RMC Discussion Paper Series, Number 118 Public Disclosure Authorized

Financing Pakistan's Hub Power Project A Review of Experiencefor Future Projects Public Disclosure Authorized Public Disclosure Authorized

Michael Gerrard

Project Finance and Guarantees Department Public Disclosure Authorized Resource Mobilization and Cofinancing Vice Presidency August 1997

121 The World Bank CFS/RMC DISCUSSION PAPERS

101 - Privatization in Tunisia,Jamal Saghir, 1993. 102 - Export Credits:Review and Prospects,Waman S. Tambe, Ning S. Zhu, 1993. 103 - Argentina'sPrivatization Program, Myrna Alexander, Carlos Corti, 1993. 104 - EasternEuropean Experience with Small-ScalePrivatization: A CollaborativeStudy with the CentralEuropean University PrivatizationProject, 1994. 105 - Japans Main Bank Systemand the Role of the Banking Systemin TSEs, Satoshi Sunumura, 1994. 106 - SellingState Companiesto StrategicInvestors: Trade Sale Privatizations in Poland,Hungary, the CzechRepublic, and the Slovak Republic,Volumes 1 and 2, Susan L. Rutledge, 1995. 107 - JapaneseNational RailwaysPrivatization Study II: InstitutionalizingMajorPolicy Change and ExaminingEconomic Implications,Koichiro Fukui, Kiyoshi Nakamara, Tsutomu Ozaki, Hiroshi Sakmaki, Fumitoshi Mizutani, 1994. 108 - ManagementContracts: A Review ofInternational Experience,Hafeez Shaikh, Maziar Minovi, 1995. 109 - CommercialReal EstateMarket Developmentin Russia,April L. Harding, 1995. 1 10 - ExploitingNew Market Opportunitiesin Telecommunications:Lessons for DevelopingCountries, Veronique Bishop, Ashoka Mody, Mark Schankerman, 1995. 111 - BestMethods of Railway Restructuringand Privatization, Ron Kopicki, Louis S. Thompson, 1995. 112 - EmployeeStock OwnershipPlans (ESOPs),Objectives, Design Options and InternationalExperience, Jeffrey R. Gates, Jamal Saghir, 1995. 113 - AdvancedInfrastructureforTimeManagement, The CompetitiveEdge in EastAsia,Ashoka Mody,William Reinfeld, 1995. 114 - Small ScalePrivatization in Kazakhstan,Aldo Baietti, 1995. 115 - Airport Infrastructure:The EmergingRole of the PrivateSector, Recent Experiences Based on Ten CaseStudies, Ellis J. Juan, 1995. 116 - Methods ofLoan GuaranteeValuation andAccounting, Ashoka Mody, Dilip Patro, 1995. 117 - PrivateFinancing of TollRoads, Gregory Fishbein, Suman Babbar, 1996.

JOINT DISCUSSION PAPERS

Privatizationin the Republicsof the FormerSoviet Union: Frameworkand Initial Results,Soo J. Im, Robert Jalali, Jamal Saghir; PSD Group, Legal Department and PSD and PrivatizationGroup, CFS - Joint Staff Discussion Paper, 1993.

MobilizingPrivateCapitalfor the PowerSector. Experience in Asia andLatin America,David Baughman, Matthew Buresch; Joint World Bank-USAID Discussion Paper, 1994.

OTHER CFS PUBLICATIONS

JapaneseNational RailwaysPrivatization Study, World Bank Discussion Paper, Number 172, 1992.

Nippon Telephoneand TelegraphPrivatization Study, World Bank Discussion Paper, Number 179, 1993.

BeyondSyndicated Loans, World BankTechnical Paper, Number 163, 1992.

CFS Link, Quarterly Newsletter.

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The findings,interpretations, and conclusionsexpressed herein are entirelythose of the authors and should not be attributed in any manner to CFS, the World Bank, or to members of the Board of ExecutiveDirectors or the countries they represent.The World Bank does not guarantee the accuracyof the data included in this publication, and accepts no responsibility whatsoeverfor any consequence of their use. The paper and any part thereof may not be cited or quoted without the author's expressedwritten consent. RMCDISCUSSION PAPER SERIES I I 8

Financing Pakistan's Hub Power Project A Review of Experiencefor FutureProjects

MichaelGerrard Contents

Foreword v Acknowledgments vii Abbreviationsand Definitions ix ExecutiveSummary 1 Finance Plan 1 Issues Affectingthe WorldBank 3 SignificantProject "Firsts" 6 Project Development 6 MobilizingSufficient and Least-CostFinance 9 Shorteningthe DevelopmentPeriod 9 Conclusion 10 FinancePlan 11 Overview I 1 Developmentof the Plan 14 BankingStrategy 19 StructuralIssues 23 Guidelinesfor Future Projects 27 ProjectDevelopment 31 Market Experience 32 TimetableAnalysis 34 SponsorGroup Formation 35 DevelopmentCosts and Risks 37 WorldBank Perspectives 40 Guidelinesfor Future Projects 41 InstitutionalDevelopment 43 The PSEDF and the ECO GuaranteeFacility 43 Institutionsin Pakistan 44 Postscript 47

.. Appendixes Appendix1 Offshorecommercial bank facilities syndicate profiles 49 Appendix2 Projectchronology 50 Appendix3 Principalproject agreements 52 Appendix4 Projectparticipants 53 Appendix5 Overviewof insurancearrangements during construction and operation 55 Appendix6 ExpandedCofinancing Operation (ECO): Summary of termsof the guarantee 58 Boxes Box1 Profileof privatesector risk 16 Box2 Roleof globaldepository receipts in Hub PowerProject financing 18 Box3 Savingtime through privatization 33 Box4 Effectsof publicity 35 Tables Executivesunmmary table 1 Summaryof the basefinance plan 1 Executivesummary table 2 Facilitiesfunded by offshorecommercial banks 3 Executivesummary table 3 Reasonsfor successin syndication 4 Table1 Basefinance plan 11 Table2 Compositionof the PrivateSector Energy Development Fund 12 Table3 Mobilizationfinance 13 Table4 Facilitiesfunded by offshorecommercial banks 20 Table5 Reasonsfor successin syndication 20 Table6 Bilateralfunding and procurement 26 Table7 Keyevents and activitiesin projectdevelopment 31 Table8 Principalactivities subject to delay 34 Table9 Timetableof projectactivities 35 Table10 Breakdownof developmentcosts 38 Table11 Personneldeployments 38

iv FinancingPakistan's Hub Power Project Foreword

T he Hub PowerProject is a 1,292megawatt oil-fired power station located in the Pakistanprovince of Balochistan, some 40 kilometers northwest of Karachi. It is a private sector project undertaken by the Hub Power Company Limited (Hubco), a special single-purpose company listed on the Karachi and Luxembourg stock exchanges that has a concession to build, own, and operate the power station. The project has become a landmark in the field of infrastructure finance. From project conception in 1987 through financial close in January 1995, it has evolved in line with the international market for private sector infrastructure. By demonstrating the viability of private finance for a major infrastructure project in a developing country, the project has set an important precedent, particularly in the energy sector. Commercial power was first exported from the station in June 1996, and construction was completed in early March 1997, ahead of schedule. What was foreseen by the government of Pakistan and the World Bank in 1985 as the only way to relieve a serious financial bottleneck in the development of Pakistan's energy sector has since been embraced as economic orthodoxy by governments around the globe and by all types of financial institutions. Moreover, this transformation has occurred not only in the energy sector but also in transport and, increasingly,other infrastructure sectors such as water supply The catalytic effect of the World Bank's participation in the Hub Power Project-relative to financing of the project as well as development of the energy sector and local institutions in Pakistan and of the international market for private sector infrastructure-has been profound. The skepticism that pervaded the market in the early 1980s has been replaced by a "can do" attitude that is due in no small measure to the successful financing of the project. As might be expected during a period of rapid market advancement, a new constraint has emerged-namely, the speed at which these transactions can be implemented. In highlighting this and other market constraints the project has been, to some extent, an exercise in financial research and development for the Bank. The project absorbed about 225 person-years of resources, 25 of them from within the Bank; required more than 200 individual project documents; and claims no fewer than 16 "firsts" in the field of project finance. That so many people within the government of Pakistan, the Bank, the sponsors, and other financiers of the Hub Power Project prevailed over the many setbacks and frustrations inherent in the creation of such novel financial "technology" is to their collective and lasting credit. Because of its pioneering nature, during implementation the project encountered most of the problems likely to be faced by a private infrastructure project in a developing country. Thus the solutions developed and lessons learned have wider applications. This report highlights the solutions and lessons that generally apply to similar private infrastructure projects, with an emphasis on the financial instruments used by the Bank and its management of the project development process. In addition to its significant physical and financial dimensions, the Hub Power Project has sizable institutional dimen- sions: agencies of six governments collaborated with the Bank and the project's sponsors in developing the project, and more than forty international commercial banks are direct lenders to the project. As a result knowledge of and experi- ence with the project have been widely distributed. It is hoped that through this report it will be even more widely shared, for the benefit of future project development.

v

Acknowledgments

his report wasprepared under the directionof SumanBabbar, Project Finance and GuaranteesDepartment, with Tthe assistanceof Nina Shapiro,Thomas A. DuvalIII, and PankajGupta. The reportwas written by Michael Gerrard, an independent consultantand former project finance manager of HRPG Limited, the Hub Power Project's developmentcompany. Other contributorsinclude Maurice Fitz Gerald,an independentconsultant and former adviserto HRPG Limited,who helped analyzecofinancier perspectives and reviewedthe report; Per Ljung,division chief, Energy and ProjectFinance Division,Country Department 1, South AsiaRegion, who contributedwidely to the report and in particularto the sectionon institutionaldevelopment; and RichardBarton, an independent consultantand adviserto the commerciallenders to the project,who wroteappendix 5. The author is also gratefulto the followingfor their time, recollections,and insights:Dr. Ibrahim Elwan,former divi- sionchief at the Bankand key functionaryresponsible for the projectat the Bank;Adolfo Menendez of K&MEngineering & ConsultingCorporation and formermanaging director of HRPG Limited;Philip Smith and TracyGraham of National Power;James Chapmanof XenelIndustries; Badar Khan of CommonwealthDevelopment Corporation; Jean Fouillaud of COFACE; Dott. Carlo Cafaggi of SACE,Wasif Mustafa Khan of National Development Finance Corporation; MichaelWoodroffe of Hubco; PatrickCrawford of DeutscheMorgan Grenfell; Terry Sheat of Linklaters& Paines; Ned Yescombeand Sian Dunstan of Bank of Tokyo-Mitsubishi;Saadia Khaid and RobertWelford of Citibank; RogerWarby and Maarten van Kempenof Credit Lyonnais;Victor Smith (formerlyof SakuraBank); and Bill Morrisof NatWest.The report was edited by Paul Holtz and laid out by Glenn McGrath,both withAmerican Writing Corporation.

vii

Abbreviationsand Definitions

Arrangers Arrangergroup:Citibank, CreditLyonnais, NatWest, Sakura Bank, and Bankof Tokyo- Mitsubishi;as well as MedioCreditoCentrale (with respect to the SACEinsured facility) Bridge finance The facilitiesprovided by Al Rajhi (Istisna)and the National DevelopmentFinance Corporation(rupee term facility),forming part of mobilizationfinance. CDC CommonwealthDevelopment Corporation of the United Kingdom COFACE CompagnieFrancaise d'Assurance pourle CommerceExterieur (France's export credit agency) ECO ExpandedCofinancing Operation ECU European currencyunit Export credit agency COFACE,MM, SACE,and others, as the contextimplies Finance plan Sourcesand arrangementsfor providing$1,545,000,000 (equivalent) of base finance and $221,000,000(equivalent) of standbyfinance for the Hub PowerProject Financialclose First date (in January1995) on which all conditionsprecedent to first disbursement of the ECO guaranteefacility and other offshorecommercial bank facilitieswere either satisfiedor waived Fuel supplyagreement BetweenPakistan State Oil and Hubco GDR Global depositoryreceipt HRPG HRPG Limited,the projectdevelopment company for the Hub PowerProject Hubco Hub PowerCompany Limited IBRD InternationalBank for Reconstructionand Development Implementationagreement Betweenthe governmentof Pakistanand Hubco IFC InternationalFinance Corporation Istisna Islamicform of finance JEXIM Export-ImportBank of Japan K&M K&MEngineering & ConsultingCorporation of the United States LTCB Long TermCredit Bank of Japan MlTI Ministryof InternationalTrade and Industryof Japan Mitsui Mitsui & Co., Ltd. of Japan (constructionconsortium leader) Mobilizationfinance Financemade availableto the Hub PowerProject prior to financialclose to mobilize the turnkeycontractor National Power National PowerPLC of the United Kingdom(lead sponsor) NIC National InsuranceCorporation of Pakistan NDFC NationalDevelopment Finance Corporationof Pakistan

ix Operationsand BetweenNational Powerand Hubco maintenanceagreement PIC PakistanInsurance Corporation Powerpurchase agreement Betweenthe Waterand PowerDevelopment Authority and Hubco Projectcoordination agreement BetweenHubco and its variouslenders (intercreditoragreement) PSEDF PrivateSector Energy Development Fund, dividedinto two facilities:PSEDF I and PSEDF II PSO PakistanState Oil SACE SezioneSpeciale per I'Assicurazionedel Creditoall'Esportazione (Italy's export credit agency) Shariahlaw Islamiclaw as appliedin Pakistan Sponsors NationalPower, Xenel, Mitsui, IHI, and K&M USAID U.S. Agencyfor InternationalDevelopment WAPDA Waterand PowerDevelopment Authority WorldBank InternationalBank for Reconstructionand Development Xenel XenelIndustries Limited of SaudiArabia (lead sponsor)

x FinancingPakistan's Hub PowerProject Executive Summary

Finance Plan Overall,the Hub PowerProject is financed 24 percent fromequity and 76 percentfrom debt (executivesummary The World Bank participates in the Hub Power Project table 1). Debt comprisesseven (senior) term loan facilities financeplan in two capacities:as a lender,contributing up (48percent) and eightPSEDF (subordinated)facilities (28 to $225 million through the Private Sector Energy percent).Equity is contributedby the project's sponsors- DevelopmentFund (PSEDF) administeredby Pakistan's NationalPower, Xenel, Mitsui, Ishikawajima-Harima Heavy NationalDevelopment Finance Corporation (NDFC), and Industries,and K&MEngineering & Consulting(10 per- as a guarantor of politicalrisks for a syndicateof thirty- cent of overall funding)-as well as by other offshore four commercialbanks lending up to $240 millionto the investors(12 percent)and onshore investors (2 percent). project through an Expanded Cofinancing Operation Allfigures and exchangerates used in this report are taken (ECO) guaranteefacility. fromthe informationmemorandum prepared for Banksyn- Other contributorsto the PSEDF includethe Export- dicationof the Hub PowerProject in May 1994, as sup- Import Bank of Japan (JEX[M),the governmentsof Italy plementedin September1994. and France, and the U.S. Agency for International Theparticipation of fifteendebt facilitiesmakes the pro- Development (USAID). Forty-three international com- ject the mostcomplicated private project financingunder- mercialbanks lend directlyto the projectthrough the ECO taken to date.A secondarydimension of the financeplan's guarantee facility,a similarfacility guaranteed by JEXIM, complexityis the number of currencies(seven) in which and three exportcredit agency-insured facilities supported sourcesand applicationsof financeare denominated. by France's Compagnie Fran,aise d'Assurancepour le Commerce Exterieur (COFACE), Japan's Ministry of PrivateSector EnergyDevelopment Fund (PSEDF) InternationalTrade and Industry(MM), and Italy'sSezione Specialeper l'Assicurazionedel Credito all' Espartazione The PSEDF provides long-term and mostly fixed-rate (SACE).Direct loans are also made to the projectby the finance.In so doingit anticipatesthe two advantagesnor- United Kingdom's Commonwealth Development mallyassociated with a refinancingafter completion of con- Corporation(CDC) andasyndicateofninePakistanibanks. struction. No other independent power producer in

EXECUTIVESUMMARY TABLE I Summaryof the basefinance plan Amount Contribution Typeof financing Source (US$million equivalent) (percent) Equity 371 24 Debt 1,174 76 Seniordebt ECOguarantee facility and six other facilities 738a 48 Subordinateddebt PSEDFcomprising eight facilities 436 28 Total 1,545 100 a. Doesnot include$60 millionin standby debt provided by ECO($40 million)and JEXIM ($20 million).

1 developingmarkets has enteredthe constructionphase with on suchmaturities to Pakistan,the ECO and JEXIMguar- suchlong-term (twenty-three years) fixed-ratefinance. In antees create an environmentin which private sourcesof this contextthe PSEDF can be seen as not onlyforward- financecan perform the functionsto which they are best lookingbut also as genuinelyinnovative. suited-namely,the identification,evaluation, management, The availabilityof suchlong-term finance compensates and acceptanceof commercialrisks. for the fact that the balanceof the debt finance(the senior One importantrole of the ECO and JEXIMguarantee debt) availableto the project comeswith shorter maturi- facilitiesin the financeplan is as a providerof untied and ties (twelveyears) than commercialbanks providein more entirelyflexible finance-that is,as a "sweeper"of coststhat developedmarkets (fifteento twenty yearsor more). The cannototherwise be funded becauseof strictprocurement PSEDF increasesthe weightedaverage overall maturity of constraints.One commoncharacteristic of cofinanciercon- debt financefor the projectto sixteenyears. The subordi- tributionsto the PSEDFand financeinsured by the export nation of PSEDF facilities,in rankingof securityinterest credit agenciesis the rigid conditions that apply to their and by virtue of their longermaturity, creates significant use. Expendituresfunded by the ECO guarantee facility, additionalrisk coverfor the providersof senior term debt. by contrast,need onlysatisfy the more subjectivecriteria of Loan drawingsfrom the PSEDF are made by the pro- economyand efficiencyThe CommonwealthDevelopment ject in the currenciesof the underlyingcofinancier loans to Corporationis similarlyflexible. the governmentof Pakistan and in accordancewith cofi- In project finance there are significantcosts, such as nancierconditions relating to eligibilityof procurement and interest during construction and funding of reserve the like.The project'sdebt serviceobligations to the PSEDF accounts,that satisfyneither tied nor Bank international are,however, standardized and becomerupee denominated competitivebidding procurement criteria, and yet are just as and when eachrespective drawing is made,thereby pro- as much capital costs of the project as the powerstation's tecting the project from exchangerate risks between the equipment. The ratio of these "soft costs" to the "hard rupee and currenciesof drawing. costs" of construction generallylies in the range 1:4 to The government'sobligations to makedebt servicepay- 1:1, depending on the type of project and the length of ments to the Bank and other contributorsto the PSEDF the constructionperiod. For the Hub Power Project the are not conditionalon the project's abilityto meet its debt ratiois 1:1.6.The term debt financein the projectfinance service payments to the NDFC (which administers the plan is 35 percentflexible and 65 percentinflexible. Equity PSEDF on behalf of the governmentof Pakistan).That is, financeis 100 percent flexible. the government, not the cofinanciers, accepts limited The problemsof fundingsoft costs are even greater rel- recourseexposure to the project. ativeto standbyfinance (sometimesreferred to as contin- gent finance),which is held in reserve to fund unforeseen ExpandedCofinancing Operation (ECO) guarantee costs incurredin completingconstruction that cannot be facility met from other sources.This contingentreserve typically is equal to 10-15 percent of the base finance (in the Hub The ECO guarantee facilityand a similarfacility guaran- PowerProject the reserveis equivalentto 14 percent, or teedbyJEXIM together support $360 million of seniorterm $221 million),where the constructioncontract has been debt (including$60 millionin standbydebt) for the pro- let on a strictlyfixed-price turnkey basis. The ECO and ject. The coverprovided under the ECO and JEXIMguar- JEXIMguarantee facilities together provide 27 percent of antees is partial, pertaining to certain defined political the standbyfinance arranged for the project. risks such as nationalizationand foreign currencyavail- Exchangerate risks between the rupee-denominated ability.The guaranteescover 100percent of loan principal. tariff revenuesof the project and the debt serviceon the They do not coverinterest, which is securedthrough cash ECO guaranteeand other seniorterm facilitiesare insured collateral accounts. By removingthe politicalrisks that by the State Bankof Pakistanthrough its foreignexchange would otherwiseprevent commercialbanks from lending risk insurancescheme.

2 FinancingPakistan's Hub PowerProject Commercialbank syndication ance in the overallcommercial bank syndicateof several banks that previouslyhad not participatedin financingof Offshorecommercial banks provided$686 millionin lim- private infrastructure.The decisionby a group of Italian ited recourse senior term debt for the project, allocated banks,led by MediocreditoCentrale, to participatein the between the ECO and JEXLMguarantee facilities and the firstsuch financing supported by SACEalso led other banks three facilitiesinsured by exportcredit agencies (executive to participatein privateinfrastructure for the first time. summarytable 2). Syndicationof these fivefacilities was carried out simul- IssuesAffecting the World Bank taneouslyby a five-bankarranger group comprisingBank of Tokyo-Mitsubishi,Citibank, Credit Lyonnais,NatWest, Additionality and SakuraBank, supported byMediocredito Centrale with respect to the SACEinsured facility.The arrangergroup The unanimousand unequivocalview of the government was chosen to reflect the nationalcombination of suppli- of Pakistan,the arrangerbanks, sponsors,and cofinanciers ers withinthe constructionconsortium and associatedexport of the Hub Power Project is that they would not have credit agency-insuredfacilities and to includebanks with acceptedthe costs,risks, and diversionof resources required a proven reputation in large limited recourse projects. to complete the development of the project had it not Syndicationwas launched in May 1994 and closed four been for the participationand support of the WorldBank. months later, more than 100percent oversubscribed.The The Bank's participationwas also fundamentalfor banks reasons for such a successfulsyndication ranged fromthe joiningthe projectin syndication. participationof the WorldBank and the noveltyand scope The Bankprovides 39 percentof the PSEDF's funding of the ECO guaranteeto the extendedexport credit agency and,through the ECO partialrisk guarantee, supports 29 per- insurancecover (executivesummary table 3). centof seniorterm finance. Thus, of the $1,766milion mobi- From the Bank'sperspective, syndicationwas anunqual- lized for the project(base and standbyfinance combined), ifiedsuccess. It achievedits objectiveof mobilizingthe nec- $465miDlion (26 percent) was provided or partlyguaranteed essaryforeign currency commercial bank debt for theproject by the Bank.This representsan overallmobilization ratio of with an overallmaturity of twelve years and in so doing Bankto all sourcesof financeon the order of 1 to 4. created an opportunityfor thirty-fourcommercial banks Furthermore,the project is the first time so many cofi- from eight countries to participate in the first ECO- nanciershave participated in a privateproject. If the agen- guaranteed limited recourseproject financing.The pres- ciesof the French,Italian, and Japanesegovernments that ence of the Bank and JEXIM and the novelty of the contributedto the PSEDF are considered distinct from guaranteeprogram are also partly responsible for the appear- COFACE, SACE, and MITI, the project had nine

EXECUTIVESUMMARY TABLE 2 Facilitiesfunded by offshorecommercial banks Amount Numberof Averageparticipation Facility (US$million equivalent) banks (US$million equivalent) Facilityagenta

ECOguaranteed 2 4 0b 34 7.1 Bankof Tokyo-Mitsubishi JEXIMguaranteed 120c 19 6.3 SakuraBank COFACEinsured 45 7 6.4 CreditLyonnais MITI insured 86 17 5.1 SakuraBank SACEinsured 195 18 10.8 MediocreditoCentrale

Total 686 43d 6.0e a. Citibankisthe intercreditor agent. b. Includes$40 million of standbydebt. c. Includes$20 million of standbydebt. d. Mostbanks participated in more than one facility. e. Averageoverall participation per bank.

ExecutiveSummary 3 EXECUTIVESUMMARY TABLE 3 not require that all the equipment procured be the cheap- Reasonsfor successin syndication est available. (percent) In principlethe Bank's rules may be applied to a pro- Indicative ject's output costs, such as a power tariff-as in the 60 Rank Reason weighting megawatt Rockfort power project inJamaica (financial close I Presenceof theWorld Bankand novelty 20 October 1994)-which opens the door for all of a pro- of the ECOguarantee 2 Scopeof the ECOguarantee 20 ject's capital costs (hard or soft and however procured) to 3 Marketbming 15 become eligible for Bank funding. But it may not always 4 Financialand commercial structure and quality IS be possible to adopt this approach, particularly for larger of sponsors 5 Arrangergroup and marketpresentation 10 projects in which the tenders for the output costs are con- 6 Italianmarket underwriting ofthe SACEinsured facilityI 10 ditional upon sources of finance other than the Bank being 7 Pricing 5 8 Extendedexport creditagency insurance cover S available on appropriate terms. (forcommercial risks) after completion of construction In the absence of this or alternative approaches, the Total 100 Bank's participation in a project through a vehide such as Source: Surveyof arrangers. the PSEDF will be limited to the extent of procurement that satisfies Bank rules. About 40 percent of the Hub Power cofinanciers. The Bank played a central catalytic role in Project's turnkey construction contract costs satisfied Bank introducing the cofinanciers, sustaining their interest, and procurement rules. The procurement of goods and services bringing them together within the context of the inter- under intemational competitive bidding has the potential creditor agreement. to introduce delays into a project timetable. Most of the offshore banks that participated in ECO, JEXIM, and the three facilities supported by export credit Finance planfragmentation agencies had never lent to Pakistan before, and many had never participated in a Bank cofinancing before. It has become increasingly apparent that the financing of major private infrastructure projects in developing mar- lntemationalcompetitive bidding kets requires the participation of several cofinanciers and multiple loan facilities. For example, the finance plans for The philosophy underlying fixed-price turnkey contract- the Paiton I power project in Indonesia, the Sual power ing-in which the contractor absorbs cost overruns but ben- project in the Philippines, and the Izmit Su water project efits from savings if it can procure goods or services more in Turkey each comprise at least four foreign currency senior cheaply than the original estimate that lies behind the con- loan facilities supported by various export credit agencies. tract price-is not necessarily consistent with the philoso- The Hub PowerProject finance plan differs from these only phy of international competitive bidding, in which there in the extent of its fragmentation. can be a transparent relationship between the cost of pro- These finance plans are fragmented for two reasons. curement and the price charged to the client. Nonetheless, First, the contractor may divide procurement responsibil- fixed-price turnkey contracting is ubiquitous in private infra- ities into a series of discrete national packages. Second, structure projects with limited recourse financing (such as there is generally a tight ceiling on the political risk cover build-own-operate projects). available for a single country or project from individual For project sponsors the competitiveness of the overall export credit agencies or other cofinanciers. Other cofi- tariff offered to the client (host government) from the infra- nanciers also may be responsible for the contractor opting structure project and the project's deliverability in terms for discrete national packages of procurement. If the Bank of available sources of finance are more important than is involved in the project, the objective of cofinancier mobi- the capital costs of procurement. Thus a project sponsor lization, as well as the Bank's role as lender or guarantor will want to select contractors according to criteria that may of last resort, further encourage fragmentation.

