has already made two investments in Finland, as follows:

Amount, less Cancellations No. Borrower Purpose As of July 31, 1963

33 Oy Kutomotuote A.B., Tricol Oy, Toli Oy (K.T.T.) Textile mill 156,000

34 Rauma-Repola Oy Pulp and paper, ship- building and metal industries 1,875,000

Total: 2,031,000

Sold: 1,290,000 Repaid to IFC: 531,000 Held by IC: 210,000 - 3 -

PART II - DESCRIPTION OF THE PROPOSED LOAN AND INVESTMENT

6. INSTITUTION: - TEOLLISTAMISRAHASTO OY (Indus- trialization Fund of Finland.)

PURPOSE: - To assist the Fund in providing financing to small- and medium-size private industrial enterprise in Finland.

BANK LOAIN:

(a) Amount: - The equivalent in various curren- cies of US $7 million (about Fmk 22.4 million.)

(b) Guarantor: - Republic of Finland.

(c) Interest, including commission; - To be determined for each part of the Loan when credited to the Loan Account.

(d) Commitment charge: 3/4 of 1% per annum.

(e) Term: - Each part of the Loan to be re- Fayable over a term suited to the project, not to exceed 15 years from the date the Loan Account is credited.

(f) Repayment: - In semi-annual payments on April 1 and October 1.

IFC INVESTMENT: - The subscription, at par, to not less than 500 and not more than 1,000 Series A shares of Fmk 1,000 par value each, and the reimbursement to the Fund of the stamp tax of 2% of the subscription price. - 4 -

PART III - APPRAISAL OF THE PROPOSED OPflRTION

7. An appraisal of the project (DB-6a) is attached (No. 1).

Need for the Project

8. Industrial growth in Finland has been particularly rapid in postwar the period iihen rising world consumption of pulp and paper made pos- sible a large expansion in wood processing capacity and in foreign ex- change earnings which, in turn, enabled the country to raise its level of income, thereby stimulating dermand for both domestically produced and imported manaufactures. Conditions in Finland are favorable for a continued expansion of industry: the existence of adequate public facilities, a high level of education and high quality of technical training, ample managerial skills, a high rate of saving and investment, and political and social stability provide a solid foundation for in- dustrial development.

Continued industriaLization is a necessity for Finland, which has still too high a proportion of its population engaged in a naturally unproductive agrJZcultzEre and >is also faced with a relatively rapid in- crease ir! its labcr force. In view of recert large expansion in the Finnish waodvorking industry axd the prcspects of some world exceas capacity in this sector in the coming years, the bDest opportunities for further economic growth now seem to liein other industries. There seen to be good prospects in fields such as specialized engineering products, chemicals and quality consumer goods for export. In addition, w.lith the progressive reduction in tariffs, resulting from its membership in EFTA, Finland will have to continue iimroving the competitiveness of its home market industries. Both tasks will require a considerable volume of newt investments and will fall mainly on medium and small firms. The demand for industrial finance from this sector, which is already great and partly unsatisfied, w-rill further increase. At present many firms are already seriously handicapped. in their efforts to modernize and expand their pro- duction by lack of capital. In the past, the medium-size entrepreneur has had no source of credit other than the comercial banks iwhich have tended to give preference to the larger and financially stronger firms. He has not been able to have recourse to the capital market which is relatively underdeveloped for a country as econormically advanced as Finland.

10. The Fund has been reorganized to fill part of this gap in the provision of medium and long-term credit, equity capital and other services. -5-

The Fund

11. The Fund was established in 1954 as a limited liability company to provide long-term credit to small and medium-size industrial firms in Finland. The Fundts share capital amounted to Fmk 0.5 million of which 85% was held by five private commercial and savings banks and the Post Office Savings Bank. The large majority of the shares was in the hands of private shareholders. At the end of 1962 its total resources amounted to new Fmk 12 million (US $3.7 million), of which Fmk 6 million were a Government loan and Fmk 4.5 million were debentures held by the Fundts shareholders and the Bank of Finland. By then, however, these funds had been committed and operations were tapering off.

12. The Fund acted mainly as an intermediary for the shareholding banks through which loans were made. It did not engage in any financial, technical or market analysis of the projects it financed. In fact, its functions were limited primarily to the establishment of priorities among the various applications once they had received the preliminary approval of the respective shareholding banks.