4 FinancingPakistan's Hub PowerProject Theproblem is compounded when export credit agency the processof evolutionarychange may be acceleratedby coverfor a countryis limitedor whena projectwishes to the use of competitionto "testthe envelope." accessa significantportion of the coveravailable from a Theseprocesses have been evident in subsequentinde- singleexport credit agency. The duty of exportcredit agen- pendentpower projects in Pakistan,which have progres- cieswill remain to their exporters,and theymay reduce sively fewer governmentundertakings within their theircommitment to a singleproject rather than see it ster- implementationagreements, lower levels of politicalrisk ilized(that is, committedbut undrawn)by projectnovelty coverage,and less commercial risk coverage under export or complexity,which cause a projectto take yearsto bring creditagency insurance policies, as well as lowerdebt cov- to financialclose. erageratios. Since 1995 there havebeen increasing exam- The ECO andJEXIM guarantee facilities use an iden- ples of internationalbanks beingprepared to commit ticalform of guarantee,whereas each export credit agency uncoveredterm financefor projectsin Pakistan-in con- uses its traditionalform of insurancepolicy. As a result trastto the marketposition in the early1990s. four formsof documentationfor politicalrisk cover were deployedon the Hub PowerProject. Mobilizationfinance Giventhat the numberof exportcredit agencies par- ticipatingin the projectis not abnormallyhigh compared Theturnkey contractor for the Hub PowerProject was a withother developing country independent power projects, consortiumcomprisingAnsaldo of Italy, Campenon Bernard thePSEDF's structure is the most significant source of frag- of France,and Ishikawajima-HarimaHeavy Industries mentationand consequentcomplexity. The difficultiesof and Mitsuiof Japan,with Mitsuias overallconsortium coordinatingmultiparty cofinancings may be partly reduced leader.The contractorwas mobilized in December1992, by bilateralcollaboration arrangements and internal reor- sometwo years prior to financialclose. As a resultpower ganizations,which some cofinanciers-notably export credit fromthe project was first exported less than eighteen months agencies-havesince initiated. afterfinancial close, inJune 1996. Mobilizationfinance was provided by the Bankand the Risk transfer governmentsof France and Italyin the formof term loans throughthe PSEDF;by Al Rajhiand NDFCin the form For developingcountries one of the centralachievements of bridgeloans; by the CommonwealthDevelopment of the Hub PowerProject is the creationof a contractual Corporationthrough a termloan; and by the projectspon- frameworkin whichthe commercialrisks normally associ- sorsthrough equity contributions. Some $423 million in atedwith an independentpower project are transferred to mobilizationfinance was advanced from these sources- privatelenders and projectinvestors. This reflects one of inthe caseof debtfacilities, largely with the supportof the the government'sand the Bank'searliest and most funda- governmentof Pakistan. mentalobjectives of the privateinitiative in Pakistan- Mobilizationfinance played a crucialrole in maintain- thatcommercial bank finance and equity capital be mobilized ing the project'stimetable for deliveringpower to the withoutdirect government guarantees of debt serviceor Pakistangrid and in avoidingthe potentialcost increases return. As a result the risk matrixused in the project's that mayfollow from the expirationof a turnkeycontract bankinformation memorandum is essentially the sameas priceoffer. It alsorepresented a "crossingof the Rubicon" for an independentpower project in an industrialcountry for allconcerned-the government of Pakistan,the Bank, (except,of course,with respect to politicalrisks). andsponsors-in terms of creatingan unstoppable momen- The envelopeof riskthat lieswith the privatesector in tum to the projectdevelopment effort. In circumstances infrastructureprojects maybe expanded in twoways. First, whereinstitutional development forms an integralpart of becauseof increasedexperience and the confidencethat the overallproject development effort (as in the caseof flowsfrom it, the privatesector will be progressivelymore the HubPower Project) or whereother factors give rise to willingto acceptrisk, to priceit morefinely, or both.Second, unacceptabledelays in the startof construction,mobiliza-

ExecutiveSummary 5 tion finance is one of the few mitigating measures avail- and the first limited recourse financing. For the Bank, it able to the host government and the Bank. was the first private infrastructure project, Bank-financed In arranging mobilization finance that did not disturb infrastructure fund (the PSEDF) to support private pro- the overall permanent finance plan, the project encoun- jects, partial risk guarantee under the ECO program, ECO tered an important limitation on the ability of some facili- guarantee with another institution (JEXIM), and use of ties to refinance construction expenditures that had already the ECO program to support a private project. been funded, but that were otherwise entirely eligible. For the financial markets, it was the first major private This crowding out of some of the permanent facilitieswould infrastructure project in a sub-investment grade develop- have become a serious problem for the project had finan- ing country to be financed by international commercial cial close been further delayed. banks on a limited recourse basis, international equity offer- ing (global depositoryreceipt) and underwriting for a devel- Cofinancier leadership oping country infrastructure project under construction, stock market flotation of a single power station under con- At the project's cofinancier meetings, sometimes attended struction, multi-cofinanced private infrastructure project, by as many as forty delegates, it was natural that the Bank COFACE-supported limited recourse financing for an infra- be perceived as the catalyst and assume the role of chair- structure project,JEXM-supported limited recourse financ- man, particularly since government institutions were in ing for an infrastructure project, Mm-supported limited attendance. Moreover, pressure on the Bank to assume a recourse financing for a major infrastructure project, SACE- wider coordinating role on behalf of cofinanciersgrew from supported limited recourse financing for an infrastructure this chairmanship. Given that the Bank was already a major project, and markup-based (in accordance with Islamic prin- contributor to the development of the energy sector in ciples) limited recourse infrastructure project financing (the Pakistan, this coordinating role had an inherent rationale. locally arranged rupee term facility). The Bank may have been a reluctant leader in circum- stances such as these, particularlygiven the intensivedemand Project Development on personnel resources that such a role brings. But it has a unique capacity to shoulder these responsibilities, and its Developmenttimetables suitability is universally endorsed by the government of Pakistan and the project's cofinanciers, banks, and spon- The origins of the Hub Power Project can be traced back sors. Most cofinanciers see proactive cofinancier coordi- to 1985,to the announcement by the government of Pakistan nation by the Bank as the best hope of speeding up the of an initiative to encourage private participation in power flow of future projects. generation. Work on developing the project began in the The Bank was also, quite naturally, cast in the role of summer of 1987 and expanded rapidly from April 1988 confidante to the government of Pakistan. On occasion this onward, when a detailed feasibility study began. role extended to "honest broker" to help resolve issues Construction of the station began in December 1992, on between the government and the project's sponsors. Both the basis of mobilizationfinance, and the total finance pack- roles are invaluable when the project under development age for the project became irrevocably committed in is pioneering and the sectoral initiative is new for the host September 1994. Financial close was achieved in January country. 1995. The elapsed time taken to develop the project is generally regarded to be eight years (1987-95). Significant Project "Firsts" If, however,allowances are made for time lost through unforeseen events such as the Gulf war (1990-91), a Pakistan The Hub Power Project occasioned many "firsts" for court ruling on the applicability of Shariah Law to the pay- Pakistan, the Bank, and the international financial markets. ment of interest (1991-92), the disruption caused by hav- For Pakistan, it was the first private infrastructure project ing to reconstitute the construction consortium following

6 FinancingPakistan's Hub PowerProject the departure of two members(1990), and the occasional does not easilylend itselfto classicalproject management losses of continuitythat attended severalchanges of gov- techniquesthat assumea levelof controlover events by the ernmentin Pakistan,the activeperiod of projectdevelop- projectmanagement team. There are several common causes ment is closerto five years. of timetableslippage that are rooted in the numberof inde- The project's history is not simplyabout the develop- pendent partiesrequired to contribute to a project, often ment of a project,but about givinglife to an entire policy with very differentpriorities and levelsof relevantexperi- initiativeby the governmentof Pakistanand the Bank.This ence.These difficulties are compoundedby projectnovelty, endeavornecessarily entailed the creationof new institu- complexity,and the disruptiveeffects of force majeure. tions in Pakistanas well as a large body of documentation, The preparationof timetablesis an important activity all of which are of a general (ratherthan project-specific) in project development-not because they give accurate application. The speed with which severalfurther inde- predictionsof when financialclose will occur (whichthey pendent powerprojects reached financial close in Pakistan, do not) but becausethey help define componentdevelop- subsequentto the Hub PowerProject, illustrates this point. ment activities,identify potential critical paths, milestones, In developedmarkets independent power projects usu- and decision points, determine the level of resources allytake one to twoyears to bringto financialclose. In devel- required,and establishpriorities. opingmarkets a pattemis emergingof suchprojects requiring For partiesunfamiliar with private sectorproject devel- an averageof two to three years, althoughthe distribution opment,having only partial control over the projecttimetable of developmentperiods is skewedtoward longer than aver- is unnerving as well as frustrating. It can often lead to age periods.In taking eightyears to reach financialdose, sponsorslosing patience and confidence and pullingout the Hub PowerProject is at the upperend of lengthydevel- of projectsas they find that financialclose is forecastto be, opment periods-but it is not unique. If the activeperiod say,nine months away-year after year. of project developmentis considered(five years), the pro- Fewcompanies in the privateinfrastructure market have ject is in the third quartileof projectdevelopment periods. sufficientfinancial strength and resources to undertake Projectsthat achievethe shortestdevelopment periods, major capitalprojects alone. Moreover,most are relative fromthe point of viewof privatesponsors, are usuallywell newcomerswith limitedexperience working in developing defined technicallyand commerciallyby the host govern- countries.As a result the pattem that is emerginginterna- ment or authoritybefore the procedure for awardof con- tionallyis of infrastructureprojects being undertaken as cession begins (whether award is by a competitive or joint venture-sponsored or limited recourse-financed negotiatedprocess). Independent power projectsare par- enterprises-or, commonly,both. ticularlyvulnerable to timnetableoverrun because of the The market for privateinfrastructure projects, and for number of partiesand contractsnormally required to bring independentpower projects in particular,has changeddra- them to fruition. maticallysince the inceptionof the Hub PowerProject. When One importantfeature of developingprivate rather than Xenelsought an electricutilitypartner for the projectin 1988 publicinfrastructure projects is the largelysequential nature and issuedan intemationalinvitation, only four companies of the key technical,commercial, and financialtasks that responded. Of these, only National Powerhad extensive have to be performed. For example,negotiation of the experienceworking in developingmarkets. If suchan invi- core commercialcontracts supporting the project cannot tationwere issued today, between 50 and 100electric utility take placeuntil the projectis definedtechnically, and finance companieswould likely respond. Still, few would have much cannot be arranged until the project is defined commer- operationalexperience outside their domesticmarkets. cially.This sequentialpattem of activitiesis a key reason The developmentof the projecthas spannedthe trans- developmentperiods on privateinfrastructure projects are formationof the privateinfrastructure market, from being measuredin years. a rare curiosityoutside a handfulof industrialcountries (in Animportant lesson that canbe drawnabout project devel- 1987)to mainstreampolicy for manycountries, both indus- opmenttimetables is that the processof project development trial and developing(in 1997).During this period trends

ExecutiveSummary 7 of privatizationand utilityderegulation have createda mar- ing on the sponsorsto completethe assignmentsuccess- ket for 'global" utilitycompanies. fullyand asrapidly as possible.The stakeswere made higher For its projectdevelopment structure, the projectchose for the governmentby the decisionto make the project its a joint venture composed of parties with complementary soleprototype independent power producer, so that the full interests.The core groupcomprised five companies: Xenel, attention of the government,its agencies,and the Bank National Power, Mitsui, Ishikawajima-HarimaHeavy could be concentratedwith that of the sponsorson mak- Industries, and K&M.Collectively, they formed a project ing the project a success.Finally, the government'sstakes developmentcompany (HRPG Limited)that, by virtue of wereraised higher still by its supportfor mobilizationfinance. being independentlyresourced and managed,was able to Given the project's size relativeto the resourcesavail- mitigatemuch of the inertia and dilutionof management ablewithin the governmentand the Bank,no other approach resourcesthat comesfrom multipartyproject sponsorship. wasviable. The decisionto form a queue of other projects behind the Hub PowerProject already appears to havebeen Costsand risks vindicatedby the speed with which subsequent projects have reached financialclose. The developmentcosts for projectsthat arenot welldefined The frustrationof the governmentand others in having technicallyor commerciallyat the outset typicallyare 2 to to waituntil 1995 to seeso mucheffort come to fruitionmay 4 percent of the project's funding requirement.This rule be partlyoffset by the fact thatbetweenApril1988 (thedate of thumb appears to hold for most private infrastructure of issueof the firstletter of intentfor an independentpower projects(power, transport, water) and, surprisingly,for pro- projectin Pakistan) and March 1996some 2,700 megawatts jects of all sizes.Thus there do not appearto be economies of independentpower producercapacity were brought to of scalefor developmentcosts in sponsoringlarger projects. financialclose. This representsabout 330 megawattsa year In fact,there are diseconomiesof scale in that development in new capacity-an impressiveachievement. costs for larger projects tend to be near the higher end of As the prototype project for Pakistan's independent that range-that is,3 to 4 percentrather than 2 to 3 percent. powerproducer program, the Hub PowerProject inevitably The Hub Power Projectfigure of 3.6 percent, whileat bore a large measure of onetime developmentcosts and the upper end of the range, is not exceptional.Given the risks that subsequent projects have been able to avoid. project's gestation period and novelty,it is surprisingthat Although no mechanismexists to share such costs and the figureis not higher.What is inevitablyeye-catchingwith risksamong project sponsors generally, sponsors have been all large projects is the absolute sum that the sponsors willingto acceptthem becauseof the distinctionattached must put at risk in order to create a project.Few corpora- to being "the first,"whether in Pakistanor any other coun- tions can afford to take gamblesof this magnitudeon their try. Such is the degree of competitionamong sponsorsin own, particularlysince the probabilityof successin project the market for private infrastructureprojects. developmentcan be low. Given the considerableresources that had to be mobi- Thepersonnel required to developthe Hub PowerProject lizedto completethe developmentof the Hub PowerProject, and bring it to financialclose is estimatedat 225 person- as well as the risksborne and costs incurred, it is remark- yearssplit broadlyas follows:the governmentof Pakistan able that fatiguedid not set in amongthe government,the and its agenciesand advisers,25 percent;sponsors and their sponsors,the Bank, and the cofinanciers.Herein lies the advisers,50 percent; the Bank, 10 percent;and other cofi- essentialreason the projectreached financial close-namely, nanciers,leading banks, and theiradvisers 15 percent.This none of the key participantswavered in their determina- excludesthe resourcesdeployed by the turnkeycontractor. tion to see it through.The importanceto the government The sponsorswere not alone in bearing development and to the project sponsorsof the Bank's commitmentin risks;the govemmentwas alsoexposed to substantialrisks. this regardshould not be underestimated.All the project's In granting the project an exclusivityperiod in which to participantsshould be commendedfor their staminaand developand financethe project,the governmentwas rely- patience.

8 FinancingPakistan's Hub PowerProject Mobilizing Sufficientand Least-Cost Shorteningthe Development Period Finance Developmentplanning In mostcases the shortageof debt financingis a greater constrainton thedevelopment of private infrastructure pro- In its predevelopmentpreparation for a project,and prior jectsthan isa shortageof equity.Thus the ECO guarantee to issuingthe invitationfor privatesector proposals, time programis of crucialimportance to the powersector. Since spentby a hostgovernment in definingthe legislativeenvi- debt is cheaperthan equity,maximum gearing is required ronment,the project'stechnical and commercialrequire- to achievethe lowestoverall cost of fundingfor a project ments,and policyobjectives within the contextof what and,in turn, the lowesttariffs for customers. canbe financedby the private sector will be more than saved Lowertariffs for customers may also be brought about by by the timefinancial close is reached. arrangingdebt financewith extended average and overall It is also advisableto postponeas manynonessential maturities.The mainconstraint on stretchingcommercial activitiesas possibleuntil after financialclose. This may bankloan maturities is the reluctance on the part of political requiredividing the project into two or moredistinct phases, riskguarantors to accept the longer exposure. This reluctance eachwith a separatefinance plan and financialclose. Any preventsdeveloping countries from accessing the kindsof consequentreductions in the complexityof a givenphase's loanmaturities that are available for similar projects in devel- financeplan should yield time savings in reachingthe ini- opedmarkets (that is, fifteen to twentyyears or more).The tialfinancial close, albeit at the probablecost of a tempo- PSEDF,with loan maturities of twenty-threeyears (nearly raryloss of economiesof scalein outputtariff. twicethat of the commercialbank finance for the Hubpro- Debtsyndication is the mostobvious financing activity ject),has a significantimpact on availableloan maturities. that can usuallybe deferreduntil after financialclose. Still,export credit agencies and other cofinanciers should con- Generally,financial close should be soughton the basisof sideroffering maturities of fifteenyears or morefor infra- an unconditionalunderwriting against which the project structureprojects, to dose the gap between the terms of finance maybegin loan drawdowns. thatare availablein developingand developed markets. Competitionis a thirdroute through which the costof Focusedresources fundingprojects may be minimized.The large number of potentialsources of commercialterm debt for private infra- Thefewer project participants there are the better,be they structureprojects indicates what may be possiblein this contractcounterparties, contractors, cofinanciers, or pro- area.However, the scopefor competitionis lessbroad for jectsponsors. Moreover, each participantmust dedicate largerprojects. The limiting factor on the supplyof finance appropriatecomplementary resources. For sponsors,that isgenerally political risk coverfor term loanfacilities. meansa strong,dedicated management team whose pri- Anyfinance plan that stretchesto the limitthe available maryresponsibility isbringing the projectto fruition.A sep- financeand associatedpolitical risk coverfor a projector arate,self-contained, full-time project team is best. The countrywill face a furtherconstraint in the formof inade- Bankalso requires dedicated personnel; this willrequire quate flexibilityof the financeplan, relative to soft costs that resourcesbe freedup fromother responsibilitiesto andthe provisionof adequatestandby finance. This prob- concentrateon the projectat hand. lem willusually be worsenedby increased fragmentation inthe financeplan. The most important feature of the ECO Avoidablecomplexity guaranteefacility in thiscontext is its completeflexibility withregard to the provision of bothbase and standby finance. Significantcomplexity arises from a fragmentedfinance Thisis a vitalpoint of dlifferentiationbetween an ECO- plan, whichmay be unavoidable.However, within any andan exportcredit agency-supported facility that, in effect, financeplan muchtime, effort, and cost can be savedin makesthe facilitiescomplementary. implementationif the planhas beendeveloped, in at least

ExecutiveSummary 9 a rudimentaryform, before constructionand equipment prior to financialclose. Whether the Bank and the gov- supplycontracts are tendered.For example,this maybe the emrnent of Pakistanwould have remained so unwavering onlyopportunity to achievea match betweenthe currency in their support of a smallerproject remainsunknown. of fundingand the currency(or currencies)of capital expen- The Hub PowerProject is a private project embedded diture or to solveproblems that mayarise if supplierexport in a publicenvironment. The project's fuel supplier (Pakistan credit agenciesoffer banks less than 100 percent political State Oil) and power purchaser (Water and Power risk coverage. DevelopmentAuthority) are both owned by the state, as The negativeeffects of financeplan fragmentationmay are severallocal financialinstitutions that provided term be partlymitigated by the adoptionof harmonizedor more loan finance for the project. This pattern of partnership standard forms of documentation. betweenprivate and publicsectors is likelyto be repeated in future project financingsthat introduce private capital Timetable paradox into a nation'sinfrastructure development plans. The Bank's role as facilitatorof this processwas crucialand welcomed To achieve the shortest developmenttimetable a project by all the partiesinvolved in the project. should,paradoxically, be configuredto survivea long haul There are manyother waysin which the Bank can, and to financialclose, whether causedby forcemajeure or oth- in the caseof the Hub projectdid, contributeto a project's erwise.Particular measures that shouldbe taken include: success. Three measures deserve priority in the future * Determiningthe level of cross-partypolitical support because of their impact on the flow of private infrastruc- withinthe host country ture projects in developingmarkets and on the financial * Testingthe sponsors'commitment to contributeto pro- convergenceof thesewith equivalentprojects in developed ject financing markets: * Planning for continuityof resourcesdespite sporadic Assumptionby the Bank of a leadingrole with regard progress to coordinatingcofinanciers-both generally,in their * Preparing commercialcontracts so that they can sur- approachto such projects, and specifically,in relation vive unforeseen timetable slippagewithout requiring to individualprojects that the Bank agreesto support renegotiation. (thisis particularlyimportantwhenthe projectis a "first" Planners should avoid the temptationto believe in "fast for the host country). track" timetables. * Allocationof resourcesby the Bankon a project-specific and usuallydedicated basis for the duration of the pro- Conclusion ject developmentperiod (for resource planning purposes, the equivalentof at leasttwo Bank staff per project should A question often asked about the Hub Power Project is be assumed). whether, had it been smaller,it would have been devel- Deploymentof ECO guaranteesand PSEDF-stylefacil- oped more rapidly.The best answerthat can be given is itiesto extendthe maturityof availableterm financeto probably-so long as there wasan associatedreduction in twenty or more years and to ensure that projects have the complexityof the financeplan. Sucha reductionin com- sufficientflexible finance to overcomeconstraints that plexitymight have been achieved,for example,by having may attach to finance that is available from other a singlePSEDF cofinancierfacility, a singleexport credit cofinanciers. agencyfacility, and no rupee facility. Thefourth unit of the Hub Projectwas completed three Much of the project's novelty was independent of its weeksahead of scheduleon 7 March1997, and formalcom- size, as was the time taken to develop the project agree- pletion of the entire station complexwas announced, on ments and to establishnew institutionsin Pakistan.Even schedule,on 31 March1997. The actualcapital cost of com- much smallerindependent power projectscan have more pletingthe projectwasslightly below budget-infact, a sav- than 100 project agreementsand documentsto complete ings of about 1 percent of the budget were realized.

10 FinancingPakistan's Hub PowerProject Finance Plan

Overview its financeplan. Under the termsof Hubco'sagreements with Pakistan State Oil and the Water and Power The capitalcost of the Hub PowerProject was budgeted DevelopmentAuthority, the completionof thosefacilities at $1,608million. This total indudes payments for the design, wasthe responsibilityof PakistanState Oil (asoil suppler) fabrication,erection, and commissioning of the station ($989 andthe Water and Power Development Authority (as power million)as well as theassociated finance, management, pro- purchaser). jectdevelopment, and insurance costs ($619 million). During itscommissioning the stationwas expected to generate$63 PrivateSector EnergyDevelopment Fund (PSEDF) millionin net incomefrom power sales, which lowered the forecastcapital funding required during construction to ThePSEDF is a fundingstructure developed by theWorld $1,545million. This figure formed the basisfor the finance Bankto directmultilateral and bilateralfinance into pri- plan. vateenergy enterprises in Pakistan. Hub Power was the first projectto qualify.The Bankdeveloped a similarvehicle, Capitalstructure the PrivateSector EnergyFund, for the 60 megawatt RockfortPrivate Power Project in Jamaica(financial close The financeplan comprises three basicsources of capital: occurredin October1994). The Bankand other contrib- equity,which accounts for 24 percentof funding($371 mil- lion);senior debt, which accounts for 48percent ($738 mil- TABLEI lion);and subordinated debt, which accounts for 28 percent Basefinance plan ($436million; table 1). Equityis in the formof ordinary Amounta Contribution sharecapital in the HubPower Company Limited (Hubco), Source (US$million equivalent) (percent) the companythat ownsthe project.Senior debt is in the Equity 371 24 formof sevenindividual term loans-some multitranche ECOguaranteed 200 and all with an overallmaturity of twelveyears-one of JEXIMguaranteed 100 COFACEinsured 45 which is guaranteed by the Expanded Cofinancing MITlinsured 86 Operation(ECO). Subordinateddebt is in the formof SACEinsured 195 CPC 37 twomultitranche term loans from the Private Sector Energy Rupeefacility 75 DevelopmentFund (PSEDF) with an overallmaturity of Subtotal 738 48 twenty-threeyears. Subordinateddebt PSEDFI 322 Constructionof a 78 kilometerpipeline to connectthe PSEDF11 114 powerstation to the fueloil storageterminal at Pipri(near Subtotal 436 28 Port Qasim)and of a 200 kilometertransmission line to Total 1,545 100 connectthe power station to thegrid atJamshoro were out- Note:Figures arein end-1993 dollar exchange rates. In practice sources and applica- tionsof finance are in mnuftiple currencies. sidethe scopeof the projectand thus did not formpart of a.Does not include standby debt.

11 utors to the PSEDFmake loan advancesto the government ExpandedCofinancing Operation (ECO) and Export- of Pakistan which, through the state-owned National ImportBank ofJapan JEXIM)guarantee facilities DevelopmentFinance Corporation (NDFC), onlendsthe money to the Hub PowerProject on standardizedterms. The Expanded CofinancingOperation (ECO) guarantee For the first PSEDF facility(PSEDF I) the interestrate facilitywas developedunder the WorldBank's ECO pro- paid by the project is fixed at 14 percent a year for the gram.The Hub PowerProject's ECO guarantee facilityis duration of the loan. For the second facility(PSEDF II) a $240million senior term loan providedby an international the rate is fixed at 14 percent a year until the start of com- syndicateof thirty-four commercialbanks. The loan has mercial operations,then becomesa LIBOR-linkedfloat- limitedrecourse to the project except for defined political ingrate. Repaymentsfor both facilitiesbegin on the eighth risks,for whichlenders are securedby an ECO guarantee anniversaryof financialclose and are made on a straight- issued by the Bank-that is, a partial risk guarantee.The line basis over the succeedingfifteen years.The average ECO guaranteecovers 100 percent of loan principalbut loan maturityfor the PSEDF is 15.5 years. The govern- no interest, and is securedfor up to thirteen months and ment's obligationsto make debt servicepayments to the sevendays (the maximumcall period of the ECO guaran- Bank and other contributorsto the PSEDF are not condi- tee) bya cashcollateral account (guaranteed reserve account) tionalon the project's abilityto meet its debt serviceoblig- funded by the project. ations to the NDFC. That is, the governmentof Pakistan The ECO guarantee facility has four currency base (through the NDFC), not the cofinanciersof the PSEDF, tranches (denominated in U.S. dollars, Japanese yen, acceptslimited recourse exposure to the project. Europeancurrency units, and Frenchfrancs) totaling $200 The cofinanciersthat agreedto provideadvances to the millionand a singlestandby tranche of $40 million(denom- Hub project through the PSEDF are shown in table 2. inatedin U.S.dollars). Interest on eachtranche is a LIBOR- The Bank participates in both PSEDF I and PSEDF H. linkedfloating rate.A separate guarantee fee of 0.25percent The Bank's contributionthrough the PSEDF is $225 mil- a year is payableby the project to the Bank on the facility lion, or 39 percent of the project's subordinated debt amount. The conditionsof loan availabilityfollow prece- facilities. dentsfor commercialbank financefor independentpower Althoughmany of the termson whichthe NDFC onlends projectsin industrialcountries and do not imposeinterna- the PSEDF's componentfacilities to the Hub PowerProject tional competitivebidding or other procurement restric- are standardized,certain important conditionsare not- for example,the currencyof disbursementand definition CABLE2 of eligibleexpenditure, which are controlled directlyby DevelopmentFund the respective cofinancier. (US$million equivalent) Althoughdrawings from the PSEDF are made by the Base Standby projectin the currenciesof theunderlying cofinancier loans Source facilities facilities Total to the governmentof Pakistan,project debt serviceoblig- PSEDFI ationsto the NDFC becomedenominated in rupees when World Bank 145 n.a. 145 . . . . ~~~~ ~ ~ ~~94 ~ ~53 ~~JEXIM147 each respectivedrawing is made. This approachprotects France 27 n.a. 27 the projectfrom exchangerate risksthat may arisefrom a Italy 46 n.a. 46 mismatchbetween the currencyof tariffpayment under the USAID 10 n.a. 10 Subtotal 322 53 375 powerpurchase-agreement (rupee) and the currencyof cofi- PSEDF11 nancierdebt service.However, such protection makes tar- World Bank 35 45 80 ., ~~~~~JEXIM 71 38 109 iffs under the power purchase agreement significantlymore France 8 n.a. 8 complex.The interest rate paid by the projecton PSEDF Subtotal 114 83 197 drawingsincludes a marginto account for this exchange Total 436 136 572 risk insurance. n.a.is not available.

12 FinancingPakistan's Hub PowerProject tionson the project.Repayments begin on the fourthanniver- in July 1991,when the contractwas awarded,would have saryof financialdose and are made on a straight-linebasis lapsed.Since this fixedprice laybehind the tariff agreedin overthe succeedingeight years. Thus the averageloan matu- August1992 between the Hub PowerProject and the gov- rity is eight years. ernmentof Pakistan,a contractprice revisionor rebid could Debt serviceis paid by the Hub PowerProject directly have had seriousconsequences for the project's timetable to the facilityagent for the ECO guarantee facilityin the and might have necessitatedrenegotiating tariffs (see the appropriatecurrencies. The project's rupee-denominated section on project development,below). By the time of tariff revenuesare convertedinto these currenciesby the financialdose about$423 milion of financehad been drawn State Bank of Pakistan,which assuresthe project of fixed downto fund project developmentand constructioncosts exchangerates under its foreign exchangerisk insurance (table3). scheme. The two bridgefinance facilities shown in table 3 were An Export-ImportBank of Japan JEXIM) guarantee repaidout of the proceedsofthe permanentfinancing.Thus facilitycomprising $100 milion of base and $20milion of they are included in the financeplan figureof $1,545mil- standby finance is provided on terms broadly similarto lion and are not shownseparately in table 1.The four term those that apply to the ECO guaranteefacility (although financefacilities shown in table 3 rolled over at financial the JEXIM guaranteefacility is denominatedin onlya sin- dose andbecame part ofthe permanentfinance plan. Bridge gle currency,yen) and is fundedby a separateinternational financewas structured as short-term (for example,twelve syndicate of nineteen banks. The guarantee instruments months)facilities secured by the government.As a result used by the ECO and JEXIM facilitiesare the same and ofmobilization finance the firstpower exports from the sta- wereprepared byJEXIM's legal counsel. tion wereachieved on scheduleless than eighteenmonths after financialclose, in June 1996. Othersenior term loans WorldBank perspectives In addition to the ECO and JEXIM facilities,the Hub PowerProject has five senior term loans, includingthree Additionality.The unanimousand unequivocalview of base facilitiesinsured by COFACE,Mlll, and SACEthat arrangerbanks, sponsors, and cofinanciersof the Hub Power are funded by separate internationalsyndicates of com- Projectisthattheywouldnothave acceptedthe costs,risks, mercialbanks (see appendix1). and diversionof resourcesneeded to completeproject devel- The sixth senior facility is a term loan from the GommonwealthDevelopment Corporation. The seventh MobilizationTABLE3 finance is a rupee term facilitystructured on the Islamicprinciples of "markup"rather than interest.The rupeefacility is funded Source (US$million equivalent) availability by a syndicateof nine Pakistanibanks and institutions(see Equity appendix 4). Sponsors 65 January1987 The sevensenior term facilitiesall have the same over- Others 36 September1994 Subtotal 101 all maturity(twelve years), repayment profile (straight-line), Bridgefinance and averagematurity (eight years). AlRajhi Istisna 92 December1992 Rupeefacility I0 December 1993 Subtotal 102 Mobilizationfinance. Termfinance Bank(PSEDF I) 110 April 1993 France(PSEDF 1) 27 June1994 The turnkey contractorappointed to constructthe power Italy(PSEDF 1) 46 June1994 station wasmobilized in December 1992,about two years CDC 37 September1994 before financialclose (January 1995). Had mobilization Subtotal 220 been delayedfurther, the constructionprice that was fixed Total 423

FinancePlan 13 opment had it not been for the WorldBank's participation politicalrisk guaranteesmodeled on the ECO guarantee and support. The governmentof Pakistanalso welcomed deployedon the project. the Bank's participationas a cofinancier,adviser, and coor- dinator, not least because of its long-standingsupport for Mobilizationfinance. Mobilization finance played a cru- Pakistan'senergy sector. The Bank's participationwas also cialrole in maintainingthe project's timetablefor delivery essentialto the decisionsof banks and investorsto jointhe ofpower to the Pakistangrid, which was agreed in November project at financialclose. 1992 when a mobilizationagreement was signed. It also Of the $572 millionheld by the PSEDF, 39 percent is representeda "crossingof the Rubicon"for all concerned- providedby the Bank. Of the $823 millionof senior term the governmentof Pakistan,the Bank, and sponsors-in finance,29 percentis partlyguaranteed for riskby the Bank. termsof creatingmomentum for the project development Thus of the $1,766million in financingmobilized for the effort (see the sectionon project development,below). project (base and standby finance combined), the Bank The short-termnature of part ofthe mobilizationfinance provided or partly guaranteed$465 million (26 percent). (namely,the bridgefinance facilities) and the rate at which This represents an overallmobilization ratio of the Bank constructionexpenditures are generallyincurred once a to all sourcesof financeof about 1 to 4. The projectis the contractor has been mobilizedplaced considerablepres- first time so many cofinanciershave participatedin a pri- sure on all concerned. In hindsight this pressure can be vate project. If the French,Italian, and Japanesegovern- recognizedas beneficialfor the project, although poten- ment agenciesthat contributedto the PSEDFare considered tiallyweakeningto the negotiatingposition of parties already separatelyfrom COFACE, SACE, and Mm, there are nine involvedin the project and for whom commercialissues cofinanciers. were stilloutstanding. Such issueshad been few and rela- In all, forty-threeinternational commercial banks par- tivelyminor on the project by this time. But if commercial ticipated in the facilitiessupported by ECO, JEXIM, and issueshad been outstandingat the time of mobilization, the three export credit agencies.Most had never lent to the additionalpressure could easilyhave been destructive Pakistanbefore, and manyhad neverparticipated in a Bank rather than constructive. cofinancing.For some banks the Hub PowerProject was In arrangingmobilization finance that interfaced effi- their first participation in private infrastructure project cientlywith the overallpermanent finance plan, the pro- financing. ject encounteredan important limitationon the abilityof The Hub project was the first time that COFACEand somefacilities (such as Bank and JEXIM contributionsto SACE had supported a limited recourse infrastructure the PSEDF) to refinance constructionexpenditures that project financing.The Bank clearlyplayed a catalyticrole had alreadybeen funded but that were otherwiseentirely in introducing them, sustainingtheir interest, and bring- eligible.This crowding out of someof the permanentfinance ing them together to share certain common views-for facilitieswould have become a serious problem for the example, the project coordination agreement between projecthad financialclose been delayedfurther. Hubco and its various lenders (the intercreditor agree- ment). The rupee term facilitywas Pakistan's first domes- Development of the Plan tically arranged limited recourse financing for an infrastructureproject. Origins The project also has stimulatedinitiatives among cofi- nanciersthat go beyondtheir direct participation in the pro- Thebasic structure of the financeplan wasestablished early ject and even among some cofinanciers that did not in the development of the project and underwent rela- participatein the project.For example,COFACE has since tivelyfew changesbefore final implementation.The pri- establisheda projectfinancing group, and its ExportCredit maryobjective, as with all financeplans for infrastructure GuaranteeDepartment and the AsianDevelopment Bank projects,was to mobilizethe longest maturityand cheap- are consideringparticipating in projectfinancings through est financeterms possiblein order to achievean accept-

14 FinancingPakistan's Hub PowerProject able tariff. The primaryconstraint on the financeplan was introducingconsiderable extra noveltyto the project. In the limitedor, in the case of longermaturities, nonexistent 1991JEXIM agreed, in principle,to providea sisterguar- availabilityof foreigncurrency commercial bank term loans antee facility.One of the moststriking features of the Hub for private enterprises in Pakistan, other than with the project financeplan is its complexityand associatedlevel support of cofinanciers. of innovation.There are seven senior loan facilitiesand, The PSEDF wascreated in 1988, and its availabilityto through the PSEDF,eight subordinatedloan facilities. the Hub PowerProject formed a fundamentalpart of the The objectiveof securingthe cheapestavailable term of financeplan from that time. The PSEDF was designedto financewas pursued in three ways.First, the PSEDF was financeup to 30 percent of the capitalcosts of qualifying structuredto offer a fixed (14 percent a year) rupee inter- projects at maturitiesof up to twenty-threeyears, subject estcost to borrowersthat was(when the PSEDFwas estab- to it not providingmore than 50 percent of the project's lished) and remainsan attractiverate for twenty-three-year foreignexchange costs. subordinatedterm finance in Pakistan.Second, senior debt The governmentset the minimumlevel of equitycon- interestcosts were based on a combinationof LIBOR-linked tributionto the financeplan at 20 percent.(This lower limit floatingrates, export credit agencysubsidized rates, and was also subsequentlyadopted as a loan conditionby the fixed rates. All were settled on an open-bookbasis and, PSEDF.)The government briefly adopted a 25 percentlimit where competitionamong finance providerswas not pos- on equity contributionsin 1988-90,but ultimatelyit set- sible(which was generally the case),the projectwas obliged tled back at 20 percent (notwithstandinga target of 25 to demonstratethat reasonablegoing-market rates had been percent if market conditions permitted, which they ulti- achieved.Third, in the case of equity,which is usuallya mately did). more expensiveform of capitalthan debt, the government The fixedcomponents of the financeplan becameequity specifieda ceilingof 18 percent a year on base-caserates (20-25 percent) and the PSEDF (30 percent), whichleft of return on equity for the project. Adherenceto a regu- a balance of 45-50 percent to be found in mostlyforeign lated, base-case rate of return was achieved by using a currency term loans. Identifyingsources for these loans computer-based model of the power tariff and finance became the project's main fundraisingtask. Originallyit plan that wasmaintained by the government,the Waterand had been hoped that facilitiesinsured by exportcredit agen- PowerDevelopment Authority, and the projecton an open- cies and term loans from multilateraland bilateralagen- book basis. cies (other than the Bank) would meet the shortfall.By It shouldbe stressed,however, that the actual rate of 1990, however,it had become clear that because of the returnto investorsis not assuredby the governmentor any limitedand cydicalavailability of exportcredit agency insur- other party.Whether the projectionsof future shareholder ance cover for Pakistan and such agencies' nervousness (and lender)cash flow contained in the base-casecomputer about limited recourse finance structures, these sources modelare realizeddepends on the projectachieving timely were unlikelyto be sufficient. and on-budgetcompletion of constructionand subsequent In 1988the CommonwealthDevelopment Corporation reliableand efficientoperation (box 1). had indicated its interest in providingterm finance and equity for the Hub Power Project. It was, however,the ThePSEDF's role onlymultilateral or bilateralagency to do so apart fromthe Bank, although others were invited (includingthe Asian The PSEDF provideslong-term finance, and in so doing, DevelopmentBank, International Finance Corporation, anticipatesone of the key advantagesof longmaturities that and IslamicDevelopment Bank). As a result the Bank's would normallybe associatedwith a refinancing(which timelyannouncement of the ECO program(in 1990)and wouldtypically be implementedby an independentpower its subsequent approval(in 1991)made the ECO guaran- produceronce constructionwas complete). No other inde- tee facilitypart of the financeplan to make up for the short- pendentpower producer in a developingmarket has entered fall in senior term finance-although at the expense of the constructionphase with such long-term finance (twenty-

FinancePlan 15 involvedin the infrastructurebusiness at that time. Since Box I Profileof privatesector risk the Hub project,several smaller independent powerpro- Investorsin and lendersto the Hub PowerProject-including jects have reached financial close in Pakistan without the commercialbanks participating in the ECOand JEXIM guar- PSEDF support, relying solely on different combinations antee facilities-areexposed to the samecommercial risks that of export credit agency-, IFC-, and JEXIM-supported they wouldface in a limitedrecourse financing of an indepen- debt finance, as well as equity and locally arranged term dent power projectin an industrialcountry-that is,during con- finance struction,risks of the plantbeing built on timeand within budget and of itsachieving intended performance characteristics; and duringoperation, risks of the plantperforming reliably consum- ECOguarantee facility's role ingfuel, and requiringmaintenance in line with expectations. Anadverse outcome with respectto one or moreof these The ECO guarantee facility and its sister JEXIM guaran- risksresuks in reduced or no retumsfor shareholders and could, tee facilitytogether provide about 40 percent of base senior in severecases, leadto Hubcohaving insufficient cash flow to metdetsevcepyensfalngde term debt-that is, $300 millon of $728 million-fulfill- meet__debt_service __payments__falling__due. ing their primary role of supplementing the $326 million of insurance cover provided by export credit agencies. By three years) in place. In this context the PSEDF can be seen limiting the cover provided under the ECO and JEXIM as not only forward-looking but as genuinely innovative. A guarantees to sovereign contractual obligations (including second important feature of PSEDF I and, to a lesser extent, nationalization, foreign currency availability,and other polft- PSEDF II is the fixed interest rate that it offers the Hub ical risks), the guarantees create an environment in which Power Project. private sources of finance can perform the functions to Such long-term finance compensates for the fact that which they are best suited-namely, identifying, evaluat- the balance of debt finance (that is, the senior term debt) ing, managing, and accepting commercial risks. for the project is available at shorter maturities than com- Another important role of the ECO and JEXIM guar- mercial banks can provide in industrial countries. antee facilities is the provision of untied and entirely flex- Independentpower producers in industrial countries can ible finance. One of the common characteristics of finance usually secure construction finance from commercialbanks insured by multilateral and bilateral agencies and export with fifteen to eighteen or more years' maturity. For the credit agencies (though not the Commonwealth Hub project the maturity is twelve years. However, with the Development Corporation) is the conditions that apply to PSEDF facilities the project's weighted average overall its use. Project finance involves significant costs, such as maturity of debt finance, at sixteen years ($738 million, or interest during construction and project management, that 63 percent, at twelve years and $436 million, or 37 per- satisfy neither tied nor intemational competitive bidding cent, at twenty-three years), is comparable with those in procurement criteria and yet are just as much capital costs industrial countries. The subordination of the PSEDF facil- as equipment. The ratio of these "soft" costs to the "hard" ities, in ranking of security interest and by virtue of their costs of construction generally are in the range 1:4 to 1: 1, longer maturity, creates significant additional risk cover depending on the type of project and the length of the for the providers of senior term debt. construction period. For the Hub Power Project this ratio The availabilityof the PSEDF became the driving force is 1:1.6. behind the government's private sector initiative in power In addition to interest during construction, there are sig- generation. Publicity materials for this initiative were nificant soft costs associated with funding reserve accounts issued by the Ministry of Water and Power's Private Power to compensate for the less than 100 percent insurance of Cell in 1989, 1991, and later years. These materials loan principal for political risks under the SACE insured included descriptions of the PSEDF, since without the facility,for the lack of interest cover under the ECO and long-term finance provided by the PSEDF private pro- JEXIM guarantee facilities, and to provide a "markup" jects were not considered feasible in Pakistan by anyone reserve account for the rupee facility.

16 FinancingPakistan's Hub PowerProject The problemsof fundingsoft costs are all the greaterin extent by onshore investors,in each case a mix of corpo- relationto standbyfinance, which, if used,is usuallyneeded rations,institutions, and privateinvestors. to meet the costs of a delay in completingconstruction. The governmentof Pakistanhad alwaysfavored a com- Little if any additionalprocurement of equipmentis usu- binationof offshoreand onshoreinvestors, and initialplans allyrequired in suchcircumstances, and rarelyanything that had calledfor a more even splitbetween the two.However, would lend itself to formalinternational competitive bid- the difficultyin underwritingsuch a large issue onshore ding procedures.As a result the ECO and JEXIMguaran- meant that, at least initially,most of the equityfinance had tee facilitiesare crucialto the provisionof adequatestandby to be mobilized offshore. Ownership of the project is financefor the project.The ratioof standbyto basefinance expectedto migrateslowly and progressivelyonshore over is typically10-15 percent,with standby financecovering the lifeof the station-particularly giventhe interestshown budgetarycontingencies and the constructioncontract let in the localequity market, where the initialRs 300 million on a fixed-priceturnkey basis-that is, with no contract share offer was four times oversubscribed.This experi- price reopeners (for the Hub projectthe ratio was 14 per- ence illustrates how difficult it can be to estimate local cent, equivalentto $221 million).This ratioshould be suf- marketappetite in suchcircumstances. The portion of shares ficient to sustain a delay in project completion of up to held onshore,about 5 percent,is stilllow, though it iswidely twelvemonths caused by circumstancesfor whichthere is distributed. Hubco now has about 100,000shareholders no alternativesource of funding-such asinsurance or liq- in Pakistan. uidateddamages from the contractor.The ECO andJEXIM The projecthad fortunate timingin its launchingof the guarantee facilities together provide 27 percent of the internationaland domesticequity offering (October 1994). standbyfinance availableto the project. The level of interest in the project meant that the target The role of the ECO guaranteefacility as a "sweeper" of 25 percent equity contributionto the finance plan was of costs that cannot otherwisebe funded because of pro- attainable (in fact, 24 percent). This achievement had curement constraintsalso extendsto its role as a multicur- the indirect benefit of creating a finance plan in which rencyfacility that sweepsup remainingmismatches between the equity contribution was still greater than 20 percent currenciesof expenditureand currenciesof funding.The evenif all availablestandby finance were drawn. Of course, only other "sweeper"term facilityin the financeplan was by itself fortunate timing is no more sufficientin equity providedby the CommonwealthDevelopment Corporation. markets than in debt markets, and much credit shouldbe Equity and revenuesgenerated during commissioningare givento the thorough and effectiveway the project was also entirelyflexible in their application. presented to the market in financial centers around the The term base financein the project'sfinance plan is 35 world. percentflexible and 65 percentinflexible. If equityand rev- The flotationof Hubco on the Karachistock exchange enues duringcommissioning are included,these sharesare and the global depository receipt issue listed on the more evenlysplit. Luxembourgstock exchange(box 2), which formed the basis of the successfulinternational offering, were firsts Equityfinance for a private power station still under construction.The successof these offeringswas greatly assisted by the highly The share of equity in the financeplan remained constant successfulsenior debt underwritingand syndicationthat at 20 to 25 percent throughoutthe developmentof the Hub precededthem. For internationalinvestors that subscribed Power Project. The government,the sponsors, and the to the globaldepository receipt issue, the central role in financierspreferred that the shareof equityremain at the the projectof NationalPower, a major internationalpower higher end of this range, if possible.The sponsorequity utility,was a moreimportant investment consideration than contribution of $149 millionrepresents about 40 percent the WorldBank's presence. The sharesand globaldepos- of the project's equity capital.The balance was provided itory receipts have performed well since flotation; shares mainly by other offshore investors and to a much lesser in Hubco have been one of the most activelytraded on

FinancePlan 17 have implications for World Bank participation in future Box 2 Roleof globaldepository receipts in Hub projects. PowerProject financing The shares in Hubcoare rupeedenominated (10 rupeesper Internationalcompetitive bidding. The first issue is the share par value)and are listedon the Karachistock exchange. balance that has to be struck between the philosophy of Formany offshore investors these features create two issuesthat fixed price tumkey contracting, which is ubiquitous in pri- mayaffect their investmentdecision: investment valuation in a currencynot freelyconvertible or hedgableinto dollars and set- vancinfratc reaprec thatorce el roecose tlementarrangements in an unfamiliarstock exchange environ- financing (for example, build-own-operate projects), and ment.Global depository receipts (GDRs) were created specifically procurement under intemational competitive bidding. In to addressthese issues:first, they are dollar-denominated:and fixed price turnkey contracting the contractor absorbs cost second,they are listedon the Luxembourgstock exchange. overruns or benefits from savings if the costs of procure- AGDRrepresentstwenty-fiveshares in Hubcoand gives the ment deviate from the original estimate behind the con- holderthe rightto receivethese shares,if desired. The shares . . . that are representedby the GDRsare registeredin the name tractprice pUneri ertional com ti bidd ent ofa depository(the Bankof NewYork, New York)and are held is usuallytransparency between the costs of procurement by a custodian(ANZ Grindlays Bank, Karachi). GDRs are traded and the price charged to the client. throughan intemational book-entry settlement system to which A project sponsor will select a turnkey contractor based GDRmarket makers in London,New York,and other major on many criteria, which may include a willingness to share financialcenters have access, through systems such as Euroclear project development costs. Deciding factors may not, how- Thetotal number of Hubco GDRs available may change over time,within certain limits, in responseto marketdemand for ever, cud a reqie nttat indiiduahpiees ofae GDRsrelative to the underlyingshares. The gradualonshore ment procured by the contractor be the cheapest available migrationof Hubco share ownership should mean thatthe num- (in capital cost terms). What matters to the sponsor is the ber ofGDRs will eventually decline. More than 13million Hubco ability to offer the client (host government) the most com- GDRswith atotal subscription price of around $145 millionwere petitive tariff from the power station (or toll bridge, water sold in October 1994.These GDRsrepresent about 30 per- treatment works, or other project). Many factors enter centof the equityin Hubco. into this equation, not least of which are the terms of finance Dividendspaid by Hubcoon the underlyingshares are con- vertedinto dollars bythe depository, priorto distribution to GDR or even the availability of sufficient finance that the con- holders,through foreign exchange operations in the Pakistan tractor may be able mobilize for the project. domesticmarket (for which there arecertain govemment assur- In principle, the World Bank's rules may be applied to ancesin the implementationagreement). GDRowners are enti- a project's output costs, such as a power tariff-as in the tled to instructthe depositoryon the exerciseof the voting case of the Rockfort power project injamaica-which opens rightsattached to the underlyingshares. Theas DRcordiatedbyisue Dutsce Mogan the door for all the project's capital costs (hard and soft The GDRissue was coordinatedby DeutscheMorgan cs,hoerpouedtobomelglefr Bakfud Grenfelland wasfully underwritten by DeutscheBank: such an costs, however procured) to become eligible for Bank fund- underwritingwas itselfan importantprecedent. ing. However, such an approach requires the project to be largely defined technically, commercially, and financially prior to tender, which becomes more difficult as the pro- the Karachi stock exchange, and Hubco has enjoyed much ject's size increases. In these circumstances the tenders for favorable comment from international stock brokering the output cost are heavilyconditional on sources of finance firms. other than the Bank being available on acceptable terms. In the absence of this alternative approach, the Bank's WorldBank perspectives participation in a project through a vehicle such as the PSEDF willbe limitedby the extent of procurementthat Twokey issues-international competitive bidding and satisfiesits rules.In the Hub PowerProject about 40 per- financeplan fragmentation-arose in the developmentand cent of the turnkeyconstruction contract cost satisfiedthe implementationof the Hub PowerProject finance plan that Bank'sprocurement rules. The procurementof goodsand