13. The proposed reorganization now under way has the following main purposes;

(a) to enlarge the Fund's resources so that it can make a greater contribution to Finnish industry through finan- cial assistance to small and medium-size concerns;

(b) to provide a capital structure which, together with tax and other preferences, would provide in due course a reasonable return on its equity and which, with a conservative reserve policy, gives promise of a financially sound insti- tution capable of attracting capital from conventional sources on its own credit;

(c) to strengthen the Fund's staff and organization so as to enable it to appraise projects, to provide technical assistance to its clients and to assist in the development of a capital market in Finland;

(d) to change the Fundts mode of operation from indirect lending through its shareholding banks without responsi- bility and risk to the Fund, to direct financing normally falling within the scope of an investment corporation.

14. Action has already been taken in pursuance of these objectives. In March 1963 the Fund's share capital was increased to Fmk 13 million (US i4.2 million) consisting of Fmk 4 million Series A shares subscribed to by the original shareholders and Fmk 9 million Series B shares - 6 - subscribed to by the Bank of Finland. Series B shares are redeemable out of profits before taxes over 30 years. They have one-tenth of the voting power of Series A shares and carry a 3t non cumtiulative dividend. In addition, newT debentures were issued, bringing total debentures out- standing to Fmk 10 million. In the event of liquidation the debentures are subordinated to all other debt. Of the total, Fmk 5.5 million will mature in the year 2000 and the balance between 1994 and 2004. Further- more, the main shareholders agreed to make a Fmk 7.5 million long-term loan to the Fund to be drawn as needed. (The proposed text of the agree- ment for this loan is attached as No. 6).

15. Additional resources Aill be provided from a further increase of Fik 2 million in the Fund's Series A share capital, which is expected to be subscribed by foreign shareholders and by IFC, and from a $7 million (Fnmk 22.4 million) Bank loan. Upon the implementation of the reorganiza- tion plan, the Fund's total resources, inclusive of funds agreed upon and to be drawn upon in the future, will amount to Fmk 61.7 million (US $19.3 million) as follows:

Share Capital

Series A shares (6,000 shares of Fmk 1,000 each) 6,000

Series B shares, redeemable (9,000 shares of Fink 1,000 each) 9,000

Total capital: 15,000

Debt

Debentures, subordinated to all other debt Debentures of 1956 4,500 Debentures of 1963 5,500 10,000

Debt not subordinated I23RD Loan 22,400 Loan from shareholders (agreed upon but to be drawnm upon later) 7,500 Loan from Government 6,000 Credits from foreign banks 757 36,657

Total debt: 46,657 Total resources: 61,657 Of the above Fmk 61.7 million, the loan from the Government (Fmk 6 million) and the credits from foreign banks (Fmk 0.8 million) which have already been disbursed, are repayable by the Fund as it collects from its ultimate borrowers. Accordingly, the resources available to the Fund for its new operations will amount to only about Fmk 55 million.

16. After all Series A shares are issued, the private shareholders, together with IFC (holding Series A shares only) will hold 77% of the total voting rights: 48% will be held by Finnish shareholders, 22% by foreign shareholders, and 7% by IFC. Governmental shareholders will hold the remaining 23% (Fmk 0.7 million Series A shares by the public Post Office Savings Bank and Fmk 9 million of Series B shares by the Bank of Finland). As Series B shares are retired, the voting power of the private shareholders, together with IFC, will increase correspond- ingly; when Series B shares are completely retired, the private share- holders, together with IFC, will hold 88% of the voting power in the Fund. The only public holdings of Series A shares are 707 shares or 8.5% of total Series A shares held by the Post Office Savings Bank, which has played a key role in supporting the reorganization of the Fund. It is contemplated that this institution will reduce its interest in the Fund's stock in due course.

17. The Fund's Articles of Association have been amended to enable it to reorganize and to enlarge its scope of operation. First steps to build up a professional staff have been taken and a further increase in staff is planned. A new General M4anager has been appointed and a Management Committee of Directors has been formed to support him. The Fund also intends to obtain a foreign adviser in financial matters. The Fund has agreed to consult the Bank before making any change in its management structure and personnel.

18. As a condition of effectiveness of the loan the Board of Adminis- tration of the Fund is to approve a Statement of Policies agreed upon with the Bank and IFC, which sets forth the policies and procedures which will govern the operations of the Fund (Annex 3 to the Appraisal Report).

19. The Loan Agreement will provide a debt limitation of three times the Fund's share capital (Series A and B), free reserves and surplus and debentures which are subordinated to all other debt. This would leave an ample margin for additional borrowing (of Fmk 38 million or about $12 million equivalent).

20. Finnish legislation exempts corporations from a 1% tax on their net worth if the Articles of such corporations contain a clause limiting their payments of dividends to 5%. The Fund's Articles contain such a limitation but the Finnish shareholders will remove this limitation from the Articles as soon as it becomes advisable to do so. A draft agree- ment to this effect to be executed by the Finnish shareholders is attached (No. 7). - 8 -

21. The financial prospects for the Fund appear satisfactory. On the assumption that the Fund would have disbursed a total of $16 million by the end of 1965 or soon thereafter, the Fund would be in a position to earn a return on its Series A capital of about 10%.

22. Once reorganized, with its resources increased, the Fund should prove to be a sound and profitable institution and should contribute effectively to the growth and diversification of industry and to the development of a capital market in Finland.

The Proposed Bank Loan

23. The terms and conditions of the proposed loan are substantially in accordance with what has now become conventional for Bank loans to industrial finance companies. It should be noted that the Fund will not bear the exchange risk for loans made out of the Bank loan proceeds. Legislation has been passed authorizing the Finnish Government to bear that risk up to Fmk 500,000 for each loan made by the Fund; to the extent that risk is not borne by the Government, it will be passed on to the Fund's borrowers.

24. Procurement of equipment will be based upon active competition among Finnish and foreign suppliers. In Finland a large proportion of industrial equipment is either entirely domestically produced or manu- factured from imported components; the need of an enterprise for capital accordingly bears no particular relation to its need for imported goods. The Fund will therefore make loans to meet a portion of the costs of the projects which it finances without reference to the foreign exchange component of the project. Since foreign exchange is freely available for imports, borrowers may cover their foreign exchange needs through normal banking channels. The need and justification of local currency financing was recognized in past Bank loans to Finland where the proceeds were used in part to cover the cost of locally produced goods. Such flexi- bility is all the more necessary in the case of the Fund in order that it may make an effective allocation of its resources.

The Proposed IFC Investment

25. The IFC would subscribe at par to not less than 500 shares of Series A capital of the Fund, of Fik 1,OCO par value each.* The IFC would also undertake to subscribe to not more than 500 addi- tional shares, if private institutions in Europe and in the United States do not subscribe 1,500 shares which are being offered to them but, in any case IFC?s obligation would be conditional upon subscriptior by - 9 -

European and U.S. banks to a minimum of 1,000 shares so as to bring the total of the new shares issued to 2,000 shares. Participation by IFC and the Bank has been an essential factor in the reorganization of the Fund and the fact that IC is to be a shareholder and will watch closely the Fund's progress has been influential in bringing in United States and European shareholders.

26. All shares of the new issue will be paid in full at the time of the subscription. In addition to the par value of the shares, a 2% stamp tax is payable, in accordance with Finnish legislation, by the issuing corporation; howeveo. in Finnish corporate practice, the tax is then passed on to the subscribarS. All Finnish shareholders,including the Bank of Finland wtior;,h enjoys certain tax immunities, paid this tax on shares of the Fiund -vo which they subscribed. IFC's owri tax immlunities do not affect the P s obli-ation to pay this tax. It is, therefore, proposed that T10 c2nior -;nFirnish p-actice and reimburse the Fund for the amount of t;ie t-x attributable to its subscription. The minimum cost to IFC of its irses'Iment aocordingly would be US $159,375 (including iTS l53,125 tax), and tile maximum cost would be US '{31S,750 (including US 1p6,250 tax).

27. The Bank of Finland will confirm in a letter to "'C that the registered holders of the Fund's new share issue subscribed by IFC may from time to time freely convert and repatriate the capital, and any appreciation tLz'J n, rn.esented by such shares, and that all dividends paid by the Funid o Thnwi may be freely converted and transferred.

Economic Situa1 cn

28. The economic background against which the proposed loan and in- vestment should be considered is described in the report "Economic Position and Prospects of Finland" dated August 6, 1962 (R62-63). Major develop- ments since then are summarized in a memorandum attached (No. 2).