18 FinancingPakistan's Hub PowerProject servicesunder internationalcompetitive bidding can delay ther pursue these initiatives.This form of collaborationis a project timetable unlessthe relationshipbetween a pro- greatly facilitated by the creation of specialized project ject's procurement and funding is defined at the outset, financegroups within existing organizations, a development whichis seldom possibleexcept on smallerprojects with a that hasbeen significantlystimulated for somecofinanciers less fragmentedfinance plan. by their experiencewith the Hub project. One positiveaspect of financeplan fragmentation,at Financeplanfragmentation. The secondissue is the frag- least from the perspectiveof cofinanciers,is the rationale mentednature of the financeplan. A pattern is now emerg- of securityin numbers.This rationalecarries most weight ing in developing markets of multiple cofinancier if the projectin questionis novel.Consequently, its impor- participationsin these kinds of projects.For example,the tanceto cofinanciersis expectedto diminishas more large financeplans for the Paiton I powerproject in Indonesia, and complexlimited recourse projects are financed.The the Sualpower project in the Philippines,and the IzmitSu converselynegative point about fragmentation is a phe- water projectin Turkeyeach includedat least fourforeign nomenonthat occursduring negotiation, whereby the con- currencysenior loan facilities. sensus alwaysreflects the position of the least flexible There are two main reasons for the fragmentednature participant(that is, "the lowest common denominator"), of these financeplans. First, procurementmay be divided which generallyacts to the disadvantageof the borrower up by the turnkey or the engineering,procurement, and and host government. construction contractor into a seriesof discrete national In responseto the potentialdifficulties created by finance packages.Second, there is generallya tight limitationon plan fragmentation,in 1993 the arrangers developed a the availablepolitical risk coverfor a singlecountry or pro- project coordinationagreement that is, in effect, a master ject from any individualexport credit agencyor other cofi- loan agreementand intercreditoragreement combined; the nancier.The latter may,of course, also be responsiblefor projectcoordination agreement was used for all senior and the contractor opting for discrete national packages of subordinatedfacilities on the Hub PowerProject. This form procurement.If the Bank is involved,there is the added of documentationhas subsequentlybeen adopted on an objectiveof cofinanciermobilization ("catalysis") and the increasingnumber of project finance transactionsaround Bank's role as lender or guarantor of last resort, both of the world. which encouragefragmentation. Given that the number of export credit agenciespar- Banking Strategy ticipatingin the Hub PowerProject is not abnormallyhigh comparedwith otherdeveloping market independent power Syndication producers,the structure of the PSEDF can be identified as the most significantsource of fragmentation.The reso- An internationalsyndicate of forty-threecommercial banks lution of these and other issueshas required the Hub pro- provided$686 millionof limitedrecourse senior term debt ject to develop relativelyextensive financial "technology" facilitiesfor the Hub PowerProject, allocatedbetween the (particularlyin terms of documentation)-certainlyhigher ECO and JEXIMguarantee facilities and the three export than was expectedwhen the project began. credit agency-insuredfacilities (table 4). (Syndicatepro- It is becomingincreasingly apparent to all cofinanciers files are providedin appendix1). involvedin large privateinfrastructure projects (including Syndicationof these fivefacilities was carried out simul- the Hub Power Project) that coordinationis essential if taneouslyby a five-bankarranger group comprisingBank financeplan fragmentationis not to imposea heavybur- of Tokyo-Mitsubishi,Citibank, Credit Lyonnais,NatWest, den of delayin reachingfinancial close. Thus severalcofi- and SakuraBank, supported by MediocreditoCentrale with nanciershave initiatedbilateral collaboration agreements respectto the SACEinsured facility. The arrangergroup was with fellowcofinanciers (particularly export credit agen- chosento reflectthe nationalcombination of suppliers within cies), and there is a strongdesire among cofinanciers to fur- the constructionconsortium and associatedexport credit

FinancePlan 19 TABLE4 Facilitiesfunded by offshorecommercial banks Amount Number of Averageparticipation Facility (US$million equivalent) banks (US$million equivalent) Facilityagene

ECOguaranteed 240b 34 7.1 Bankof Tokyo-Mitsubishi JEXIMguaranteed 120' 19 6.3 SakuraBank COFACEinsured 45 7 6.4 CreditLyonnais MITI insured 86 17 5.1 SakuraBank SACEinsured 195 18 10.8 MediocreditoCentrale Total 686 43d 16.0e a. Citibankisthe intercreditor agent. b. Includes$40 millionof standbydebt. c. Includes$20 millionof standbydebt. d. Mostbanks participated in more than one 6cility. e. Averageoverall partcipation per bank. agency-insured facilitiesand to include banks with a proven in the first ECO-guaranteed limited recourse project financ- and leading reputation in large limited recourse projects. ing. The presence of the Bank and JEXIM and the novelty Syndication was launched in May 1994 and closed four of the guarantee program are also partly responsible for months later. During this period some eighty banks were the appearance in the commercial bank syndicate of sev- approached. In the end syndication was more than 100 eral banks that previously had not participated in financ- percent oversubscribed. The reasons for such a successful ings of private infrastructure. The decision by a group of syndicationranged from the participation of the World Bank Italian banks, led by Mediocredito Centrale, to participate and the novelty and scope of the ECO guarantee to the in the first such financing supported by SACE was also extended export credit insurance cover (table 5). responsible for other banks being introduced to the pri- From the World Bank's perspective, syndication was an vate infrastructure market. unqualified success. Syndication achieved the Bank's objec- Though ranked fifth among the reasons for success in tive of mobilizing the necessary foreign currency commer- syndication, the quality of market presentation that was cial bank debt for the project with an overall maturity of achieved on the project-in terms of information memo- twelve years. In so doing, it created an opportunity for thirty- randums and road shows-is widelyacknowledged to have four commercial banks from eight countries to participate set new standards for quality and completeness in the field of project finance and to have transformed the project's TABLE5 image in many eyes.The only negative aspect of such a suc- Reasonsfor successin syndication cessful syndicationis that, in the desire to disappoint no one, (percent) the resulting syndicates are large and fragmented (average Indicative participation per facility is $7.1 million). Such fragmenta- Rank Reason weighting tion givesrise to increased administrative overheads for the I Presenceof the World Bank and novelty 20 facility agents and greater difficulties in managing the vot- of the ECO guarantee 2 Scope ofthe ECO guarantee 20 ing procedures under the project coordination agreement. 3 Markettiming I S 4 Financialand commercialstructure and quality 15 Roleof underwriting of sponsors 5 Arrangergroup and marketpresentation 10 6 Italianmarket underwriting ofthe SACEinsured facility 10 The dilemmafaced by the Hub PowerProject of whether 7 Pricing 5 8 Extended export credit agency insurancecover S to underwrite the commercial bank facilities and then syn- (for commercialrisks) after completion of construcon dicate or move straight to syndicationis one faced by all Total 100 projects. Reasons that support underwriting prior to syn- Source:Survey of arrangers. dication are:

20 FinancingPakistan's Hub PowerProject * The early reassurancegiven to the borrowerand cofi- The most significantbenefit of underwritingthe com- nanciersthat there is sufficientcapacity in the market mercialbank facilitiesfor the projectwas that it savedtime to completethe financing. on the underwritingand launch of the internationaland * The possibility of delaying the tasks associated with domesticequity offers by creatinga higherlevel of confi- syndicationuntil after financialclose, so that they do not dence in an early financialclose. Most participantsin the divertthe arrangerbanks'and borrower'sresources away project,particularly cofinanciers, in hindsightexpressed a from the task of achievingfinancial close. preferencefor the senior debt to have been underwritten Reasonsthat favormoving straight to syndicationare: much sooner, althoughthey recognizedthat its value in * Keepingthe arranger bank group small and therefore advanceof PSEDF I and II being irrevocablycommitted more easilymanaged from a logisticalpoint of view,and and the equityfully underwritten would have been largely less prone to the phenomenonof bowingto the lowest symbolic. commondenominator during negotiation of term sheets and loan documentation. Commercialbank perspectives * The costs saved in not payingunderwriting fees (par- ticularlyif the projecttimetable is liableto slip). Risktranfer. One of the centralachievements of the Hub However,the sheercomplexity of the Hub PowerProject PowerProject is the creationof a contractualframework favoreda smallarranger group. Still, even a five-bankgroup in whichthe commercialrisks normallyassociated with an at times became unwieldy,and the strategyof keeping a independentpower project are transferredto privatelenders smallgroup that did not underwritewas maintained almost and investors.Thus the project achievedone of the gov- to the end. Theneed to reassurethe government,the spon- ernment's and the Bank's earliest and most fundamental sors,the Bank, and the cofinanciersthat sufficientmarket objectivesfor the privatesector initiative: that commercial capacityexisted was satisfied in the summerof 1993through bankfinance and equitycapital be mobilizedwithout direct pre-marketing,on the basis of a short informationmemo- governmentguarantees of debt serviceor return.As a result randum. This market soundingshowed a levelof support the risk matrixused in the Hub PowerProject's bank infor- for the transactionthat accuratelypredicted the eventual mationmemorandum was substantially the same as for an levelof oversubscriptionin 1994. independentpower project in an industrialcountry (except, In project financethe termunderwriting does not always of course,with regardto measuresincluded in the project carrythe samemeaning it maycarry in a corporatefinance structureto mitigateagainst political risks in Pakistan). or capitalmarkets context.From a borrower'sperspective, In some instances investors and limited recourse an underwritingis onlyof value if funds can be disbursed financiersof the projectare takinggreater commercial risks earlierthan would havebeen the case had the facilitybeen than wouldusually apply in an independentpower project syndicated. The conditions precedent to disbursement, in an industrialcountry. For example,the fact that the pro- which are usuallylengthy in project finance,are generally ject is locatedin a relativelyremote regionof a developing the same whether the facilityis underwritten or syndi- countrymakes the commercialjob of managing,resourc- cated. ing, building,supplying, and operatingthe power station In responseto a request fromthe Bank, the Hub Power much greater. No cover is provided to lenders for these Project was underwrittenconditionally on 14 September risks under the ECO guarantee.Conversely, by virtue of 1994by a sixteen-bankgroup comprising the fivearrangers, the ECO guarantee and the WorldBank's credit rating, Fuji Bank, the Long Term Credit Bank of Japan, Dai-Ichi commercialbank lenders to the project enjoyan imputed KangyoBank, DeutscheBank, MediocreditoCentrale, and AAAcredit rating for the paymentobligations for the power six other Italian banks. Syndicationclosed with the same off-taker(Water and PowerDevelopment Authority), which conditionalitysome two weeks later. These conditions prece- wouldbe unusual(though not unknown)for an indepen- dent were not finallyand fully satisfied until 23 January dent powerproject in a developedmarket. The same might 1995, at financialclose. alsobe said ofregulatory and environmentallegislation risks

FinancePlan 21 againstwhich, paradoxically,lenders enjoybetter protec- International commercialbanks' appetite for project tion (through the implementation agreement between financeassets continuesto be strong,so the possibilityof Hubco and the governmentof Pakistan)than they might individualbanks reachingtheir notionalcountry or sector expect in a developedmarket because of the rudimentary limitsshould not be a constrainton the overallfinancing legislationand lackof sufficientcase lawin Pakistanin these ofprivate infrastructure projects in Pakistanor other coun- areas. tries where such partial risk coverage is made available. Because it provides subordinated debt, the PSEDF Whether participatingin ECO guarantee facilitieswould enhancessubstantially the loan cover ratios on the senior causebanks to reach their limitsfor projectsin a particu- debt and, in so doing,mitigates the effectsof any increased lar countrymore slowly than participatingin an exportcredit commercialrisks that arisefrom the project'slocation. More agency-insuredfacility or an IFC B loan, for example,has recent and smallerindependent power projects in Pakistan not yet been fullytested. Overall, however,export credit have been successfullyunderwritten and syndicatedin the agencyinsurance and other forms of politicalrisk cover commercialbank market without a tranche of PSEDF- are likelyto be exhaustedfor privateinfrastructure projects subordinated debt and so with lower cover ratios. This in a countrybefore commercialbank market capacityfor process of subsequent projects progressivelypushing out the underlyingcommercial risks. the envelopeof risk transfer to the privatesector can also be seen in project agreements,induding the implementa- Strategyformulation. The formulation of a banking tion agreement, in the trend toward graduallyreducing strategy-includingthe appointmentof arrangersand deci- levels of politicalrisk coveragebeing required by banks, sions on the timing of underwritingand syndicationand and in the trend for export credit agenciesto reduce the theirmethods of implementation-is, properly,the respon- extent of commercialrisk coveragethey provide after com- sibilityof the privatesponsors of the project.Nonetheless, pletion of construction.In the early 1990sPakistan was these decisionsmust necessarilybe made in consultation unable to accessany uncoveredfinance from international withthe respectivecofinanciers, including the WorldBank, banks other than short-termtrade finance;since 1995 there that provideguarantee or insurancesupport for the com- have been severalexamples of internationalbanks being mercialbank facilities. prepared to commit uncovered longer-termfacilities for Sincethis wasthe first time that it had participated,as projectsin Pakistan. guarantor,in a limitedrecourse project financing, the Bank wantedto be moreclosely involved in formulatingand imple- Assetallocation.Banks participating in the project'sECO mentingthe bankingstrategy than wouldnormally be the guaranteefacility have, as expected,not booked their par- case.The fewinstances when the Hub projectsponsors or, ticipationagainst Pakistan (inthe senseof directexposure particularly,the Bank acted unilaterallyin approaching to Pakistansovereign risk), but have booked it againstthe potentiallenders and underwritersserved only to highlight WorldBank. However,the cover provided by the ECO the crucialimportance of all thoseinvolved adhering to an guarantee does not entirely eliminate lenders' concerns agreedstrategy. about the project's location(see the sectionon risk trans- fer, above).In practice,banks are recordinga notionalcoun- Counter-indemnities.Despite the extensivesecurity pack- try exposure against each loan that enjoys partial risk age that was created for lenders' and cofinanciers' pro- coverage(that is, politicalrisk coverageonly) whether the tection-particularlywith respect to governmentobligations partialrisk coverageis providedby an ECO guaranteeor and the WorldBank and JEXIM's subrogation rights as an export credit agencyinsurance policy.There are, for guarantorsof the ECO and JEXIM guarantee facilities- example,some banks that, havingparticipated in morethan Bankpolicy obliged the governmentto enter intoa counter- one independent power project in Pakistan, have ruled indemnity with the Bank. The principle of out participatingin any more for the time being,with or nondiscriminationbetween cofinanciersmeant that par- without the benefit of an ECO guarantee. allelcounter-indemnities (for political risks) were also given

22 FinancingPakistan's Hub PowerProject to JEXIM, the three export credit agencies, and the The diverse currencies of denomination of the PSEDF Commonwealth Development Corporation. Several cofi- (and some senior) facilities caused particular problems. nanciers would not have required a counter-indemnity had In an extreme case, one of the PSEDF facilitieswas sized the Bank not received one; and, in fact, have not gener- in dollars, drawn in yen, and applied to meet ECU expen- ally required them on subsequent projects supported by diture. The hedging of these exposures was an additional an ECO guarantee. cost burden for the project. International competitive bidding or tied procurement Structural Issues rules generallydo not take sufficient account of associ- ated costs inherent in a project financing-for exam- The PSEDF ple, interest during construction-that need to be funded. The government of Pakistan, not the underlying cofi- Assessments of the PSEDF by the parties involved in the nancier contributors to the PSEDF, faces limited recourse Hub Power Project found that its best features were: exposure to the Hub Power Project. * Longer maturity finance than can be secured from com- * A PSEDF administrator that is state-owned (such as mercial sources. At twenty-three years, the PSEDF's the NDFC) may suffer from potential conflicts of inter- maturity is nearly twice that of the ECO guarantee and est when negotiating with a borrower, if the borrower is other commercial bank facilities (twelve years). relying on the state for measures to protect its assets or * The National Development Finance Corporation's revenue stream from financial loss. (NDFC) ability to onlend on a limited recourse basis. * The introduction of variable rate funding after comple- * The PSEDF's ability to fund up to 30 percent of pro- tion of construction of PSEDF H is an unwelcome dilu- ject costs. tion of the rationale for the PSEDF (namely, offering * Available funding, for the most part, at a fixed interest long-term fixed-rate funding not otherwise available to rate. private enterprises in developing markets). * Subordination creating additional risk cover for providers Whereas an increase in the size of the ECO or JEXLM of senior term debt. guarantee facility could have substituted for some of the * Institutional development (see the section on institu- PSEDF in the finance plan, the reverse was not the case tional development, below). because the ratio of inflexible finance (that is, the PSEDF * The PSEDF II standby facility, provided by the Bank and export credit agencies) to flexible finance (all other and JEXIM, is an untied and flexible form of finance. sources) was close to its practical limit, given the pattern The worst features were cited as: of procurement. From the point of view of overall funding * Facilities are complicated to establish because of the flexibility,the Hub Power Project is slightly heavy on the three-step lending route needed to advance loans from PSEDF and light on the ECO and JEXLMguarantee facil- the Bank (and other cofinanciers) first to the govern- ities. Because of the tradeoff between an increased PSEDF ment of Pakistan, then to the NDFC, and finally from contribution to the finance plan (extending the average loan the NDFC to the Hub project. Responsibility for man- maturity) and a decreased ECO guarantee facility (reduc- aging this process and associated documentation was ing the flexibilityof disbursement of the available finance) diffused among many parties. the Hub Power Project is close to its maximum use of the * Administration of the eight facilities within the PSEDF PSEDF. is complicated and resource-intensivefor lender, admin- An alternative deployment of the PSEDF facility and istrator (the NDFC), and borrower. Implementation of ECO (or JEXM) guarantee facility in a finance plan, and draw-downs was in some instances subject to delay and one that exploits their respective strengths, would be to time-consuming documentation. use the ECO guarantee facility(in parallel with export credit * Inflexible currency of denomination: loans often did not agency and other term debt) preferentially to fund con- match the currency of expenditure that was to be funded. struction expenditure and the PSEDF to refinance the pro-

Finance Plan 23 ject after construction was completed. Such a finance plan Some eighteen months were spent negotiating and was developed forJamaica's Rockfort Private Power Project, amending the implementation agreement and a further six albeit without the deployment of an ECO guarantee. This months negotiating the ECO guarantee document on the approach is suited to much smaller projects than the Hub project. To the extent that adoption of a standardized start- Power Project where the constraint on availability of term ing point for these documents is possible, significant sav- construction finance is not so pressing. ings should be possible on the time required to implement The World Bank is also considering a reverse structure future projects. The experience of the Lal Pir power pro- in which the PSEDF finances construction expenditure and ject in Pakistan, which reached financial close within about an ECO guarantee commercial term facility (bank or bond four months of the Hub project, supports this observa- issue) takes out the PSEDF at completion of construction, tion. The Lal Pir project used the implementation agree- in a refinancing. Both structures highlight ways in which ment and JEXIM guarantee documents from the Hub the PSEDF has potential flexibility. project with only minor amendments.

ECOandJEXIM guarantee facilities Exportcredit agency-insured facilities

Assessments of the ECO and JEXIM guarantee facilities The basic export credit agency insurance policies used on by parties involved in the Hub Power Project found that the Hub Power Project have been in place for some time, their best features were: although thiswas the first time theywere used by COFACE * 100 percent coverage of loan principal. and SACE on a limited recourse infrastructure project. The * The World Bank and JEXIM's involvement as guaran- export credit agencies' cautious approach to participating tors. in a pioneering limited recourse project was evident in the * Absence of rigid conditions on disbursement relating to fact that, despite contractor mobilization in December 1992, procurement of goods and services. the agencies did not make firm commitments until the end * Availabilityin multicurrencytranches (not for the JEXIM of 1993 and early 1994.As with the banks, the export credit guarantee facility). agencies are unequivocal in their admission that the Bank's * Flexibility on first loan repayment date and interest peri- participation was instrumental in their decision to partici- ods (in contrast to export credit agency facilities). pate in the Hub project, given its size and complexity. * Guarantee fees paid annually. The export credit agencies' acceptance of a portion of The worst features were cited as: commercialrisk after completion of construction is an impor- * Lack of interest cover (this coverwill be availablein sub- tant difference between these and the ECO and JEXIM sequent IBRD guarantees). guarantees. Otherwise, the guarantees seek to achieve the * Call period of up to thirteen months and seven days. same objective, political risk cover, although in slightlydif- * Poor readability of the guarantee document. ferent ways. The ECO and JEXIM guarantees list the indi- * Requirement for counter-indemnity. vidual circumstances under which the guarantee may be The absence of interest cover under the ECO andJEXIM called. By contrast, the export credit agency documenta- guarantees increased the funding requirement of the pro- tion, being by tradition more of an insurance policy,describes ject by roughly $20 million, reflecting the cash allocated to the insured risks. The somewhat vaguer wording of the the guarantee reserve account and consequential increases export credit agency insurance policy is said to favor the in net interest during construction. A further $15 million insured party (the lenders) where precedent can be invoked. was added to the funding requirement by virtue of an anal- The provisionby COFACE and SACE of extended insur- ogous account, the rupee markup account, being required ance cover for commercial risks post-construction was cited by the rupee facilitybanks. Interest coveragehas since been by the arrangers (see table 5) and Hub project participants added to the scope of the ECO guarantee program and as one of the reasons for the highly successful syndication will be available for future projects. of the commercial bank facilities. In hindsight, however, it

24 FinancingPakistan's Hub PowerProject is likelythat syndicationwould still have been oversubscribed Tothe extentthat paymentof exportcredit agency insur- (althoughto a lesserdegree) had the exportcredit agency ancepremiums is front-ended(rather than amortizedover coverbeen restrictedto politicalrisks. The decision to request the term of the loan)-which is often the case and was on extended insurancecover from the export credit agencies the Hub PowerProject-an unwelcomeconsequence is reflectedthe inevitablenervousness about banking market an increasein the project's funding requirement, further reactionthat accompaniesany pioneering and, particularly, magnifiedby the need to fund consequentinterest during large financing.On subsequentprojects export credit agen- construction.Guarantee fees on the ECO and JEXIMguar- cieshave, on the whole,expected the privatesector to bear antee facilitiesare paid annuallyin advanceover the term progressivelymore and ideallyall the commercialrisks-a of the loan and do not give rise to an increased funding policy strongly supported by the Commonwealth requirement. Export credit agencyinsurance premiums DevelopmentCorporation, COFACE, and otherHub Power includedin the fundingrequirement of the Hub projectare Project cofinanciers.Some exportcredit agenciesthat did about $40 million;ECO and JEX[M guarantee fees paid not participatein the Hub projectare morewilling to accept during constructionare, in aggregate,about $6 million. commercialrisks in additionto politicalrisks. Althoughthe export credit agenciesprovide Hub pro- A second important differencebetween the ECO and ject lenders with partial cover for commercialrisks after JEXIM guaranteesand export credit agencycover is the completionof construction,their counter-indemnities with less than 100 percent cover on loan principalprovided by the governmentof Pakistan are similarto the ECO and the agencies' insurance policies.There are at least three JEXIM guaranteefacility counter-indemnities that cover ways the portion of loan principalthat is not coveredfor politicalrisks only.For these purposes, the export credit political risks can be addressed on a project. First, the agencyindemnities are the same as the ECO and JEXIM bank that has the benefit of the exportcredit agency insur- guarantee facilities and Commonwealth Development ancepolicy can accept this exposureand makebalance sheet Corporationindemnities. provisionsaccordingly. Second, the risk can be shifted to One consequenceof the multipleand occasionallycom- the supplier whose equipment is being financed by the peting objectivesof the PSEDF, the ECO guaranteepro- export credit agency-insuredfacility. Third, the borrower gram,and the exportcredit agencieswas that the sources can arrange supplementarysecurity, typically cash collat- of bilateralfunding for the project did not match particu- eral.In the case of the Hub PowerProject, supplementary larlyclosely the procurementsupply sources under the con- securitywas used for the SACEinsured facility and at least structioncontract (table6). one of the other mechanismswas used for each of the As a direct result of their participationin the Hub pro- other export credit agencyfacilities. ject, COFACEand SACEhave developedspecialized pro- The need to cover a 10 percent uncoveredportion of ject financegroups to act as a focus and resourcebase for the SACEinsured facilityincreased the project's funding future transactions.The experienceof the project and of requirementby about $20 million,reflecting the cash allo- other recent major private infrastructureproject financ- cated to the relevantcollateral account and consequential ingshas alsoincreased collaboration between export credit increasesin net interest during construction.The higher agencies,including sharing specialist advice to minimize financingcosts that this incurredwere, in fact, largelyoff- costs.The effects of greaterconfidence through these efforts set by the subsidiesprovided by MediocreditoCentrale to willbe increasinglyapparent in comingyears. the interest rate payableby the Hub projecton the SACE insured facilityUnder the export credit agencyinsurance Politicalrisk cover policies,interest is coveredto the sameextent as loan prin- cipal,so no further reserve accountswere required, as was Where lender aversionto host-countrypolitical risk is a the case with the guarantee reserveaccount for the ECO key issue underlyingthe financeplan, as in the case of the and JE=M guarantee facilities (and the rupee markup Hub PowerProject, the main obstacleto achievingfinan- accountfor the rupee facility). cial closeis the limitedmarket capacity for this risk and, as

FinancePlan 25 TABLE6 Bilateral fundingand procurement (US$ million equivalent) Supplier-mobilizedfinance Procurement Export JEXIM Country supply creditagency PSEDF guaranteed Total

France 194 45 35 - 80 Italy 382 195 45 - 240 Japan 377 86 256 120 462

Total 953a 326 336b 1200 782 a. Total turnkey contract price includingcharges for customs duties, ncome taxes, and variousminor adjustmentsis $989 million. b. ncludes base and standby facilities. a result, the availability of sufficient finance. This simple Averageloan maturities may also be extended within the fact lay behind the creation of the PSEDF and the appli- limit of a fixed overall maturity by adopting annuity or other cation of the ECO and JEXIM guarantees to the project. back-ended repayment profiles. In private infrastructure Two mitigating measures are available to projects to projects, which generally favor leveled tariff profiles, annu- reduce the required funding: phasing construction so that ities are best suited and are commonly available to projects early generation of revenues can partly fund later con- in developed markets. However, this would require guar- struction costs (in the extreme case, splitting the project antor and insurer (that is, the World Bank, JEXIM, and into two or more phases) and drawing equity finance ahead export credit agencies) as well as lender acceptance of of debt to reduce interest during construction. The Hub extended average maturities. Power Project used both measures. With regard to the draw- If export credit agencies are reluctant to extend cover ing of equity finance ahead of debt, a more usual arrange- beyond twelve years, this may open the way for the World ment is for equity and debt financing to be drawn down pro Bank (under its guarantee program) and other cofinanciers rata. to cover the later maturities beyond those covered by the A second constraint on the availabilityof sufficient polit- agencies or an IFC B loan. Such cover could be within the ical risk cover is the term of the cover. When the commer- context of a single commercial bank facility.However, this cial contracts (Hubco's implementation agreement with the arrangement would not substitute for an ECO guarantee government, power purchase agreement with the Water and facility that covered the period during which loan dis- Power Development Authority, and fuel supply agreement bursements are made, to the extent that the finance plan with Pakistan State Oil) underlying a project are of a much still required a flexible untied "sweeper" facility to com- longer term than the available finance-thirty years in the pensate for the rigiditiesof export credit agencyand PSEDF case of the Hub project-the term of the political risk cover modes of finance. Such an arrangement might, through a dictates the term of financeunless some other limit is reached parallel cofinancing, alsobe used to encourage export credit in the banking market (such as the term over which banks agencies to extend maturities of cover for infrastructure can access funds). Maturities of fifteen to eighteen years projects. and beyond for independent power projects in developed Despite the work that went into structuring the imple- markets have been secured from commercial banks, and it mentation agreement and ECO and JEX1M guarantees, is likelythat had the ECO andJEXIM guarantees and export some banks declined to participate in the syndication of the credit agency insurance policies had terms of that order, the Hub Power Project because they felt that it did not offer a banking market would have responded with longer than a political risk environment comparable to one enjoyed by an twelve-year term for the Hub project (although perhaps independent power producer in, for example, Europe or with less oversubscription). However, OECD consensus North America. Furthermore, a number of well-known pro- rules ultimately limit maturities for export credit agencies. ject finance banks declined to participate simply by virtue

26 FinancingPakistan's Hub PowerProject of the project's location,notwithstanding the ECO guar- might be very difficultto achieve,however. Export credit antee, or because all arranging roles were already allo- agenciesare knownto be highlyskeptical of the feasibility cated. Many top project finance banks did participate, of generalharmonization, although some are prepared to however. explore it further through the Berne Union and other The nervous reaction by some banks may be partly channels. explained by the perception that there is a class of com- Whicheverway it is attempted, the key issues to be mercial risks inherent in a project, such as the Hub pro- addressedin harmonizingdocumentation will be the need ject, simply by virtue of its location (see the section on for: bank perspectives, above). Moreover,these banks may * Export creditagencies to move to 100percent coverof believethat suchrisks cannotbe addressedby an ECO or principaland interest. JEXIM guaranteeor exportcredit agencyinsurance policy * The Bankto moveto coverinterest as well as principal because they are not, in essence,political risks. The best for politicalrisks (alreadyimplemented for subsequent mitigationfor these risks is to have strong, experienced, projects). and well-regardedproject sponsorsand operators. * Export creditagencies to acceptannual payment of guar- antee fees and insurancepremiums. Harmonizationof documentation * Exportcredit agencies to accepta greaterelement of the soft costs associatedwith procurementas eligiblecosts. The ECO and JEXIM guaranteefacilities use an identical * Exportcredit agencies to adopt the Bank'sflexible posi- formof guaranteeon the Hub PowerProject. Each export tion on issuessuch as first repaymentdate and interest credit agencyuses its traditionalform of insurancepolicy. periods. Thus four forms of documentationfor politicalrisk cover * Uniform policiesregarding call mechanismsand tim- were deployedon the project. The first step in any move ing, partialcallability, and accelerability. towardharmonization of documentationought logically to If there are insurmountabledifficulties in harmonizing be among the export credit agencies.The need for such documentation,an alternativeapproach would be for the coordinationhas become a perennial topic of discussion Bank to be the primaryguarantor and for export credit at emergingmarket and project finance conferences,and agenciesto participateon a risk-sharingbasis to the extent there are signsthat a consensusin favorof harmonization of their exportingcontractor's requirements.A borrower is being achieved, although initiallyon bilateralbases in wouldthen require only a singleguarantee for all its com- which the agencies agree on common policiesbetween mercialbank facilitiesthat enjoypolitical risk cover,and it themselves. wouldbe up to the Bankto enter into risk-sharingagree- Betweenthe exportcredit agencies and the WorldBank, ments with the relevant agencies.A common guarantee there is clearlya need for the Bankto try to increaseaccep- involvingthe Bankcould not providecommercial risk cov- tance of its politicalrisk guarantee.A suitableoccasion for erage for borrowers,which would be seen as an advantage attemptingthis mightbe a commercialbank facility in which by most export credit agencies. an agencyinsures the earlymaturities and the Bankthe later maturities.An analogousarrangement has been success- Guidelines for Future Projects fully implemented through ECO guarantees applied to financingsfor the YangzhouThermal Power Project in China Financeplan objectives and the Leyte-Luzon Geothermal Power Project in the Philippines. Thegoal of anyfinance plan for a privateinfrastructure pro- A more ambitiousroute would be to attempt general ject is to achievethe lowest tariff to the customer.There harmonizationof export credit agencyand Bankpolitical are twomain routes by which this objectivemay be achieved: riskguarantees.Theprizeisconsiderableintermsofreduced maximizinggearing and ensuring access to the longest cost and time in arrangingcofinancings. Such an outcome possiblematurity finance. Market or policyconstraints ulti-

FinancePlan 27 matelylimit how far a projectmay go alongeither route. It giventhe project's size, location and novelty,and timingcon- willgenerally also be the objectiveof the host government straints.The largenumber of potentialsources of commer- to maximizerisk transfer to the private sector. cial term debt finance indicateswhat may be possiblein this area,although political risk coveris generallythe limit- Gearing.Since debt is cheaperthan equity,maximizing ing factoron the overallavailability of finance. gearingwill lower the overallcost of fundingfor a project. A project must be highlydeveloped contractually and Independentpower projects are typically financed with gear- particularlyfrom the point of viewof risk allocationbefore ings rangingfrom 75:25to as high as 95:5, depending on it can be tendered meaningfullyamong competing sources the project's contractualstructure and the nature of risks ofcommercial term debt finance.The tradeoff between the that fall insidethe project "fence."Globally, the averageis increasedcost of arrangingan underwriting,the timeframe about 80:20. over which the underwritingis expectedto remain valid, The Hub PowerProject lies at the lowerend ofthe range and the requirementfor evidencethat sufficientfinance for two reasons. First, minimumlevels of equity of 20 to will be available,will always be specificto a project's cir- 25percent were specified by thegovernment and the Bank. cumstances.The value of an underwritingto a borroweris Second,the availability of sufficientdebt finance, or at least directlylinked to the extentthat the termsheet and agree- politicalrisk insurance cover, proved more of a constraint mentsunderlying the project(all of whichsupport the under- onthe financeplan than the availability of equity.The expe- writing)are developed in detail. rienceof a greatershortage of debt than equityis becom- ing increasinglycommon among project sponsorsin Risktransfer The envelopeof riskthat lieswith the pri- developingmarkets and is not uniqueto the Hub project. vate sectorin infrastructureprojects may be expandedin Thisunderscores the crucialimportance of the ECO guar- twoways. First, as a resultof increasedexperience and the anteeprogram in assistingprivate sector projects. marketconfidence that flowsfrom it, the privatesector willbe morewilling to acceptrisk or to priceit morefinely Loanmaturity. Through a combinationof seniordebt Second,the processof evolutionarychange may be accel- andthe PSEDF,the Hub projectachieved a weighted aver- eratedby use of competitionto "test the envelope."The ageoverall maturity (sixteen years) comparable to that of recentemergence in the internationalcommercial bank independentpower projects in developedmarkets. As far marketof a limitedwillingness to lend to privateinfra- as averageloan maturity is concerned,the projectis below structureprojects in Pakistanwithout political risk cover normsfor developedmarkets because of its straight-line frombilateral or multilateralsources (whether from a B repaymentprofiles. The principal constraint on stretching loan,guarantee, or insurancepolicy) is an indication of how maturities,overall and average-for example, by adopting quicklythe marketenvelope can move. annuityrepayment profiles-is reluctanceon the part of politicalrisk guarantorsand insurersto acceptthe longer Avoidanceoffragmentation. Asecondary objective is avoid- exposure.Export credit agencies and the WorldBank are anceof financeplan fragmentation,with the predictable largelyresponsible for decidingwhether developing mar- qualificationthat forlarger projects there may be fewalter- kets shouldbe able to accessannuity and otherlonger nativesto theassembly of a multi-cofinancierpackage. Even averagematurity debt repayment profiles available to sim- splittinga projectinto several phases may not reducefrag- ilarprojects in developedmarkets. mentationand complexity,but shouldbe considered. TheWorld Bank may be responsiblefor fragmentation Competition.Athird general way to minimizecosts in pro- becauseof itsdesire to limitits exposure, demonstrate addi- ject financeis the sameas elsewhere-namely,to procure tionality,and mobilizemulti-cofinancier-supported facili- undercompetitive conditions wherever possible. However, ties.The implications of fragmentation liemore in the impact theextent to which this principle maybe applied wil inevitably on developmentcosts and the timetaken to reachfinan- dependon the degreeof potentialoversupply of finance, cialclose than in the long-term cost of finance for the project.

28 FinancingPakistan's Hub Power Project The marketperforms best undercompetition, but mean- be tested furtherin subsequentprojects, particularly in rela- ingfulcompetition between equipment suppliers that takes tion to the averageand overallmaturity of loans. account of the true cost of their respectiveexport credit agencyfacilities (that is, their impact on the eventualtar- ThePSEDF iff) may not be possibleat the time procurementdecisions are made. Moreover,project sponsors may selectsuppliers The PSEDF's main role is as a source of long-term,low- based on criteriathat do not maximizeassociated export cost, and, ideally,fixed-rate funding; and, to the extent credit agencycover. that it is available to a project, its use should be maxi- Theproblem is further compoundedwhen exportcredit mized.In the form deployedon the Hub PowerProject, it agencycover for a particularcountry is limitedin any case, introduces a number of restrictions to the finance plan or when a project wishesto accessa significantportion of that do not sit comfortablywith either the philosophyof the cover availablefrom a particularagency. The duty of fixedprice turnkeycontracting or build-own-operatepro- export credit agencieswill remain to their exporters,and jects.However, these problems can be (andin the Hub pro- theymayreducetheircommitmenttoasingleprojectrather ject were) overcome, albeit with some difficulty and than see it sterilized(that is, committedbut undrawn)by consequentialdelay. It is stronglyadvised that the effects project noveltyor complexitythat causes a projectto take of these restrictions be anticipated before the procure- yearsto bring to financialclose. ment plan or the financeplan for a project is finalized. The main restrictionsrelate to procurement.There are ECO guarantee program two waysthat these restrictionscan be overcome.First, it is importantthat the Bankbe ableto refinanceeligible pro- The main roles of an ECO guarantee in the financeplan curement that has alreadybeen funded (perhaps under are to: mobilizationfinance), thus avoidingany loss of available * Supplement availablepolitical risk cover in terms of finance for the project through delaysin reachingfinan- amount and maturity. cial close.Second, project output costs (ratherthan input * Providea flexibleform of financethat compensatesfor costs), such as the electricitytariff charged by the power the restrictions that apply to the export credit station,may be subject to internationalcompetitive bid- agency-supportedand direct cofinancier(for example, ding(rather than the underlyingprocurement), which opens the PSEDF) forms of financein terms of fundingsoft the way for Bank financing of all costs (soft and hard) costs (such as interest during construction),providing duringconstruction or for refinancingafter completion of standbyfinance, and currencyof denomination. construction(as in the case of Jamaica's RockfortPower In fulfillingthe first of these roles,the Bank has a diffi- Project). cult balancingact to performbetween encouragingexport The lack of use of the PSEDF in most of the energy credit agenciesand other cofinanciersto participatein the projectsthat have reachedfinancial close in Pakistan sub- financingand, as always,avoiding crowding them out.Apart sequent to the Hub PowerProject is in large part due to from strivingfor the best balance between ECO guaran- the procurementrestrictions that apply to its availability. tee and exportcredit agency participation in a project,there The optimalmix of the PSEDF and the ECO guarantee are clearbenefits to devisingstructures in whichthese facil- facilityis one that achievesthe lowest output tariff from ities complementone another (for example,in terms of the project (thatis, the lowestcost of finance)while retain- maturities, risk coverage,and documentationsimplifica- ing sufficientflexibility within the matrix of sources and tion). The objectiveshould be to achieveterms for com- applicationsof financesuch that the overallproject finance mercialbank financethat more orless match those available plan is workable,including in relationto standbyfinance. fromthe samesources in developedmarkets for similarpri- Deploymentof these modes of financein alternativeand vate infrastructureprojects. This market envelopeshould equallycomplementary structures is also possible.

FinancePlan 29

Project Development

T he sponsorsmade their first significantinvestment The implementationof a generalprivate power initia- in developingthe Hub PowerProject in April1988, tive by the governmentalso required that, in parallelwith when they initiateda detailedfeasibility study. The the project's development,institutions be establishedin originsof the project,however, can be traced back as far as Pakistanthat would have roles reachingfar beyondthose 1985,to the announcementby the governmentof Pakistan of simplysupporting implementation of the Hub project. of an initiativeto encourageprivate participation in power Theseinduded private power cellswithin the Ministryof generation.Construction of the stationbegan in December Water and Power, the Water and Power Development 1992 on the basis of mobilizationfinance. The project's Authority, and the National Development Finance financepackage became irrevocably committed in September Corporation (or NDFC; see the section on institutional 1994, by which time the project had sufferedtwo events causing significantslippage in its timetable:the Gulf war TABLE7 (1990-91) and a Pakistancourt rulingon the applicability Keyevents and activities in projectdevelopment of ShariahLaw to the paymentof interest(1991-92). Year Extent Workingfrom these key dates and allowingfor the time 1987 Sponsorssubmit proposal Initialsite is selected lost throughthese and other interveningevents, the period 1988 Govemmentissues letter of intentto projectsponsors of active developmentof the project is estimated at five Detailedfeasibility study is completed years. In elapsed time, however-from first involvement Bankapproves the PSEDF of the sponsors inlearly 1987 until financial close in January Ministryof Water andPower's Private Power Cell is established 1995-it is nearer eightyears. The key eventsin the devel- 1989 I pmplementaronagreement between the govemment and Hubco andpower purchaseagreement between WAPDA and Hubco opment ofthe projectare summarizedin table7. Appendix arenegotiated and initaled 2 containsa more detailed chronology NationalDevelopment Finance Corporabon's Private Energy The Hub Power Project's history is not simplyabout Disionis established the developmentof aroet1990 Fuelsupply agreement between Pakistan State Oil and Hubcois the development of a project, but about giving life to an negooiated entirepolicy initiative by the governmentof Pakistanand Re-tenderofturbine island is effected the WorldBank. In mostother countries that haveattempted 1991 Constructioncontract is signed such a fundamental reform-inviting large-scale private Arrangerbanks are mandated investment in what had hitherto been an exclusivelypub- ECOprogram isapproved by the Bank lic industry-the reform had been preceded by the enact- 1992 Mobilizationfinance is arranged Constructionisstarted ment of enabling legislation. In the case of the Hub project 1993 Commercialbank and ECO guarantee term sheets are signed the implementation agreement assumed the role of this leg- Commercialbank due diligence is completed islation, so the project sponsors and the Bank became 1994 Commercialbank debt isunderwritten and syndicated inextricably involved in the complex discussions that such Equityis underwritten and placed structuralreform involves.The implementationagreement Bankand JEXIM approve guarantee faciliies took more than eighteen months to develop. 1995 Rnancialclose

31 development,below). Given that the fuelsupplier (Pakistan cause an even greater delay than this rule would suggest, State Oil),power purchaser (Water and PowerDevelopment particularlyproject novelty and force majeure. Such was Authority),and administratorof the PSEDF (the NDFC) the case with the Hub PowerProject. are all public entities, the projectwas and is essentiallya Independentpower projects in developedmarkets may partnershipbetween the publicand private sectors. take one to two yearsto bring to financialclose; in devel- The speed with which subsequent independentpower opingmarkets a pattern isemerging of these projectsrequir- projectshave reachedfinancial dose in Pakistanowes much ingat least twoto three years,although the distributionof to their use of documentationand institutionscreated for developmentperiods is skewedin favorof longer than aver- the Hub projectand the knowledgeand experiencegained age periods.In takingeight yearsin elapsed time to reach by those who worked on it. financialclose, the Hub PowerProject is at the upper end of lengthydevelopment periods-but it is not unique. If Market Experience onlythe activeperiod of projectdevelopment on the Hub projectis considered(that is, fiveyears), the projectlies in Despite the considerablethought and effort that may go the third quartile. into their preparation,projects seldomif ever progressin Recentexamples of independentpower projects taking accordancewith their original (or even revised) timeta- longer than averageto reach financialclose can be found bles. A typicalproject developmentoffice will have many inAustralia,Indonesia, and the United Kingdom(over four out-of-datetimetables filed away,induding somethat had yearsin each case), and in Turkey.In Turkeythe elapsed useful livesof perhapsonly a fewweeks. There are several time for project developmentfor the Birecikproject was reasons project developmenttimetables depart from their similar to that of the Hub project. Tollroads appear to originalschedule: havethe greatestpotential for marathondevelopment peri- * Insufficientallowance in the originaltimetable for the ods, with examplesof projects taking fiveto ten years to lack of timely availabilityof independent parties, for reach financialclose found in the Australia,the United whom the projectwill be just one of manyresponsibili- Kingdom,the United States, and a number of developing ties. countries.Projects are as vulnerableto timetableslippage * Underestimationof the committedtime required,exdu- in industrialcountries as in developingcountries. siveof other responsibilities. The projectsthat achievethe shortestdevelopment peri- * Decisionmakingprocesses and timeframesof indepen- ods, fromthe point of viewof privatesponsors, are usually dent partiesbeing poorly understood or defined,or both, those that have been well defined technicallyand com- at the time the timetablewas constructed. merciallyby the host governmentor authoritybefore the * Inexperienceof the partiesinvolved with respect to the procedurefor awardinga concessionbegins (whether award principlesand practicesof privateinfrastructure devel- is by a competitiveor negotiated process).The particular opment, with the project often having to move at the vulnerabilityof independentpower projects to slippageis speed of the slowest. due to the numberof parties and contractsnormally required * Projectnovelty and complexity,particularly if the pro- to bringthem to fruition. ject requires new legislation,institutions, or forms of The Hub PowerProject, for example,requires five core documentation. commercialcontracts: the implementationagreement, power * Changesin project scope. purchaseagreement, fuel supplyagreement, turnkey con- * Forcemajeure. structioncontract, and operationsand maintenanceagree- Allprojects suffer from these problemsto someextent. ment. Independent power projects seldom require fewer For people workingin project development,a useful rule and oftenrequire more than fivecore contracts. Toll bridges of thumb for determiningtheir likelyimpact on an out- and roads,by contrast,usually require only three core con- turn project developmenttimetable is often to doublethe tracts (a concessionagreement, turnkey constructioncon- originaltime estimate. In fact, some of these factors can tract, and operations and maintenanceagreement); their

32 FinancingPakistan's Hub PowerProject tendency to delay often owes more to choice of routing pared habituallyon a "fast track" basis,particularly as the and issuesof rightsof way.The Hub projectultimately had project'sdevelopment costs begin to mount.The basicflaw more than 200 project agreementsand documents.Most, in allfast-track timetables is that theyfail to take intoaccount however, have only minor commercialsignificance, and a realisticexpectation of delayscaused by the manyexter- are due to the limited recourse nature of the financing, nal influencesreferred to above.A minimalprovision of which requires all aspects of a project to be defined with floatmeans that out-turnevents are more likelyto diverge legal clarityprior to disbursementof funds. Independent from a timetable,with the consequent risk of demotivat- powerprojects carriedout in industrialcountries and of a ing all concemedunless a degree of project development sizecomparable to the Hub projectwould have fewer(say, pragmatism, if not resilience, is shown by the project's 100 to 150) final agreementsand documents.The addi- sponsors. tionaldocumentation required for the Hub projectderives Despitethe limitedvalue of projectdevelopment timeta- mainlyfrom its more complicatedfinance plan. A list of bles as predictorsof when financialclose will occur, their the more than fortyprincipal project agreements and doc- preparationand revisionremains an important discipline uments supportingthe project appearsin appendix3. that helps define componentproject developmentactivi- One importantfeature of developingprivate, as opposed ties and identifypotential criticalpaths, milestones,and to public, infrastructureprojects is the largelysequential decisionpoints. It also helps sponsorsdetermine the level nature of the keytechnical, commercial, and financialtasks of resourcesrequired and establishpriorities. that have to be performed. For example,negotiation of the core commercial contracts supporting the project (notably, power purchase and fuel supply agreements and the turnkey constructioncontract) cannot occur until the Infrastructureassets that are financed and built in the public sec- project is defined technically,and finance cannot be torand subsequently privatized, either individually orcollectively, arrangeduntil the projectis definedcommercially This avoidthe problemof commercialarrangements and project- sequentialpattem ofactivitiesisaeyreasondevebased (thatis, limited recourse) finance arrangements deiaying sequential pattern of activities is a key reason develop- thestart of construction. ment periods for private infrastructureprojects are mea- Althoughthis route maynot be suitableor availablefor sured in years. largerprojects and for hostgovernmentsthat have limited finan- An important lesson that can be drawn about project cialresources, there are obvious attractions incompleting nego- developmenttimetables is that project developmentdoes tiationsof implementationagreements, power purchase not easilylend itself to classicalproject management tech- agreements,and the likeand in arranging project-based finance inparallel with project construction. Inthese circumstances the nques, which assume that the projectmanagement team technicaildefinition ofthe project, tendering of procurement, and has a levelof controlover eventsthat is normallynot avail- mobilizationof public sector finance lie on the criticalpath to able.This accountsfor an aphorismof project development: thestart of construction. "it willtake as long as it takes." Thedisadvantages ofthis route lie in the poortrack record For peopleand institutionsunfamiliar with privatesec- ofpublic sector construction projects relative to their private sec- torproje,theexperience of havingonly par- tor alternativesinterms of capitalcosts and the timeto com- tiarpontroject develothe pm jent,timetableisunnervingand plete,and the loss of linkage between the responsibilityto build andthe responsibilityto operate the facility. The use of govern- frustrating.It can often lead to sponsorswho experienceit ment-securedmobilization finance to hastenthe startof con- for the firsttime losingpatience and confidenceand pulling struction,as in the caseof the Hub PowerProject, is reallya out of projects when they find that financialclose is fore- special,hybrid approach based partly on projectfinance and cast to be, say,nine months away-year after year. (See partlyon privatization.However, a key issue underlying such a box 3 for a brief discussionof public sector development projectmay still be the availabilityof sufficient public financial projects,thatare later privatized.) resources,even if the requirementfor mobilization finance is modestand represents only a smallportion of the total cost of Paradoxically,this frustration with timetable slippage completingthe project. leadsto revisedproject development timetables being pre-

ProjectDevelopment 33 TimetableAnalysis meetto resolveoutstanding project issues took months of planning,and such meetingswere inevitably subject to A timetableprepared for the Hub PowerProject in 1987 rescheduling,often on shortnotice. showed about eighteenmonths to financialclose. If Theprincipal events of forcemajeure that affectedthe anotherproject of similarsize and complexitywere to be projectwere the Gulfwar (1990-91)and a Pakistancourt developedin Pakistantoday, in the wakeof the Hub's rulingon the applicabilityof ShariahLaw to the payment success,it could probablyachieve this speedof imple- of interest(1991-92). Some loss of continuitywas also mentation.However, the significantdelays that the Hub causedby the need to reconstitutethe constructioncon- projectexperienced relative to this idealizedtimetable sortiumin 1990after two members resigned; and by peri- are attributableentirely to the factorsdescribed in the odic changesin governmentin Pakistan,of whichthere previoussection-in particular,project novelty,com- wereseveral between 1987 and 1995. plexity,and forcemajeure. Tosome extent, each componentactivity in the Hub Theproject's novelty is well illustrated by the more than PowerProject found itself at one timeor anotheron the sixteen"firsts" that theproject achieved (see the executive criticalpath for the project'sdevelopment. Nonetheless, summary)and by the need to developcore contractual there are undoubtedlysome activities that, in retrospect, agreementsfrom first principles. tooktoo longto complete-evenallowing for the factors With a complexfinance plan came many parties and referredto above(table 8). attendantlogistical difficulties. A goodexample of these Finally,when consideringthe Hub Power Project werethe problemsthe projectfaced in schedulingcofi- timetableaccount must be takenof a minorthough impor- nanciermeetings, which required the attendanceof nofewer tant factor-namely,its multinational nature. Project oper- than fortyrepresentatives of governments,their agencies, ationswere conducted in fiveregions: contractors,sponsors, banks, and advisers. Scheduling sev- * In Pakistan,where project business was carried out in eralconsecutive working days during which all parties could Islamabad(location of the headquarters for the