29. The proposed loan is well within Finland's ability to service. The public external debt of Finland exclusive of Soviet credits amounted to US Q326 million as of December 31, 1962, of which the annual service currently represents about 3p of exchange earnings in Western currencies. - 10 -

PART IV - LEGAL INSTRUCHENTS AND LEGAL AUTHORITY

30. The following draft documents are attached:

(a) Loan Agreement between the Bank and the Pund (No. 3);

(b) Guarantee Agreement between the Republic of Finland and the Bank (No. 4);

(c) Subscription Letter of IFC to the Fund (No. 5);

(d) Finmark Loan Agreement (No. 6);

(e) 5,, Dividend Agreement (No. 7);

(f) Subscription Agreement between the Fund and potential foreign subscribers (No. 8).

31. Also attached is the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank (No. 9).

The Bank Loan

32. The provisions of the Loan and Guarantee Agreements give the Bank substantially the same rights as it normally obtains when lend- ing to industrial Afinance companies. The following features are of particular interest:

(a) All projects to be financed from the proceeds of the Loan are, unless the Bank shall otherwise agree, subject to the Bank?s prior approval (Loan Agreement, Section 3.02(a)); Section 4.01 of Loan Regulations No. 4 dated February 15, 1961 has been modified so as to enable the Fund to make withdrawals on account of expenditures in local currency;

(b) The Fund shall adopt an agreed statement of policies and procedures to be followed in its operations, and such statement shall not be amended without the Bank's con- currence (Loan Agreement, Section 5.01(b));

(c) Conditions of effectiveness include, interalia, all neces- sary action, satisfactory to the Bank, relating to (i) the subscription and full payment of shares of the Fund (Section 7.01(a)), (ii) the borrowing by the Fund of Fmk 7,500,000 (Section 7.01(b)), (iii) arrangements for the removal in due time of the dividend limitation in the Fund's Articles of Association (Section 7.01(d)), (iv) the exemption of the Fund from the provisions of Finnish law concerning the right - 11 -

of foreigners to own fixed property and shares (Section 7.01(h)), and (v) the exemption of the Fund from certain provisions of tax legislation (Section 7.01(g));

(d) The Bank shall have the right to suspend or terminate the Loan if the terms of the exemptions referred to under sub- paragraph (c)(iv) and (v) above shall have changed without the approval of the Bank (Section 6.02(c)).

The IFC Investment

33. The subscription letter of IFC follows the general form which has been used in other similar projects relating to investment corpora- tions. IFC's obligation to subscribe is subject, among others, to the following conditions, namely that:

(a) non-Finnish private investors shall have subscribed to not less than 1,000 Series A shares of the 1963 share issue and shall have paid the full subscription price of the par value thereof in cash (4)(a);

(b) the Bank's Loan Agreement shall have become effective (4)(b);

(e) the Bank of Finland shall have addressed a letter to IFC stating, among others, that the registered holders of the 1963 share issue subscribed by IFC may freely convert and repatriate the capital and any appreciation thereon, re- presented by such shares, and that all dividends paid by the Fund on them may be freely converted and transferred (4)(c). - 12 -

PART V - COFMPLIANCE 1WTH ARTICLES OF AGREEDENT

3h. I anm satisfied that the proposed Bank loan comkplies wgith the re- quirements of the Articles of Agreement of the Bank and that the proposed investment by IFC complies with the requirements of the Articles of Agree- ment of the IFC. The Government of the Republic of Finland has advised IFC thlat it has no objection to the proposed investment by the IFC.

PART VI - RECCIIIENDATIONS

35. I recommend that:

(a) the Bank make a loan to TEOLLISTA-IJSRAHASTO OY, with the guarantee of the Republic of Finland, in an amount in various currencies equivalent to US $7 million, at such rates of interest and substantially on such other terms and subject to such other conditions as are specified in the draft Loan and Guarantee Agreenents attached, and that the Bank's Executive Directors adopt a resolution to that effect in the form of the draft resolution attached (No. 10);

(b) the proposed IFC subscription to the capital stock of TEOLUISTAI[SRA,HASTO OY be approved on substantially the terms outlined above, conditional upon legal arrange- ments satisfactory in form and substance to IFC's Manage- ment, and that the Board of Directors of IFC adopt a re- solution in the form attached (No. 11).

George D. Woods

Attachments

Washington DnC. August 29, 1963