TABLE8 Principalactivities subject to delay Activity Comment Implementatonagreement Noveltyof the documentfor all concemed(lack of precedents) Intermittentavailability of advisersto the govemmentof Pakistan Tumkeyconstructon contract price Consortiumreconstituted following expiration of validityof originalbid price Powerpurchase agreement Inexperienceof hostauthorities, intermittent availability of advisersto hostauthorities, and resource overheadfor all partiescaused by transparencyof tariffprocess Complexindexation methodology PrivateSector Energy Development Fund (PSEDF) PSEDFI took five years(in elapsedtime) to achieveits $375 milliontarget because of diversityof contrib- utorsand complexity of documentabon.PSEDF II, by contrast,took one yearto reach$197 million Implementationof internationalcompetitive bidding procedures Foreigncurrency senior debt Fiveof the seniorloan faclities required political risk guarantees (ECO, JEXIM, and the threeexport credit agencyfacilities). At onebme or anothereach found itself on the project'scritical path since approvalprocedures for eachcofinancier were different,unsynchronized, and generally untested in relationto a limitedrecourse infrastructure financing Periodiclapsing of indicatonsof supportfrom cofinancierscompounded the problems Cofinancierdocumentation Requiredthree cofinanciers meeting over a nine-monthperiod to agreeon intercreditorprinciples Finalexport credit agency documentation was, in somecases, not availableuntil financial close Conditionsprecedent Difficultyin procuringrelevant documents in a satisfactoryform from somany parties in Pakistanand abroad Localfinance Tookthree years(in elapsedtime) Landtitle acquisition Diversityof landownership and unavailability of reliableland records

34 Financing Pakistan's Hub Power Project government of Pakistan), Lahore (the Water and Power the subsequent five years, when they had become available, Development Authority), Karachi (Pakistan State Oil was significant in terms of the efficiency of project and the financial center of the country), and Quetta (the development. government of Balochistan). As discussed, the various constraints and force majeure * In Washington, D.C., location of the World Bank and events prolonged the time taken to complete each of the the principal project management office. project's three main activitygroups (technical, commercial, * In Tokyo,Japan, home of the construction consortium and financial). Moreover, the sequential pattern of devel- leader. opment activitiesin the project clearlyextended the timetable * In London, United Kingdom, home of one of the main of principal project activitiesbeyond expectations (table 9). sponsors of the project and the center from which most Beyond these factors, the publicity attendant on such a of the finance was arranged. novel project approach likely lengthened the public's per- * In Jeddah, Saudi Arabia, home of the other main pro- ception of the project's timeframe (box 4). ject sponsor. Furthermore,the constructionconsortium included com- SponsorGroup Formation panies from France and Italy. The project's finance plan includes contributions from all seven locations. Two classic dilemmas arise during project development: A complex and novel project that is also multiparty and what is the optimum size of a project, and what is the opti- geographicallyspread out creates special difficultiesin terms mum number of project sponsors? There are no universal of coordinating activities-even with project offices that answers to these questions. Still, the issues that lie behind are effectively staffed twenty-four hours a day, as was often them are worth discussing because of their relevance to the case on the Hub project. the Hub Power Project and all private sector projects. The key operational issues that arise with any multina- tional endeavor are travel times, nonoverlapping time zones, nonsynchronous working weeks and public holidays, and Box 4 Effects of publicity language difficulties. If it can be said that project finance One of the reasonsthe Hub PowerProject is widelyperceived has been made possible on a wide scale by the advent of to havetaken a longtime to developis that it attractedpublicity PC-based spreadsheet programs, then it can be argued that andan associated level of expectation, particularly inPakistan, from multinational projects such as the Hub Power Project have an earlystage. Moreover, as one yearmerged into another, the timeframelengthened in people's minds. By the timethe project reachedfinancial close, it wasfar from being a new story-and between 1987-89, the initial development period for the for manyobservers there wasa strongsense of dejavu. Hub project-during which fax machines were generally The publicitysurrounding the Hub projectwas inevitable not available or were, for a time, illegal in Pakistan-and givenits pioneering nature, the WorldBank's participation, and the project'ssize and location.However, much of the publicity TABLE9 resultedfrom the numerousconference speeches given and Timetable of project activities pressannouncements issued by allthose involved(the govern- ment, its agencies,the sponsors,and the Bank)as each mile- stonein project development was reached 1987 l Predevelopmentwork Still,press exposure prior to a project'sfinancial close has 1988 l Feasibilitystudy certainimportant benefits. One isthat the riskoffailure becomes 1989-9 i 3 Commercialcontract negotiaions and public,and the potentialloss of reputationof those involved consortiumformation Insitutionaldevelopment (including the PSEDF) increasestheir determination to see the enterprisethrough to andrealization ofECO guarantee program a successfulconclusion. Another potential plus is that progres- 1992 i Arrangementofmobilization finance and start siveand positive publicity can stimulate lender and investor inter- ofconstuction est.Afterfinancial close, the Hubprojectwas unanimously voted 1993-94 2 Arrangementofpermanent finance "Dealof the Year"by leadingspecialist financial journals. Total 8

ProjectDevelopment 35 Projectsize ciallyin circumstanceswhere availabilityof financeis a key projectconstraint. Argumentsthat favorlarger projectsinclude: A host governmentmay prefer a large sponsoringgroup to * Economiesof scalerelative to deliveredunit output price. dilute project ownership, avoiding an important infra- * Increased commitmentof resources and streamlined structureasset being ownedby a singleforeign party. decisionmakingby the host government,reflecting the Arguments that favor small project sponsor groups project's macroeconomicsignificance. inmcude: * Need for new capacityin one increment. * Simplerchain of commandin project management. Argumentsthat favorsmaller projects include: * Less potentialfor overlappingor conflictinginterests. * Lowerdevelopment costs (in absoluteterms). * Timesavedbynothavingto seekconsensus among share- * Fewercounterparties, reduced complexity,and poten- holdersbefore decisionscan be made. tiallygreater speed. Relativelyfew companies have the financialstrength, resources, * Smallerfunding requirement and correspondinglygreater and experienceto undertakemajor capitalprojects alone. flexibility. Oilcompanies are the best exampleof the kind of enterprise Many of the benefits of both large and small projects that canpursue such ventures. Within the privateinfrastruc- are,in principle,accessible to largeprojects comprising sev- ture marketthere are even fewerexamples of companiesof eral phases, each separately financed and constructed. sufficientsize to do this, and most are relativenewcomers Whether a large project is better split into two or more with limitedexperience in developingcountries. As a result phases is often determined by economic and technical the pattern that is emerginginternationally is of infrastruc- considerations.Still, the advantagesof smallerand simpler ture projectsbeing undertaken as jointventure-sponsored (phased) financeplans shouldbe recognized. orlimited recourse-financed enterprises or, commonly,both. In this context it is worth recappinghow dramatically Projectsponsor group the marketfor privateinfrastructure projects, and for inde- pendentpower projects in particular,has changedsince the Project sponsors may favor large groups for several inceptionof the Hub PowerProject. When Xenel sought reasons: an electricutility partner for the Hub project in 1988 and * Assemblyof complementaryskills that maynot be avail- issued an international invitation, there were only four able in a singlesponsoring company (for example,the respondents.Of these, only National Power (then in the classic combination of a utility company,contractor, formof BritishElectricity International) had extensiveexpe- and localpartner). rienceworking in developingcountries. Were such an invi- * Reduced downsiderisk exposure for individualspon- tationto be issuedtoday, between 50 and 100electric utility sors through the sharingof developmentcosts. companieswould respond, although it would still be the * Increased probabilityof overall corporate success by casethat fewwould have much operational experience out- spreadinglimitedresources among several projects rather side their own domesticmarkets. than concentratingall on one. The developmentof the Hub project has spanned the * Opportunitiesfor off-balancesheet financing for share- transformationof the privateinfrastructure market from a holders with equityinterests below certain percentage rare curiosityoutside a handfulof industrialcountries such thresholds(depending on jurisdiction). as the United States and the United Kingdom (in 1987), * Sharedownership among the variousparties with a com- to mainstreampolicy for manycountries both industrialand mercial interest in the project (for example,fuel sup- developing(in 1997).During this periodtrends towardpri- plier, contractors,off-takers, and so on). vatizationand utility deregulationhave created a market * Psychologicalsecurity from collectivecorporate action. for "global"utility companies. * Greater ease in arrangingfinance as a result of an inter- The core Hub PowerProject sponsor group comprised nationallydiverse group of sponsors.This applies espe- fivecompanies: Xenel, National Power, Mitsui, Ishikawajima-

36 FinancingPakistan's Hub PowerProject Harima Heavy Industries, and K&M.The choice of so developmentcosts for largerprojects tend to be more in largea groupreflected, to varyingdegrees, the influenceon the 3 to 4 percent range than the 2 to 3 percent range. the sponsors' thinking of the above rationales for larger Exceptionsto this rulearise where the concessionfor a pro- groups. Collectively,the project sponsorsformed a project ject is tenderedby the host governmentor authorityon the developmentcompany (HRPG) that, byvirtue of beinginde- basis of a well-definedtechnical and commercialspecifi- pendently resourced and managed,was able to mitigate cation, in whichcase lowerfigures (around the 1 to 2 per- much of the inertiaand dilutionof managementresources cent range)would be expected. that comesfrom multiparty project sponsorship. Only in the Developmentcosts are defined as costs that are borne latter stagesof the project'sdevelopment, following its pri- by the private sponsorsof a project and that are sunk in vatization and increasedcommitment to overseasinvest- tryingto reachfinancial close (that is, they willbe incurred ment, did it becomepossible for NationalPower to play a whether the project reaches financialclose or not). They leading (rather than supporting) commercialrole in the do not includethe costs borne by other parties suchas the project and its financing. host government or the Bank, nor do they encompass Asthe marketfor internationalindependent power pro- pre-financialdose constructioncosts where these are funded jects matures and host governments,financiers, and pro- by separatelysecured mobilization finance. ject sponsors become more experienced, it willbecome The Hub PowerProject development cost figureof 3.6 increasinglypossible for smallergroups or even individual percent,while toward the upper end of the market range, companiesto bear the costs and risks of developingpro- is not exceptional.Given the gestationperiod of the pro- jects as large and complexas the Hub PowerProject. Still, ject and its high degree of novelty,it is surprisingthat the the issue of eventualownership of the projectwill remain figureis not higher.What is inevitablyeye-catching with all dependent on the manyfactors referred to above,such as large projectsis the absolutesum that the sponsors must the desire of sponsorsto keep the project'sdebt off their put at risk in order to create a project. balancesheets. Few corporationsin the world can afford to take gam- The creationof a dedicatedproject development com- bles of this magnitudeon their own, particularlywhen his- pany focused solelyon the developmentof the Hub pro- tory shows that the probability of success in project ject, and withan identitydistinct from those of the sponsors developmentcan be low.The primaryincentive for a pro- and contractors,was found by the cofinanciersand banks ject sponsorto shoulderfront-end risk is the possibilityof to be a practicalarrangement that greatlyassisted their com- creatinga muchlarger investment opportunity at fnancial municationswith the project.Despite the protracteddevel- close-typically six to ten times the equitycapital invest- opment phase, with its intermittentperiods of lowactivity, ment in developingthe project.A secondincentive is, gen- the sponsors managed through HRPG to achievea sur- erally,the possibilityof earning a higher return on the. prisinglyhigh degree of continuityof personnelas, indeed, developmentperiod investment if the projectis successful. did the WorldBank. This continuitywas crucial to the pro- Projectdevelopment costs can generally be brokendown ject's success. into the standard categories,although allocationamong thesecategories can vary significantly by project. The devel- Development Costsand Risks opment costs for the Hub Power Project are shown in table 10. The largestelement of the project development Project developmentcosts are usually2 to 4 percent of a budget waslegal costs, which is typical of a project-financed project's fundingrequirement. This rule appearsto hold independent power project. Moreover,given that almost for most privateinfrastructure projects (power, transport, all 200project agreements and documentshad to be nego- water) and, surprisingly,for projectsof all sizes.Thus, as tiated and drafted from scratch, this came as no surprise. faras developmentcosts are concerned,there do not appear Hub project sponsorsended up paying for the servicesof to be any economiesof scale in sponsoringlarger projects. fourteenlegal firms,most of which were acting for banks In fact, if anything,there are diseconomiesof scalein that and cofinanciersrather than for Hubco.

ProjectDevelopment 37 The questionof resourcemobilization is central to the ers. The total personneldeployed in developingthe Hub setting of a developmentbudget. Resourcemobilization is Power Project, based on estimates made by the relevant determined by a project's management in light of four participants,is shownin table 11. considerations: Thetotal estimated personnel deployed in reachingfinan- * The probabilityof the project proceedingsuccessfully cial close (225 person-years)can be summarizedin broad to financialclose, as comparedwith other projectsthat categoriesas follows:the governmentand its agenciesand the sponsorsmay be pursuingat the time. advisers(25 percent),sponsors and their advisers(50 per- * Theminimum critical mass of expertiseneeded to ensure cent), the WorldBank (10percent), and other cofinanciers, that each project agreementis properlystructured and leadingbanks (arrangers),and their advisers(15 percent). that issuesthat are interactivebetween different agree- These figuresand those provided in table 11 exdude the ments are properlyhandled. personnel deployedby the contractor in bidding,negoti- * A pattern of workloadthat may vary dramaticallyand ating, and assistingwith mobilizingexport credit agency unpredictablythroughout the developmentperiod. support for the project and all activitiesrelated to con- * The tradeoffsbetween the flexibilityof havingadvisers struction. who can be mobilized and demobilized accordingto Severaltasks cut acrossthe aboveheadings and are worth workload,the cost of suchconsultants, and the risks of highlightingseparately because of their relevanceto future having knowledgeof criticalagreements held outside projects.These were developmentof the implementation the sponsormanagement group. agreement(ten person-years),development of the power The compromiseoften struck betweenthese consider- purchaseagreement (fifteen person-years),and creation ationsis to assemblea core managementteam comprising, of the PSEDF (twentyperson-years). say,six to twelveexperts dedicatedor seconded from the An equallyintensive though often underestimated activ- sponsororganizations and a supportingcast of legal,tech- ityis the buildingand runningof spreadsheet financial mod- nical,and financialadvisers. Good advisersmay not be easy elsto supportthe projectdevelopment effort. This activity to retain, however,so individualadvisers must be reserved consumedabout twelveperson-years of resources spread for a projecteven though they maybe requiredto workonly acrossthe sponsors,financial advisers, arrangers, the NDFC, intermittently.This wasthe approachadopted by the Hub and the Waterand PowerDevelopment Authority. The Hub PowerProject. PowerProject models are amongthe largestand mostcom- The costs and resources of the project's sponsors are plicated ever built for a projectfinancing, and are capable onlypart of the picture.Each counterparty to an agreement TABLEII has to staffnegotiations and allocatemanagement time. In Personneldeployments fact, the managementof advisersis as much an issue for (person-years) counterpartiesas it is for project sponsors,and it wasnot Source Length alwayspossible for the governmentof Pakistanand itsagen- Ministryof Waterand Power (including Private Power Cell) 10 ciesto relyon the timelyavailability and continuityof advis- Waterand Power Development Authority 15 PakistanState Oil 5 TABLE10 NationalDevelopment Finance Corporation I0 Othergovemment agenciesa 5 Breakdownof developmentcosts WorldBank 25 (percent) Arrangers 25 Costcategory Share Cofinanciers 10 Projectsponsors and project managers 75 Legal 35 Lawyers 25 Financial 25 Financialadvisers 10 Technical IS Technicaladvisers 5 Projectmanagement is Otheradvisers 5 Cofinancieradvisers and due diligence 10 Total 225 Total______Total 100 a.State Bank of Pakistan, Central Board of Revenue, Ministry ofFinance, and so on.

38 Financing Pakistan's Hub Power Project ofhandling fifteen loan facilitiesand expendituresin seven An important financialrisk that the governmenthad to currencies.Most banks that participatedin the projectand addressduring the developmentperiod was of potentialvari- that wanted to run the model had to buy new,high-pow- ations to the power tariff payable under the power pur- ered computersto do so. chaseagreement. To cover this risk,the letter of intent and The sponsors were not alone in bearing development the subsequentlyexpanded tariff agreement(1989) con- risks; the governmentalso bore substantialrisks. In grant- tained two fundamentalprotections for the government. ing the Hub PowerProject an exclusivityperiod in which First, the permittedbase-case rate of return on equity for to develop and finance the project, the governmentwas the projectwas limitedto an 18 percent annualdollar real relyingon the sponsors to complete the assignmentsuc- internalrate ofreturn. Second,that cost elementsof the tar- cessfullyand as rapidlyas possible.The stakeswere made iffcould only increase in linewith agreed indices and exchange higherby the government'sdecision to make the project rate movements,such that the tariff's real cost to the gov- its sole prototypeindependent powerproducer, so that all emient of Pakistan remained essentially unchanged. of the government'sattention and that of its agenciesand Furthermore,an open-bookapproach was agreedbetween of the WorldBank could be focused(along with the spon- the government,the sponsors,and the Bank suchthat the sors' efforts) on making the project a success.The stakes entire cost structureof the projectwas transparent. became higher still because of the government'ssupport This strategycould be sustained onlyto the extent that for mobilizationfinance. the project's sponsorswere able to hold the cost base of Given the size of the project relative to the resources the project constant in real terms. Relativeto the turnkey availablewithin the governmentand the Bank, no other constructioncontract, this proved difficult over such an approachwas viable.The decisionto form a queue of pro- extended developmentperiod, with two consequences: jectsbehind the Hub project alreadyappears to have been * The originalconsortium that had bid a price in 1988 vindicatedby the speedwith which some of these projects- was unable to maintain it beyond December 1989, at whichcollectively add up to an additional1,400 megawatts whichtime financial dose wasstill forecast to be at least of private power capacity-followed the Hub project to nine months away.As a result two of the consortium financialclose during 1995 and the first quarter of 1996. members(Toshiba and KumagaiGumi) departed, and The frustrations felt by the governmentand others with their responsibilitieshad to be rebid. having to wait until 1995 to see so much effort come to * Having reconstituted the construction consortium in fruition may be partly offsetby the thought that between 1990-91, even the revalidatedprice had onlya limited April 1988 (the date of issue of the letter of intent to the validityperiod, as is normalin contracting.This validity Hub project) and March 1996 some 2,700 megawattsof period expiredin December 1992,at which time finan- independentpowerproducercapacitywasbroughtto finan- cial close was still forecast to be at least nine months cial close,representing an averageof about 330 megawatts away.Rather than face an additionalrebid, the decision (net) a year-an impressiveachievement. wasmade by the government,the sponsors,and the Bank As the prototype project for Pakistan's independent to mobilizethe contractor based on a limited down- powerproducer program, the Hub PowerProject inevitably paymentin December 1992. bore a large measure of one-timedevelopment costs and In hindsight, the expectation that so much front-end risks that subsequent projectshave avoidedand willcon- developmentwork on agreements,institutions, and modes tinue to be able to avoid.Although no mechanismexists of financecould be completedand financialclose achieved wherebythese one-time costs and riskscan be sharedamong withinthe typicalvalidity period of a turnkey price offer subsequentprojects, it generallyhas not deterred sponsors wasoverly optimistic. In the end the onlyway so manypar- from tryingto achievethe distinctionof being "the first," alleland interrelatedactivities could be brought to a suc- whether in Pakistan or any other country.This sponsor cessfulconclusion was for mobilizationfinance to be used enthusiasmreflects the degreeof competitionamong spon- to removethe issueof turnkey price validity (and therefore, sors in the market for private infrastructureprojects. that ofthe powerpurchase agreement tariff) from the critical

Project Development 39 path to financialclose (althoughmobilization finance had chairmanshipof these meetingsand increasedwith the num- its own maturitydeadline that maintainedpressure on all ber of cofinanciersparticipating in the project.Moreover, partiesto reach financialdose). The support for mobiliza- giventhat the Bank wasalready a major contributorto the tion financerepresented a secondimportant financialrisk developmentof the energysector in Pakistan,this rolehad that had to be addressedby the government(see the dis- an inherentrationale. cussionon mobilizationfinance, above). The Bank was also, quite naturally,cast in the role of The adoptionof an open-bookapproach to the develop- confidanteto the governmentof Pakistan.On occasionthis ment of the projectcost structureand tariff inevitablyintro- roleextended to beingan "honest broker" to help resolve duced a significantoverhead for the projectdevelopment issuesbetween the governmentand the project's sponsors effort,particularlyin terms of the resourcesrequired to ensure and banks. Both roles were invaluablegiven that the pro- that allparties involved were apprised of the project'sdetailed ject under developmentwas pioneering and the wholesec- economicsand financeplan at each step alongthe wayto toral initiativewas new for the host government.Without financialdose. The alternativeand morecommon approach the Bank's contribution as unofficialleader of the cofi- of contractingon the basisof a singleindusive tariff figure, nanciersand confidanteof the government,development with no transparencyoffered to the purchaser,is preferred. of the projectcould have presentedinsurmountable prob- This,in fact, is the basis on whichsubsequent independent lems to the governmentand the sponsors. powerprojects in Pakistanhave contracted. Such roles are, however,resource intensive and rapidly The more one considersthe resourcesthat had to be becomefull-time-which presents a problemgiven the other mobilizedto completethe developmentof the Hub Power dutiesthat managersin the relevantBank regional depart- Project-the risks borne and costs incurred-the more ment may have. The figurefor Bank resourcesdeployed remarkableit seems that fatiguedid not set in amongthe on the Hub project-twenty-fiveperson-years-makes the government,the sponsors,the Bank, and the cofinanciers. point forcefullyThis is equivalentto fivepeople working And hereinlies the essentialreason that the projectreached full-timefor the durationof the activedevelopment period. financialclose: none ofthe keyparticipants wavered in their Withoutadditional resources that can be dedicatedto a determinationto seeit through.The importance to the gov- project until it reaches financialclose, it is possiblethat ernment of Pakistanand the sponsorsof the WorldBank's attemptsto balancethe managementdemands of a project commitmentin this regard shouldnot be underestimated. withwidersectoraldevelopmentwill compromise both. Thus Allthe project'sparticipants should be commendedfor their the Bank'sleadership role would best be formalized,prob- staminaand patience. ablythrough its appointmentas chairmanof a cofinanciers steeringcommittee. Although the Bankmay be reluctantto World Bank Perspectives assumeleadership of the cofinancierand governmentliai- son aspectsof a project,it has a unique capacityto shoul- Leadershiprole der these responsibilities.Moreover, the Bank's suitability for this role is universallyendorsed by the governmentof It wasnatural at the Hub PowerProject's cofinanciers meet- Pakistan,the cofinanciers,the banks, and the sponsorsof ings that the Bank should assume the role of chairman. the Hub Power Project. In situationswhere the Bank is Cofinanciersare accustomedto the Bank showingleader- proactive,the developmenttime of projectswill generally ship in such circumstances,particularly where (as in the be shorterand, therefore,the flowof projectsgreater. case of the Hub project) the venture was a "first" for the countryconcerned. Indeed, for cofinanciermeetings held Projectownership early in the developmentperiod, the invitationsto attend had to be issuedby the Bank. Thoughdescribed as a privatesector project, the Hub Power The pressure on the Bank to assume a coordinating Project is to a large extent a partnershipbetween the pri- role on behalf of cofinanciers grew naturally from its vate and public sectors.After all, the principalinput and

40 FinancingPakistan's Hub PowerProject outputcontracts (the fuel supply and powerpurchase agree- financing,and implementationof an independent power ments) are with publicentities whose performance is guar- project in a developing country.Finally, the project has anteed by the govemment through the implementation demonstratedthat, complexas they are, suchdeals can be agreement. Moreover,all forms of debt finance for the done. project are either provided by internationalor Pakistani Furthermore,in lightof the developmentexperience of public agencies or partly guaranteed by such. A similar this and other independentpower projects, it is possibleto pattern can be expected for such "private"infrastructure identifya numberof specificrecommendations that should projectsin manyother countrieswith which the Bank has help reduce the risk of futureprojects encountering delays an activeprogram. The Bank and others involvedin such or failing: projects share a similardilemma: "Whose project is this?" * Timespent by a host governmentprior to invitingpri- Host governments,project sponsors, and the Bankwilleach vate sector proposalsin defining the legislativeenvi- legitimatelyfeel ownershipover the enterprise,although ronment, clarifyingwhat is required from the project joint ownershipmay reassurelenders and investors. technicallyand commercially,and framingits objectives withinthe context of what can be financedin the pri- Mobilizationfinance vate sectorwill be more than savedby the time finan- cial close is reached. If the powerpurchaser is a public One of the Bank's most important contributionsto short- entitythen, at a minimum,the hostgovernment's respon- eningthe timetableto the start of constructionwas its sup- sibilitiesshould include specifying available sites, plant port for and participation (through the PSEDF) in size,fuel type, mode of plant operation,and provision mobilizationfinance. In circumstanceswhere institutional of grid interconnectionfacilities. The more such para- developmentforms an integralpart of the project devel- meters are defined prior to invitation,the greateris the opment effort, as in the Hub Power Project, or where potential for meaningfulcompetition between sponsor other factorsgive rise to unacceptabledelays in the start of groups and the shorter should be subsequent project construction,mobilization finance is one of the few miti- implementationperiods. gatingmeasures availableto the host governmentand the * Efforts shouldbe made to postpone asmany nonessen- Bank.One constraint,however, is thatin suchcircumstances tial activitiesas possibleuntil after financialclose. The importantcommercial issues must be settledprior to deploy- logicalextension of this point is to split the project into ment of mobilizationfinance unless the host government two or more phases,each with a separatefinance plan is prepared to completeconstruction of the projectin the and its own financialclose. Any consequentialreduc- public sector,if necessary.In the case of the Hub project, tions in the complexityof a givenphase's financeplan all majorcommercial agreements were signed prior to mobi- shouldyield time savingsin reachingthe initial financial lizationof the contractor. close,albeit at the probable cost of a temporaryloss of economiesof scalein output tariff. Guidelines for Future Projects * Debt syndicationis the most obviousfinancing activity that can usuallybe deferred until after financialclose. The successfulfinancial close of the Hub PowerProject will Generally,financial close shouldbe soughton the basis help shorten the time needed to develop future indepen- of an unconditionalunderwriting against which the pro- dent powerprojects in whichthe Bankis involvedfor three ject may begin loan draw-downs. reasons.First, muchof the commercial,financial, and legal * Sponsor resources should be matched to the nature experienceembodied in the project documentationis of a and scaleof the project.Moreover, these resourcesmust general,not project-specific,nature. Second,a largegroup be focusedon the project at hand by assemblinga ded- of individualsspread acrossnumerous institutionsinside icated team whoseprimary responsibility is to bringthe and outsidePakistan now havefirst-hand knowledge of the projectto fruition.A dedicatedteam supported by strong principlesand practices of project development,project projectsponsors is best of all.

ProjectDevelopment 41 * Theneed to allocatededicated personnel applies equally 100percent of the loan principaland interest), and are to the Bank,which must be preparedto freeup or retain expectedto requirethe least fragmentedfinance plan. resourcesfor this purpose. For planningpurposes, the Thechosen single currency of bid shouldbe one in which Bank shouldexpect to assignthe equivalentof twopeo- debt and equityfunding for projectsis commonlydenom- ple more or less full-timeto a project in which it pro- inated and in whichinterest rates are readilyhedged. poses to participate,and the commitmentshould be for * The powerpurchase agreement tariff should ideallybe the duration of the developmentperiod. denominated or determined in the same currency as * The fewerproject participantsthe better,which applies the projectfunding, or in a currencythat maybe hedged asmuch to contractcounterparties, contractors, and cofi- againstthe currencyof funding. nanciersas to membersof the sponsorgroup. * A suitable host government institutional framework * The temptation to believe in "fast track" timetables shouldbe in placeand sufficientadministrative resources shouldbe resisted. mobilizedto expediteneeded project agreementsand * To achievethe shortestdevelopment timetable, a pro- approvals,prior to commencementof substantialpro- ject should,paradoxically, be configuredto survivea long ject developmentwork. haul to financialclose, whether delays are caused by force * All contractcounterparties should strivefor continuity majeureor other factors.In particular,a project should in the adviserswho provide specializedexpertise, as determinethe levelof cross-partypolitical support within and when required.This issue is particularlyimportant the host country; test sponsors' commitmentto con- if the project entersthe long haul. tribute to project financing;strive to achievecontinuity - Projectswith fragmentedfinance plans would benefit in the keyindividuals responsible for developingthe prin- fromthe creationof a formalcofinanciers steering com- cipal project agreementswithin the host government, mitteeduring their development. The committeewould sponsors,and Bank, and their respectiveadvisers; and be chairedby the Bank. prepare commercialcontracts so that they can survive * Logically,smaller projects shouldhave simpler finance unforeseentimetable slippageswithout requiring rene- plans, althoughthis is not alwaysthe case. Where they gotiation. do and an order of magnitudereduction in complexity e Invitationsissued to turnkey contractors shouldfavor is achievable (for example, through having a single bids that are from smallerrather than multipartycon- PSEDFcofinancing facility or exportcredit agency), sig- sortiums,are denominatedin a singlecurrency, include nificanttimetable savings should be realized.However, exportcredit agency cover in line withthe requirements the numberof agreementsinvolved in suchprojects does of the commercialbanks that will fund the respective not fall as rapidlywith scale of financingas one would facilities(including, for example,political risk coverfor hope.

42 FinancingPakistan's Hub PowerProject Institutional Development

T he institutionalframework to support privatepar- accountthe feedbackreceived from privateinvestors and ticipationin Pakistan'senergy sector evolvedas a the internationalfinancial community. Refinement of the major componentof the work carried out for the frameworkof incentives was also neededto make Pakistan developmentof the Hub PowerProject. In 1988 the gov- internationallycompetitive in attractingfinancial resources erinent of Pakistaninitiated a programto addressmacro- and to integratewith these measuresthe actionstaken by economic constraints and liberalize the economy.The governments to deregulate the economy and increase program,among other actions,required rationalizationof relianceon the privatesector. A newpolicy for privateenergy public expenditures. Budgetary allocationsfor revenue- that integratedall thesemeasures, amendments, and refine- earning public entities were reduced. Investment financ- ments was promulgatedin March 1994.The policyincor- ingfor these enterpriseswas, in the future,to be mobilized porates the originalpolicies introduced in 1988 together through internallygenerated funds and borrowingsfrom with the amendmentsmade since. the domestic and internationalcapital markets. This pro- Thepolicies for the creationof an enablingenvironment gram had a profound impact on the energysector, which for the privatesector have four components:criteria for the historicallyhad accounted for more than 33 percent of consideration of private sector projects by the govern- annual development allocations, since internally gener- ment, fiscaland financialtreatment of private energypro- ated funds and projectedborrowings fell short of the invest- jects, incentivesfor investorsand lenders,and a structure ments needed to meet the forecastdemand. In response, for the agreements,provisions, and facilitiesneeded to safe- the governmentoutlined a strategyfor rationalizing the con- guardthe interestsof the government,lenders, and investors. sumption of energy and increasingthe role of the private sectorin energyto fillthe gap left by the reductionin pub- The PSEDFand the ECO Guarantee lic investments. Facility Thegovernment identified three keyconstraints to mobi- lizingprivate capital: the absence of a policy framework The PSEDF was establishedin 1988 to providefinancing for the privatesector-that is, incentives,fiscal treatment, support to long-gestationenergy projects. The PSEDF repatriation of profits and capital, availabilityof foreign wasto providepartial, long-term subordinated debt financ- exchange,pricing, and so on;the lackof long-termfinance ingfor energyinvestments. The NDFCmanages the PSEDF for projectswith relativelylong gestationperiods and eco- for the governmentof Pakistan.The PSEDFwas structured nomic life; and the inadequacyof the institutionalstruc- to allowfor its possibledetachment from the NDFC when ture for the review,negotiation, and approval of private its staffare fully trained and when projectsthat it has already sectorprojects. financedprovide sufficientrevenue to cover the cost of its An initialframework of incentives to attractprivate invest- operations.As the developmentof projects (includingthe ment intothe energysector was put in placein 1988.During Hub PowerProject) progressed,it became apparent that the negotiationsfor the Hub projectthe governmentrec- subordinatedfinancing would not be adequate to mobi- ognized the need to fine-tunethe frameworkto take into lize the balance of loan finance required, since lenders

43 generally were unwilling to provide sufficient long-term was assigned responsibility for negotiating and adminis- financing without suitable protection from the political risks tering power purchase agreements and integrating the oper- that they perceived to be inherent in the transactions. ations of private power plants within its system. Each of In 1990 the ECO guarantee program was considered these agencies set up new units specifically charged with by the Bank's Board of Directors. The program built on supporting private energy investments. The Ministry of the guarantee aspects of the Bank's B loan program and Water and Power set up the Private Power Cell, the NDFC aimed at using the Bank's partial guarantees to mobilize created the Private Energy Division, and the Water and private finance for public or public-private projects in the Power Development Authority established the Private Bank's lending program. Many private infrastructure pro- Power Organization. jects are being developed and financed on a project finance The Private Power Cell was created in 1988 to provide (that is, limited recourse) basis, whereby a private investor an institution that would evaluate and negotiate private mobilizes debt financing secured primarily or solely on the power projects on behalf of the government. In an effort revenues generated by the project and a legal charge over to streamline the institutional structure for private power, the project's assets. Project revenues, in turn, are often the revised energypolicy of 1994 called for the Private Power based on long-term sales contracts. This concept underlies Cell to be designated as the Private Power and Infrastructure most build-own-operate (BOO) and build-own-operate- Board to function as a single-stop investment window and transfer (BOOT) projects. Based on the emerging trends assume full responsibility, on behalf of the government, in private infrastructure projects, in 1991 the Bank broad- for negotiating all private power investments. The board ened the concept to enable guarantees to support private was so designated in June 1994. commercial financing for private sector projects. The Hub Under PSEDF I the NDFC was designated as the admin- Power Project was the first application of the guarantee to istrator of the PSEDF and created the Private Energy a private infrastructure project. Division specificallyfor this purpose. The division is struc- The ECO guarantee program was reviewed in 1990 tured to allow for its future detachment from the NDFC. and 1992, with certain procedural modifications introduced The division now has a suitable complement of staff com- in the second review based primarily on experience gained prising young professionals who have undergone extensive with the Hub project. In 1994 the Bank replaced the ECO and specialized training, some of it abroad. The division program with a more generalized use of guarantees as a was set up as a self-contained unit responsible for its own mainstream instrument in Bank operations. The main- decisions on the technical and financial viability of pro- streaming of guarantees built on the successful features of jects presented to it for financing, after they have been the ECO program, but at the same time proposed modifi- approved by the Private Power Cell. The Private Energy cations to some governing rules no longer considered nec- Division has successfully undertaken all the pre-construc- essary,primarily to facilitate a broader use of guarantees for tion activities in connection with the appraisal of the Hub limited recourse-financed projects. project. The Water and Power Development Authority organized Institutions in Pakistan the PrivatePower Organization under a managingdirec- tor supported by a general manager, four directors, and six The third set of measures for the promotion of private assistant directors, and with additional specialized support energy involved the creation of institutions for the review, from consultants. The organization's original function was negotiation, and approval of private project proposals. to coordinate all the Water and Power Development Under PSEDF I the Ministry of Water and Power was Authority units involved in load dispatch, system operation, assigned responsibility for reviewing and approving power finance, system planning, and so on, to handle the com- proposals and the Ministry of Petroleum and Natural plex issues of negotiating tariffs and power purchase agree- Resources for reviewing oil and gas and coal development ments, and to outline contractual and technical aspects for proposals. The Water and Power Development Authority the integration of private sector supplies into the Water and

44 FinancingPakistan's Hub Power Project Power DevelopmentAuthority's system. The new policy organizationnow playsa majorrole in the implementation has transferred these functions from the Private Power of the recentlyapproved Power Sector Development Project, Organizationto the PrivatePower and InfrastructureBoard, particularlywith regard to the reorganizationand corpora- which now has sole responsibilityfor them. tizationof the Water and Power DevelopmentAuthority In 1993 the Water and PowerDevelopment Authority intoa holdingcompany with decentralized generation, trans- assigned the Private Power Organizationthe additional mission,and distributionsubsidiaries operating as discrete responsibilityof planning the privatizationof its assets.The autonomousprofit centers.

InstitutionalDevelopment 45

Postscript

T he fourth unit of the Hub PowerProject was com- Currencymovements aside, all base loan facilitieshave pleted three weeks ahead of scheduleon 7 March been drawn substantiallyas envisagedin the financeplan, 1997, and formal completionof the entire station althoughconsiderable difficulty was experiencedin fully complexwas announced,on schedule,on 31 March 1997. usingthe WorldBank's contribution to the PSEDF due to The outputcapacities and efficienciesof allthe unitshas restrictionsthat applyto the applicationof drawings(see proven to be at or above guaranteedlevels, and through- the sectionof project development,above). The standby out theirfirst winter period of operation (1996/97) the com- loan facilitieshave not been drawn,by virtue of the project missionedunits operated at almostfull output. The station's beingcompleted under budget. contributionto the reductionof load sheddingin Pakistan The most significantunderusage of a seniorloan facil- has alreadybeen widelyand publiclyacknowledged. ityhas been the base ECO guaranteefacility which, being The pipelineconnecting the stationto the Piprioil ter- a flexible"sweeper" of costs and currencymismatches, has minal was commissioned in October 1996 and has an ended up being only 75 percent drawn (comparedwith a installedcapacity sufficient for a 2,000megawatt power sta- forecastusage of 90 percentin the financeplan). The export tion. The first of two exportpower lines was commissioned credit-insured and other senior facilitieshave been fully in December 1995,the secondin September1996. drawn.Revenues generated from plant operationsprior to The actual capital cost of completingthe project has completionhave been ahead of the forecastsmade in the been slightlybelow budget-in fact, savingsof about 1 finance plan, to the extent that some twenty-sevenaddi- percent on budget has been achieved,equivalent to $13 tionalunit-weeks of generationwere made availableby the million.At the same time,cross-currency movements have early completionof the second,third, and fourth units. caused the dollarvalue of all loan facilitiesavailable to the The broadlysmooth experienceof managingmonthly project to increase by about $50 million relative to the drawdownsof the fifteen loan facilitiesthat comprisethe originalfinance plan. Muchof this apparentincrease in loan Hub projectfinancing has been greatlyassisted by the invest- availabilityhas been withinthe PSEDF'sJEXIM facilities ment that Hubco and the intercreditoragent (Citibank) and givesrise to a reported underusageof the PSEDF: 85 made in assigningqualified financial analysts and managers, percent drawn comparedwith 100 percent in the finance at the outset,to designand implementa computer-based plan. loan managementand reportingsystem.

47

Appendixes

Appendix I Offshorecommercial bank facilitiessyndicate profiles

Facility ECO JEXIM COFACE MITI SACE ABNAMRO BankNV / / / ANZ GrindlaysBank pic / / BancaNazionale del LavoroSpa-London Branch V Bancodi NapoliInternational SA (Luxembourg)a / Bancodi Napoli Spa-Hong KongBranch I Bankof Scotland / / Bankof Tokyo,Ltd. / / BanqueFrancaise du CommerceExterieur / / BayerischeLandesbank Girozentrale / Centrobanca-BancaCentrale di CreditoPopolare Spa I C'tibankNA / / I CooperatieveCentrale Raiffeisen-Boerenleenbank BA (Rabobank) / / / Crediop-Creditoper le impresee le opere pubblicheSpa / CreditFoncier de Franceand Auxilaire du Credit Foncier de France(jointly and severally)a / / Credit LyonnaisSA / / Dai-lchiKangyo Bank, Limited / / / DaiwaBank, Limited / / DeutscheBank I / . DresdnerBank AG / / / FujiBank, Limited / / / GiroCreditBank Aktiengesellschaft der Sparkassen / I IndustrialBank of Japan,Limited / / / InternatonaleNederlanden Bank NV / / KredietbankNV / LongTerm Credit Bankof Japan,Limited I / / MediocreditoCentrale Spa I / MediocreditoToscano Spa / MeesPiersonNV / / MitsubishiBank, Limited / 1 / MitsubishiTrust and Banking Corporation / / / MitsuiTrust and Banking Co., Ltd. / / / NationalWestminster Bank PLC / / / NorinchukinBank / / / Orix Corporation / RoyalBank of Scotlandpic / I SakuraBank Limited / / / SanwaBank, Limited / / / SBGeneral Leasing (UK) Limited / StandardChartered Bank / / SumitomoBank Limited / / / TokaiBank, Limited / / YasudaTrust & BankingCo. Ltd. / I WestdeutscheLandesbank Girozentrale / / Banksper facility 34 19 7 17 18 a.Appears as a singlebank on thetombstone for thefacilities.

49 Appendix 2 Project chronology

1987 1988 1989 1990 Govemmentof Pakistan July: April: January-December: Initialproposal submitted Letterof intentissued Implementationagreement to govemmentof Pakistan negotafons December: Implementationagreement initialed

Commercialcontracts May: May-August: January-December: January-December: andcorporate development Initialinvitation to bid for Tenderand appointment Powerpurchase agreement Fuelsupply agreement turnkeyconsortium leader of tumkeyconsortium negotiafons negotations Tenderand appointment of plantoperator December: Powerpurchase agreement May-June: initialed Projectoffices opened in Islamabad,Washington, December: andLondon Interimtariff agreement signed

Engineeringand construction October: May-November: May-October: June-December: Initalsite selecton Feasibilitystudy Constructioncontract Internatonalcompetitive negotations biddingfor turbineisland December: December Tumkeypnce validity expires New tumkeyconsortium Institutonaldevelopment November: April: Ministryof Powerand Water's NationalDevelopment Finance PrivatePurchase Cell formed Corporaton'sPrivate Energy Waterand Power Develop- Divisionfoamed mentAuthority (WAPDA) privatepower organizaton formed Other August: Gulfwar starts

Finance April: November: March: March: Initialfinancial review Firstcofinanciers meeting Secondcofinanciers meeting Mobilizationfinance review Preliminaryinformaton World Bankconsiders memorandumissued January-December: ExpandedCofinancing to cofinanciers Discussionswith cofinanciers Operation(ECO) program December: Worid Bankapproves the PrivateSector Energy DevelopmentFund (PSEDF)

50 Financing Pakistan's Hub Power Project 1991 1992 1993 1994 Apnl-November: April-August: January-September: Implementationagreement Implementabonagreement negofatons Bankdue diligenceon development implementationagreement August: Implementationagreement signed November: Supplementaryimplementation November: agreementsigned Mobilizationagreement signed April-November February-September: January-September: September: Power purchaseagreement development Operationsand maintenance Banktechnical and commercial Referencetariff agreementsigned agreementnegotiations contractdue diligence May: Fuelsupply agreement initialed April-August: October: Power purchaseagreement and fuel Indicativetariff agreementsigned May: supplyagreement negotiations Revisedtariff agreement signed November: August: Supplementarycontracts signed October: Power purchaseagreement and fuel Project site acquired supplyagreement signed Shareholdersagreement signed June: Offices in Londonand Washington September: enlarged Operationsand maintenance agreementsigned August: Hubco formed with technicallisting on Karachistock exchange Januory-June: September: September: Constructioncontract negotiations Groundbreaking Siteclearance

July: December: November: Constructioncontract signed Contractor mobilization Foundationlaying commences

June: PrivatePower and Infrastructure Board formed

Februory: December1991 -May: Gulf war ends Appealslodged against FederalShariat court ruling November: FederalShaHat court ruling March: September-December: January-June: February: Firstapplication to the PSEDF Mobilizationfinance arranged Mobilization information Fifth cofinanciersmeeting memorandumprepared ECO guaranteefinalized May: July: SACEcommitment Export credit agencymeeting Arrangersremandated February: Seniordebt term sheet signed May: August: December: Informationmemorandum issued Arranger banksmandated Mobilizationfinance-Istisna facility April: agreementsigned and drawn down PSEDFloan agreement signed; July: December: firstdisbursement COFACEand SACEloans signed ECO programapproved by the Bank May: September: ECO guaranteeterm sheetagreed Seniordebt and equity underwritten Rupeeterm loan signed July: ECO, JEXIM,and MITI loanssigned Third cofinanciersmeeting Project coordinationagreement signed Brefinginformaton memorandum issued Syndicationclosed

October October: Projectcoordination agreement finalized Globaldepository receipts and share issueslaunched November: Fourthcofinanciers meeting November: Word Bank andJEXIM approve guarantee December: facilitiesand further PSEDFfacilities Commonwealth Development Corporaion loan agreementsigned December: Rupeemobilization finance loan RestatedPSEDF loan agreementsigned agreementsigned COFACEand MITI commitments January 1995: Financialclose

Appendixes 51 Appendix3 Principalproject agreements

I. Projectcoordination agreement 2. Definitionsagreement 3 ECOfacility agreement 4. JEXIMfacility agreement S. COFACEfacility agreement and amending letter 6. SACEfacility agreement and amending letter 7. SACEreserve account agreement and SACE reserve account letter and related letters 8. MITI facilityagreement 9. CDC amendingagreement and amended and restated CDC facilityagreement 10. Seniorrupee facility agreement I . PSEDFfacility agreement 12. ECOguarantee agreement 13. JEXIMguarantee agreement 14. Guaranteecoordination agreement IS. Securitytrust deed 16. Compositesecurity agreement 17. Assignmentof insurances 18. Mortgagedeed 19. Escrowagreement 20. Implementationagreement 2 I. Governmentof Pakistanguarantee 22. Governmentof Pakistanapproval letter 23. Constructioncontract 24. Fuelsupply agreement 25. Powerpurchase agreement 26. Operationsand maintenance agreement 27. NationalPower guarantee 28. Consultancyservices agreement and supplemental agreement 29. Raytheonguarantee 30. Consultant'sagreement of warrantyand undertaking 3 i. Supportservices agreement 32. Appointmentletters a. Technicaladvisers b. Insuranceadvisers 33. Exchangerisk insurance letters from StateBank of Paklstan: a. confirmationletter b. in relationto the ECOfacility c. in relationto the JEXIMfarility d. in relationto the MITI facility e. in relationto the CDC facility f. in relationto the COFACEfacility g. in relationto the SACEfacility 34. Govemmentof Balochistanagreement 35. Ansaldohedging agreement 36. Shareholdersagreement (I1992) and novation agreement 37. Shareholdersagreement (I1994) 38. Sponsorsequity agreement 39. Memorandumand articles of associationof the Hub PowerCompany Limited

52 Financing Pakistan's Hub Power Project Appendix4 Projectparticipants

Pakistanministries and agencies Ministryof Waterand Power Ministryof Finance Waterand PowerDevelopment Authority PakistanState Oil StateBank of Pakistan Governmentof Balochistan NationalDevelopment Finance Corporation PrivatePower InfrastructureBoard

Sponsors NationalPower Xenel Industries Mitsui Ishikawajima-HarirnaHeavy Industries K&M Engineering& ConsultingCorp.

Cofinanciers Worid Bank JEXIM CDC COFACE MITI SACE U.S.Agency for intemationalDevelopment Governmentof France Govemmentof Italy

Constructionconsortium Mitsui Ishikawajima-HarimaHeavy Industries Ansaldo CampenonBemard

Plantoperator NationalPower

Principalinternational banks Citibank Arranger Credit Lyonnais Arranger Bankof Tokyo Arranger NatWest Arranger SakuraBank Arranger MediocreditoCentrale SACEjoint coordinator

Localbanks NationalDevelopment Finance Corporaion HabibBank Limited MuslimCommercial Bank Limited NationalBank of Pakistan IndustrialDevelopment Bank of Pakistan Allied BankLimited PakistanIndustrial Credit & InvestmentCompany SaudiPak Industrial & AgriculturalInvestment Company (pvt) Umited UnitedBank Limited

Appendixes 53 Arrangersof mobilizationfinance Al Rajhi IslamicInvestment Company of the Gulf ANZ Grindlays

Equitybrokers DeutscheMorgan Grenfell Globalcoordinator of GDR andshare issue DeutscheBank GDR underwriter West MerchantBank CrosbySecurities JardineFleming Bear,Steams Intemational Limited BearSteams Jahangir Siddiqui Ltd. Consultantsto localequity offer

Advisersto governmentof Pakistanand public bodies Latham& Watkins Legaladvisers to govemmentof Pakistan,Water andPower Development Authority, Pakistan State Oil, andNational Development Finance Corporation PriceWaterhouse Accountingadvisers to govemmentof Pakistan FatehaliW. Vellani& Co. Legaladvisers to NationalDevelopment Finance Corporation

Advisersto sponsors MorganGrenfell & Co. Limited Financialadvisers Linklaters& Paines Legaladvisers in UnitedKingdom HoggInsurance Brokers Insurancebrokers K&MEngineering & ConsultingCorp. Technicaladvisers K&M/Ebasco Owner'sengineer during construction Ford, Rhodes,Robson, Morrow Auditorsto Hubco Arthur Andersen Accountantsin UnitedKingdom Rawlence& Brown Accountantsin UnitedKingdom (for HRPG) Surridge& Beecheno Legaladvisers in Pakistan Ughie Nunzianti Legaladvisers in Italy Slaughterand May U.K. legaladvisers to GDR issue Cleary,Gottlieb, Steen & Hamilton U.S.legal advisers to GDR issue Elvinger,Hos & Prussen Legaladvisers to Hubcoand arrangers in Luxembourg

Advisersto arrangers CliffordChance Legaladvisers in UnitedKingdom Coopers& Lybrand Accountingadvisers (financial model) in UnitedKingdom Stone& Webster Technicaladvisers RichardBarton Consulting Limited Insuranceadvisers Arthur D. Little Hazopconsultants Rizvi,Isa & Company Legaladvisers in Pakstan Chiomentie Associati Legaladvisers in Italy

Advisersto cofinanciers Mitsui,Yasuda, Wani & Maeda Legaladvisers to MITI Adlen& Overy Legaladvisers to JEXIM

54 Financing Pakistan's Hub Power Project Appendix 5 Overview of insurance ofthe start-up date of the projectbeing deferred on account arrangementsduring constructionand of lossof or damageto importedequipment during the operation transitto the projectsite, providedsuch loss or damage is covered(or wouldhave been coveredbut for the exis- In limitedrecourse transactions the insurancecover put in tenceof a deductible)by the Marine Cargoinsurance. placeby the projectis an importantpart ofthe securitytaken * Construction "AllRisks" insurance covers the works by the projectlenders over the physicalassets of the trans- underconstruction on a replacementcost basisuntil han- action and over the revenue stream generated by those doverto the ProjectCompany, and anytemporary works assetsunder variousproject agreements.Accordingly, and and, if the partiesso agree, the contractor's plant and in order to control this part of the collateralin priorityto equipment.Cover continues after handover for the con- any other project party,the lenders take a securityinterest structioncontractor until the end of the defectsliabil- in the insurancecover that the projecthas put in place on ity period specifiedin the constructioncontract. behalf of itself and all other transactionparties. * Construction"All Risks" Delay in Start-upinsurance pro- Since lenders in limited recourse transactionsrely on videscover for the ProjectCompany and the lendersfor the revenue generated by the transactionassets to service the lossof revenuethat the ProjectCompany may incur their debt, and to coverthe project'sfixed and variableoper- asa resultof the start-update ofthe Projectbeing deferred atingcosts and itsprofit, it followsthat the lenderswill require on accountof lossof or damageto the worksunder con- wide-ranginginsurance cover to be a sourceof cash that is struction,provided such loss or damageis covered(or externalto the transactionin the eventthat there is aninsured would have been covered but for the existence of a incidentwhich resultsin a loss of or damageto the trans- deductible)by the Construction"All Risks" insurance. action assets,a reductionin or defermentof theirrevenue- * ThirdParty Liability insurance covers the liabilityof the earningability, or the generationof a liabilityto third parties. projectparties to third partieswith respectto loss of or damageto the propertyof third partiesand injuryto or Limited Recourse-FinancedProjects death of third parties. Duringthe operationphase of a limitedrecourse onshore In the construction phase of a limitedrecourse onshore transactionthe principalinsurances effected annually by transactionthe principalinsurances effected by the project- the ProjectCompany on behalfof itselfand the relevant owning company("the Project Company")on behalf of operationphase parties generally comprise physical dam- itself and the relevant constructionphase project parties age insurance, physicaldamage businessinterruption generallycomprise: insurance,machinery breakdown insurance, machinery * Marine Cargo insurance breakdownbusiness interruption insurance, third party * Marine CargoDelay in Start-upinsurance liabilityinsurance, and insurancesrequired by law. * Construction 'AllRisks" insurance * PhysicalDamage insurance provides cover on a replace- * Construction'All Risks"Delay in Start-upinsurance mentcost basisfor lossof or damageto the projectassets * Third Party Liabilityinsurance that havebeen handed over to the Project Company. * Insurancesrequired by law * PhysicalDamage Business Interruption insurance provides The coverprovided by these insurancescan be outlined coverfor the ProjectCompany's loss of revenue follow- as follows: ingan incident covered by the PhysicalDamage insurance. * MarineCargo insurance customarily covers the imported * MachineryBreakdown insurance provides cover on a equipmenton an "AllRisks" replacement cost basisfrom replacementcost basis for the ProjectCompany for lossor placeof manufactureto the project site. damageto machinery,plant, boilers, and the likeresulting * MarineCargo Delay in Start-upinsurance provides cover frommechanical and electricalbreakdown or derangement. for the ProjectCompany and the lendersfor the lossof * MachineryBreakdown Business Interruption insurance revenuethat the ProjectCompany may incuras a result provides coverfor the Project Company'sloss of rev-

Appendixes 55 enue followingan incidentcovered under the Machinery anceswere placedwith an insurerin the countryor coun- Breakdowninsurance. tries providingthe externalloans or aid. Section 13 of the The constructionand operationphase insurancesare con- NIC Act requires the NIC to reinsure with the Pakistan tracts of utmost good faith; they are expressedfor specific InsuranceCorporation (PIC) the proportionof insurance limits of liability and contain self-insuranceprovisions that it cannot retain for its own account. (deductibles);and their terms and conditionsdefine the Tohelp minimize the lenders'exposureto Pakistancoun- nature and scopeof the cover that they provide. try risk,the governmentof Pakistan agreed to provisions in the implementationagreement whereby Hubco would Public Sector-Financed Projects be exemptedfrom certain of the regulatoryrequirements referableto the constructionphase insurances. Thus Hubco When state entities(or majorprivate corporations) finance wasgiven permission: theircapital investments "On BalanceSheet," they frequendy * to insure the Marine Cargo and Marine Cargo Delayin make different and less wide-ranginginsurance arrange- Start-upinsurances outside Pakistan. ments for suchinvestments. For example,the Construction * to procurereinsurance in the internationalmarkets for 'All Risks"and Third Party Liabilityinsurances are often 100percent of the ConstructionRisk, Construction Risk arrangedby the constructioncontractor, and the Delayin Delayin Start-up,and Third PartyLiability insurances, Start-upand Business Interruption risks are often self-insured. less only the small participationsunderwritten by the The reasonsgiven by state entitiesand majorprivate cor- NIC and the PIC by agreementwith the lenders. porations for adopting,or continuing,such a fundamen- * for directcontractual arrangements, giving Hubco (and tallydifferent insurance strategy vary considerably, but there the lendersby meansof the provisionsof an assignment are increasingsigns that state entitieshave discernedmerit of insurancesagreement) rights to: in insuringmore of theirrisks with commercial insurers than * investthe controlof claimsunder the insuranceswith with their taxpayers,whereas major corporationsare self- the offshorereinsurers. insuringmore riskbecause they are improvingtheir ability * payin currencydirectly to the NIC, the PIC, and the to identifyand managethe risksto which their substantial offshore reinsurers their respective proportionate balance sheets are exposed. sharesof the premiumsreferable to the insurances. In the Hub PowerProject the ProjectCompany (Hubco) * receivedirectly in an offshoreinsurance account the effected,on behalf of itself and all projectparties, the full respective proportionate shares of claims paid by range of constructionphase insurances that are customar- the NIC, the PIC, and the offshorereinsurers. ily required in a limitedrecourse independent power pro- * resolveany disputes under the insurances,or the rein- ducer transaction.The Project Companywill be effecting surances,under a third-partylaw (English). comparableoperation phase insurance cover in due course. The combinedeffect of the consentsgiven by the gov- ernment of Pakistan and the agreements with the NIC Structure of the Principal Construction and the PIC gavethe lenders a direct contractualrelation- Phase Insurances shipwith the offshorereinsurers. Thus the lenderswere put in substantiallythe same positionas they wouldhave been Under the NationalInsurance Corporation Act No. XXII if the insuranceshad been placed directlyoffshore, and of 1976 (the NIC Act),Hubco wasrequired to insure with Hubco wasable to complywith Pakistanlaw and practice. the National Insurance Corporation (NIC) because the Hub PowerProject is defined as "public property,"being Special Temporary Funding a project financed out of externalloans and aid. Section 10 of the NIC Act did, however,give Hubco the abilityto One of the responsibilitiesof the governmentof Pakistan effect the Marine Cargo and the Marine Cargo Delay in pursuant to the terms of the implementationagreement is Start-upinsurances directly offshore, provided these insur- the provisionof specialtemporary funding under a speci-

56 FinancingPakistan's Hub PowerProject fied range of force majeure events that may be grouped it wasin immediatelyprior to the relevantevent, if feasi- broadlyas follows: ble; and second, to meet the fixed costs of the project * Pakistanpolitical events-for example,war, terrorism, that fall due during restoration of the project or during civilcommotion, national strikes, changes in law,expro- an interruption to the project that is caused by a relevant priation, changesin consents,and so on. event. * Politicalevents not directlyconnected with Pakistan but Where specialtemporary funding is provided, the gov- affecting,among other things, oil deliveries. ernment of Pakistan will cause the Water and Power * Natural eventscausing damage to the plant that cannot DevelopmentAuthority to pay a supplementaltariff suf- be coveredby insurance. ficient to cover interest and principal payments, due on * Natural eventscausing damage away from the plant,but the specialtemporary funding, which is treated as a loan affectingthe plant indirectly. from the governmentto Hubco for those purposes. Even * Actsor omissionsof the Waterand PowerDevelopment where the governmentdisputes a claim for specialtem- Authorityor PakistanState Oil that affectthe construction porary funding,it must stillpay the debt serviceand fixed contract price or the completiondate. operatingcosts elementsof the tariff payableunder the Twotypes of specialtemporary funding are provided: power purchase agreement while arbitration is taking first, to meet the cost of restoringthe project to the state place.

Appendixes 57 Appendix 6 ExpandedCofinancing PSEDFI (Ln.2982-PAK) and the replenishmentloan under Operation (ECO): Summary of terms of the proposed PSEDF II loan to be presented to the the guarantee Executive Directors in concurrencewith this ECO. The amountsallocated to Hub wouldbe US$377 millionand Borrower US$195million, respectively. The Hub PowerCompany Limited (Hubco). Procurement Guarantor The equipment,materials, and servicesunder the Turnkey InternationalBank for Reconstructionand Development ConstructionContract for the powerplant which have been (WorldBank). or willbe awardedthrough a competitiveprocess meeting the requirementsof economyand efficiency. Arrangers The Bank of Tokyo,Ltd., The Sakura Bank, Citibank Drawdown International Plc., Credit Lyonnais, S.A., National Disbursementsunder the Loan willbe for eligibleexpen- WestminsterBank Plc. ditures for the power plant. Hubco willmaintain special disbursementaccounts with Citibank N.A. or The Bank Lenders of Tokyo,Ltd., in Pakistan, denominated in the curren- A syndicateof commercialbanks. ciesof the Loan,into which the proceedsof the Loan (other than disbursementsto be paid directlyto third partiesand Amount disbursementsneeded to maintain the required balance US$240million equivalent, consisting of two facilities: on reserveaccounts) will be depositedmonthly, based on a. ECO-guaranteedbase creditfacility of US$200million the projected expenditurerequirement. Hubco willpro- equivalent;and vide the World Bankwith periodic reports on the use of b. ECO-guaranteedstandby credit facility of US$40mil- fundsfor expendituresfor the powerplant, including yearly lion. audited financialstatements, accompanied by a separate opinion of auditors on whether the expenditure state- Currencies ment supportsthe withdrawalsfrom the specialdisburse- ECO base creditfacility: U.S. Dollars, Japanese Yen, French ment account. Francs,and ECU, of which: a. ECU 29 million; AvailabilityPeriod b. French Francs 157 million; The earlierof March31, 1998,or six months afterthe pro- c. JapaneseYen 2,000 million;and ject completiondate. d. U.S. Dollars 123million. ECO standbycredit facility:U.S. Dollars Repayment The Loan willbe repayable in sixteen equal semiannual Use of Proceeds installmentsfalling due on January 10 and July 10 in each Tofinance part of the overallcost ofthe powerplant, includ- year,commencing on the first interest payment date after ingdesign and constructioncosts, financing costs, and inter- the end of the AvailabilityPeriod, providedthat the final est during construction.The balance of the costs willbe maturitydate willbe no later than January 10, 2006. financedby four syndicatesof commercialbanks covered by the Export-ImportBank of Japan and the Export Credit InterestRate Agenciesof Italy (SACE),France (COFACE),and Japan ECO basecredit facility (MITI); other senior debt; and subordinated equity. a. Six-monthLondonInterbankOvernightLendingRate Subordinateddebt is to be providedby the Fund under (LIBOR)for the relevantcurrency plus 2% per annum

58 FinancingPakistan's Hub PowerProject untilthe eighthanniversary of the date ofthe loan agree- the ECO Guaranteeis covered by the ECO Guarantee ment; and thereafter. ReserveAccounts (summarized below). b. Six-monthLIBOR plus 2.25%. c. The ECO Lenders' Agent Bank may (and, if so instructedby the MajorityLenders, shall) call the ECO ECO standbyfacility Guaranteeupon the occurrenceof the followingspec- a. Six-monthLIBOR plus 2.5% until the eighth anniver- ified events: sary of the date of the loan agreement,and thereafter * Hubco has failedto make a principalpayment or a six-monthLIBOR plus 2.75%. portion thereof when due and payableto the ECO b. The interest rate per annum on the ECO Facilitieswill Lenders eitheron a scheduledpayment date or on be reduced by 0.25%when Hubco's annual debt ser- accelerationor on voluntaryor mandatoryprepay- vice coverageratio is 2:1 or greater. ment; and Hubco has failed to make such paymentsfor rea- ConditionsPrecedent to Effectiveness sonswhich include (directly or indirectly)a Guarantee The ECO FacilityAgreement and the ECO Guarantee Event (as describedbelow). willbe effectiveonly when, interalia: a. the other debt financingfor the Plant is underwritten GuaranteeEvents and all conditionsprecedent for the utilizationthereof A claimmay be made under the ECO Guarantee in the have been fulfilled; followingcircumstances, if theyresult in a failureby Hubco b. the equitystandby financing for the Plant has been fully to make a payment of principalunder the Loan: subscribedand paid for (or where standbyequity is to a. the Governmenthas failedto pay Hubco any amount be subscribedor paid for subsequently,letters of credit due underthe ImplementationAgreement or underthe or guaranteessatisfactory to the Lenders are in place Government'sguarantee issued thereunder of the oblig- to assure that such equitywill be subscribedfor when ationsof Pakistan State Oil (PSO)under the FuelSupply required); Agreement,Water and PowerDevelopment Authority c. all agreementsrequired in connectionwith the con- (WAPDA)under the PowerPurchase Agreement, and struction and operationof the Plant (includingbut not the State Bankof Pakistan under the ForeignExchange limited to the ImplementationAgreement, the Power RiskInsurance Scheme (other than any amountpayable PurchaseAgreement, the Fuel SupplyAgreement, the by the Governmentas the result of the failureof PSO ConstructionContract, the Operationsand Maintenance to deliverfuel oil to Hubco due to certain oil-related Agreement, SecurityTrust Deed, the Governmentof foreignpolitical events). Such paymentobligations are PakistanGuarantee, and the ExchangeRisk Insurance summarizedbelow; Letters) have been executedand are effective;and b. the Governmentthrough the State Bank of Pakistan d. Hubco has been capitalizedand staffed in a manner has failed to. make available the necessary foreign satisfactoryto the Lenders. exchangein accordancewith its agreementunder the ForeignExchange Risk Insurance Scheme; GuaranteeProvisions c. any restriction has been imposed under the laws of Scope Pakistanon the free transferof foreigncurrency funds a. The ECO Guarantee will be provided by the World held by,or on behalf of, Hubco out of Pakistan; Bank in parallelwith the JEXIMGuarantee byJEXIM d. any restriction has been imposed under the laws of in the initialratio of 2:1. The ECO Guaranteeand the Pakistanon the free transfer of rupees held by, or on JEXIMGuarantee will be callableon a pari passubasis. behalf of, Hubco from a project account for the pur- b. The ECO Guaranteewill cover the principalpayments posesof the ForeignExchange Risk Insurance Scheme; due underthe Loanand remainingunpaid. Interest due e. there has been a changein Shariahlaw (or sucha change to the Lenders on the occurrenceof risks covered by is due to occur within six months) which causes the

Appendixes 59 followingto becomeunlawful, unenforceable, or invalid: nation amount, the levelof which depends on the reason Hubco's obligationto make a paymentor performan for termination but which in all cases would include the obligationunder any of the projector financingagree- Loan amount due the Lenders.The Governmentis oblig- ments;Hubco's enjoymentof its rightsunder any such atedto paya terminationamount where the Implementation agreement,or enforcement,or rightsto enforcement Agreementis terminatedbecause of: in Pakistan,by Hubco or the Lendersof any obligation * a Governmentdefault thereunder; of the parties to such agreements;provided that such * the occurrenceof a ShariahEvent; unlawfulness,unenforceability, or invalidityaffects a * the occurrenceof a naturalforce majeureevent which paymentobligation in excessof $100,000in respectof affectsthe WAPDAgrid or the PSO system (but not interest or fees or in excessof $1 millionin respect of the Plant)where Hubco and the Governmentagree to principalor anysecurity or rightconstituted by the secu- terminate or an expert determinesthat the Project is ritywhich is material to the Lendersor Hubco(a "Shariah no longerviable; Event").TheECO Guaranteespecifically exdudes from * the occurrenceof a Pakistan politicalforce majeure coverage the existingFederal Shariah court decision eventwhere Hubco and the Governmentagree to ter- on interest, which has been appealedto the Supreme minate or an expertdetermines the Projectis no longer Court of Pakistan.If such a decisionis upheld by the viable;or Supreme Court, such a decisionwould be a Shariah * the occurrenceof an uninsurednatural event causing Event fromthat time; or damageto the Plant. f. the performanceby the Governmentof anyof its oblig- ations, or the exerciseby Hubco of any of its rights, Claim on ECO GuaranteeWhere There is a Commercial under the ImplementationAgreement, or the perfor- Defaultand a GuaranteedDefault mance by Hubco of any of its obligations,or the exer- Whetheror not the occurrenceof the GuaranteeEvent was ciseby the Lendersor the Lenders'Agentof anyof their the sole cause of Hubco's failure to pay such principal rights, under the ECO FacilityAgreement has become amountwill not affectthe abilityof the ECO Lenders'Agent void,illegal, invalid, or unenforceableas a resultof any to makea daim underthe ECO Guarantee.However, where change in Pakistan law or any court decision which notwithstandingthe occurrenceof the Guarantee Event, renders inaccuratethe legalopinions obtained by the Hubco would still have been unable to performin full its Lendersat financialclosing (an "IndemnifiedEvent"). paymentobligations because of a commercialdefault, the amountpayable under the ECO Guaranteewill be reduced PaymentObligations ofthe Government under the Implementation by that portion of the paymentnot paid by Hubco because Agreementand the Government's Guarantee which are Covered of the commercialdefault. by theECO Guarantee Under the Government'sguarantee, the Government is Claim on ECO GuaranteeWhere There is a Commercial responsiblefor guaranteeingthe paymentobligations of PSO DefaultFollowed by a GuaranteedDefault under the Fuel SupplyAgreement and WAPDAunder the The ECO Lenders' Agent may claim under the ECO PowerPurchase Agreement and for guaranteeingthe oblig- Guaranteein the casewhere the Loan has been accelerated ations of the State Bank of Pakistan under the Foreign solelybecause of a commercialdefault and the ECO Lenders ExchangeRisk Insurance Scheme. are attemptingto enforce their securitybut are unable to do so because of a changein Pakistan law,expropriation TerminationAmounts or certain force majeure events. In such circumstances, The ImplementationAgreementprovides that eitherHubco the amount payable under the ECO Guarantee will in or the Government may terminate the Implementation essencebe the lesserof (i) the amountof the Loanremain- Agreementin certain specifiedevents. In certain of these ingunpaid and (ii) the differencebetween the amount the cases the Governmentis obligatedto pay Hubco a termi- ECO Lenders would have recoveredhad they been able

60 FinancingPakistan's Hub PowerProject to freelyenforce their securityand the amountsthey actu- ECO Guaranteemust be made within60 daysof the lat- allyrecovered upon enforcement. ter of (i) the due date in respect of which a failureto pay has occurredand (ii) the expiryof any applicablegrace or Limitationson Enforcement cure period relatingto the relevantGuarantee Event. If Hubco fails to make a principalpayment on the Loan as Callson the Guaranteeswill be permittedfor up to 60 a result of a Shariah Event or an Indemnified Event, or daysafter the scheduledfinal maturity date of the Facilities. because the Government has failed to make Capacity However,the Lendershave the option to extend the guar- Purchase Price or SpecialTemporary Funding payments antee, on an annual basis, for a further five years upon under the ImplementationAgreement solely as a result of paymentof an annual guaranteefee. The purpose of the a dispute as to whether such amounts are payable, the extension is to provide coverage in respect of the Lenders may call on the ECO Guarantee for any unpaid Government's continuing obligations under the scheduled installmentof principalbut may not accelerate ImplementationAgreementfollowing a commercialdefault the Loan and take enforcement action unless the default during the time when the Lendersare seekingto enforce has not been remediedby certain specifieddates, thus giv- their securityinterests as describedabove. ing the Governmentthe opportunityto remedy the situa- tionbefore a claimmaybe madeunder the ECO Guarantee Exclusionof Liability for the full unpaid principalamount of the Loan.The cure The WorldBank's liabilityunder the ECO Guaranteewill periods are six months for disputes regarding Capacity be reduced to the extent a claimarises out of or as a result Purchase Price and SpecialTemporary Funding payments, of: (a) Hubco, the Lenders,the Lenders' Agent,the secu- nine months for a Shariah Event, and twelvemonths for rity trustee, or the intercreditoragent voluntarilyentering an IndemnifiedEvent. In all cases,however, the cure period into an agreementwith the Government regardingsuch willbe reduced, if necessary,so as not to exceedthe period claim which materially reduces the claim against the of time for which interest paymentson the Loan are cov- Goverrment;(b) the insolvency(except where contributed ered by the amount in the GuaranteeReserve Account. to by the actionof the Government)of the Lenders'Agent, any of the banks holdingthe project accounts, or any of GuaranteeReserve Account the banks responsible for remitting funds to the State As the ECO Guarantee does not guaranteeinterest pay- Bankof Pakistanfor the ForeignExchange Risk Insurance mentson the Loan,an offshoreGuarantee Reserve Account Scheme;or (c) a failureby such an account or remittance willbe establishedto providethe Lenderswith interest cov- bank to transmitnecessary funds (exceptwhere such fail- erage during the cure periods when the Lenders are pre- ure is due to a Pakistanpolitical event). vented from acceleratingthe Loan and claimingunder the TheECO Guaranteewill lapse if the Lendersamend or ECO Guarantee for the full principalamount in the cir- waive certain material provisions of the ECO Facility cumstances described above. The Guarantee Reserve Agreementor the intercreditoragreement without the World Accountis requiredto be funded in an amount equal to 13 Bank'sconsent or if the Lenders'Agent fails to request the months' and 7 days'interest on the Loan.The Lenders may intercreditor agent to issue a drawstop notice following draw on the GuaranteeReserve Account for interestpay- the WorldBank's demand to do so (as describedbelow.) ments on the Loan in those caseswhere Hubco has failed to make a scheduled principalpayment installmentand GuaranteeFees the Lenders are entitled to call on the ECO Guaranteefor Theguarantee fee willbe payablein the respectivecurrency such payment. guaranteedby Hubco to the WorldBank in installments. The first installmentof approximatelytwo years' guaran- Claims tee fee willbe payableon the date of the first drawdown Unlessthe ECO Lendershave notified the WorldBank of under the Loan. Thereafter,an annual guarantee fee will a paymentdefault within 60 daysthereof, claims under the be payable,commencing on the first anniversaryof the Loan

Appendixes 61 and on eachsubsequent anniversary date (untilbut exclud- CommitmentFee ingthe anniversarydate precedingthe finalmaturity of the Three quartersof one percentper annum on undrawncom - Loan).The fee willequal one quarterof one percentof (a) mitments. the Loan commitmentsduring the AvailabilityPeriod, and (b) the maximum Loan Amount thereafter. The ECO Pre-payment Guaranteewill lapse if the guaranteefees are not paidwhen Hubco may voluntarilyprepay the Loan in full or in part due. (in agreed minimum amount and multiples thereof) on any repaymentdate. On project completion,any surplus DrawstopNotices funds must be used to prepaythe ECO/JEXIMFacilities. Duringthe AvailabilityPeriod, if Hubco has issued a pre- After project completion,45% of surplus operating rev- liminary termination notice under the Implementation enuesmust be use to prepaythe senior debt pro rata, after Agreementdue to a defaultby the Government,the World permitted shareholderdistributions. Bankhas the right to requirethe Lenders'Agent to request the intercreditoragent to issue a drawstopnotice to pre- Indemnityby Pakistan vent Hubco from makingany further drawingsunder the The Islamic Republic of Pakistan (Pakistan) will enter ECO FacilityAgreement. At any time while such a draw- into an Indemnity Agreement with the World Bank in stop notice is in effect, the Lenders may claimunder the respectof itsGuarantee. Under suchIndemnity Agreement, ECO Guaranteefor all amountsof principalwhich Hubco Pakistanwould undertake to reimburseand indemnifythe fails to pay for any reasonwhatsoever. WorldBank on demand, or as the WorldBank may oth- erwisedetermine, for anypayment made by theWorld Bank Subrogation under the ECO Guarantee and for all liabilities and Followinga paymentby the WorldBank under the ECO expensesincurred by the Bank with respect to the ECO Guarantee,the WorldBank will be immediatelysubrogated Guarantee. to the rightsof the Lenders(except for anysuch rights which relate to amountsin the GuaranteeReserve Account or in GoverningLaw and Jurisdiction respect of any amounts due from the Governmentunder The ECO Facilityand the ECO Guarantee will be gov- the ImplementationAgreement or in respectof amounts emed by Englishlaw and providefor the non-exclusivejuris- attributable to commercialdefault). However,until the dictionagainst the WorldBank of the Englishcourts. The Lenders have been repaid in full,the WorldBank will not IndemnityAgreement will followthe legal regime, and be subrogatedtoanyvoting entitlements held bythe Lenders includedispute settlementprovisions, which are custom- or be entitled to direct the Lenders as to how to exercise aryin agreementsbetween member countries and the World such rights. Under the terms of the ECO Guarantee,the Bank. WorldBank has the right to waiveits subrogationrights and relyexdusively on its rightsagainst the Governmentunder Agent the IndemnityAgreement. Bankof TokyoInternational Limited.

62 FinancingPakistan's Hub PowerProject The World Bank

Headquarters 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. Telephone: (202) 477-1234 Fax: (202) 477-6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Cable Address: INTBAFRAD WASHINGTONDC

European Office 66, avenue d'1ena 75116 Paris, France Telephone: (1) 40.69.30.00 Facsimile: (1) 40.69.30.66 Telex: 640651

Tokyo Office Kokusai Building 1-1, Marunouchi 3-chome Chiyoda-ku, Tokyo 100, Japan Telephone: (3) 3214-5001 Facsimile:(3) 3214-3657 Telex: 26838