Counterparty credit risk continues to remain a key, often threshold concern for private sector sponsors and lenders to the majority of power projects in sub-Saharan Africa. Structuring power projects in an effort to overcome or substantially mitigate counterparty credit risk in these countries is challenging for private and public stakeholders alike. Our clients often note that while every country and project in sub-Saharan Africa is unique, mitigating counterparty credit risk or perceived credit risk is typically the single most challenging aspect of project development and delivery in most sub-Saharan African countries. In this article, we consider a number of options available to private sector sponsors and lenders to assist with the counterparty credit risk challenge.
The majority of power sector offtakers in sub-Saharan Africa remain wholly or majority state owned and controlled. With a few exceptions, most of these offtakers do not have independent credit ratings and their financial position (if known at all) does not provide private sector sponsors and lenders with the necessary comfort, particularly over the longer term.
The reasons underlying the financially precarious position of state-owned power sector offtakers are well known. An unhelpful combination of continued non-costreflective tariffs and high-power procurement costs, limited financial capacity and flexibility, high technical and commercial losses, poorly maintained infrastructure and low collection rates (among other factors) has meant that offtakers have only seen modest (if any) gains in their financial standing over the last two decades. This is despite unbundling, frequent recapitalisation, external and internal intervention, ad hoc injections of additional liquidity and frequent statements of intent to restructure the power sector.
All of this has meant that private sector investors and lenders continue to require credit support and credit enhancements to underpin the obligations of power sector offtakers. The absence of meaningful credit support and enhancement often results in projects being considered unbankable and at times proves fatal to timely and cost-efficient project development.
The classic approach to secure credit support and enhancement has been for private sector investors and lenders to require government support through either a government/sovereign guarantee or more recently, through government undertakings documented in implementation or state support agreements or through put and call option agreements. Nomenclature and certain nuances aside, there is limited, if any, practical difference between these approaches.
- In its simplest form, the relevant government agrees to backstop/guarantee the offtaker's liability to pay tariff and other payments, e.g., liquidated damages or ancillary services payments which are due and payable by the offtaker and remain unpaid following the expiry of applicable grace periods
- The underlying power purchase agreement is often drafted to include a termination or transfer payment. Such payments would also typically be covered by the government undertaking even though such payments are often significant and sized to at least cover senior debt
If the underlying power purchase agreement transfers the risk of change in law or political force majeure events to the offtaker and this translates into the offtaker having to make a payment whether by way of tariff increases or capital/lump sum payments, this too would usually be covered under the broader umbrella of offtake payment liabilities. If it does not, sector investors and lenders would look to the government for a standalone obligation to protect or restore the position of the investors and lenders in such circumstances.
Securing this kind of government support has become more difficult with governments increasingly reluctant to provide such support, in certain cases going so far as to expressly rule out the notion of any sovereign guarantee or that the government back-stop the commercial risk associated with the long-term sale of electricity to stateowned offtakers. One of the key reasons for this guarded approach is the increasing emphasis and focus on the recognition and treatment of contingent liabilities on a country's balance sheet (see "Making sense of contingent liabilities") and the impact of this on the country's financial position generally.
Suggestions that 'letters of support' from governments can substitute government guarantees or government support is a request on the increase in the power sector. This is sometimes unhelpful. A letter of support can be drafted so as to be:
- Binding. In this case, each of the concerns identified in respect of government guarantees or government support continue to apply or
- Non-binding. In this case, additional layers of meaningful credit enhancement are required as a non-binding letter of support provides no legally binding commitments on the part of the government concerned and, as a result, provides nothing substantive to mitigate the creditworthiness concerns
Other forms of support
Government support has rarely been viewed as the only form of credit support and credit enhancement which is suitable or necessary for power sector projects in emerging markets. The vast majority of projects have tended to use multiple layers and different kinds of credit support and credit enhancement to achieve a position that when viewed as a whole is determined to be bankable.
Understanding and deploying such a multi-layered approach has become increasingly important as governments reject providing comprehensive government support (to avoid difficulties with contingent liabilities), projects become larger (creating significant potential exposure for the country's balance sheet) and countries themselves are downgraded, a problem which is particularly acute for countries with economies heavily dependent on globally traded commodities such as oil.
1. Liquidity support
The most commonly deployed credit enhancement option is requiring the offtaker to procure and provide liquid security. In each case, two key themes emerge: what is the appropriate amount of liquid security to be provided and what is the risk associated with its continued implementation or reinstatement if there is a draw on such support. Liquid support will usually take the form of:
- An escrow account to receive payments from (ideally a specified pool of customers) —only possible if receivables have not already been secured in favour of others; deposit mechanics need to be understood; potential restrictions on providing security on account of negative pledges (e.g., the World Bank Negative Pledge in the case of IBRD countries); there is often a reluctance to provide such arrangements as to syphon off reliable customer payment revenue streams can further compound the credit problems of the offtaker.
- A standby letter of credit confirmed by an acceptable bank — however, given the financial position of offtakers, there will frequently be a need to cash collateralise all or a significant part of any such bank security, and this is clearly not attractive for offtakers.
- A liquidity facility arrangement. This is a formal mechanism with a financial institution to make a pool of capital available in certain circumstances and to cover specified shortfalls or payment risks
- Prepayment or deposit in a secured account. Unlike in other cases where there is at least the theoretical possibility of partial cash collateralisation, this approach will require complete cash collateralization
Provision of liquid support by state-owned offtakers is an inherently inefficient use of capital and often can result in additional hard currency pressure in situations where foreign currency is not freely available.
2. Multilateral guarantees
In addition to government support, it has become increasingly common for private investors and lenders to look for guarantees from multilaterals to mitigate their exposure to a project.
Guarantees can be structured in many different ways. The World Bank, for instance, has moved away from offering a specified list of project-based guarantee structures (partial credit or partial risk) and has instead started differentiating project-based guarantees by the nature of the risks that they cover.
In the context of private sector power projects1:
- Loan guarantees. These protect commercial lenders who have provided loans to a private sector power project from debt service defaults which have been caused by certain government actions or inactions (this kind of guarantee was previously described as a partial risk guarantee (PRG))
- Payment guarantees. These cover government payment defaults in respect of amounts due to private sector investors where these payment obligations require credit support and enhancement. These payment obligations can include recurring tariff payments under a power purchase agreement, termination payments, etc.
These guarantees will require a counter-guarantee or indemnity from the relevant government. This creates a direct contractual link with the relevant country relating to the project, but presents an added layer of interaction with the government, and finalising the suite of documents required can have significant time implications. Fees are also payable in connection with this product.
The World Bank is not the only potential source of such guarantees. The African Development Bank also runs a guarantee program similar to the World Bank and other multilaterals, and DFIs are also considering similar initiatives.
3. Public political risk insurance
Political risk insurance is available from a broad range of non-private underwriters. For instance, the Multilateral Investment Guarantee Agency (MIGA) provides coverage against currency inconvertibility and transfer restrictions, expropriation, war and civil disturbance, as well as breach of contract. Additionally, MIGA can also offer some credit enhancement by providing cover in respect of 'non-honouring of sovereign financial obligations by a host government'2 and 'nonhonouring of financial obligations by state-owned enterprises or public authorities of the host country'.
MAKING SENSE OF CONTINGENT LIABILITIES
The IMF has developed a framework which recommends that countries record certain contingent liabilities in the country's balance sheet. Contingent liabilities are liabilities whose timing and amount are contingent on the occurrence of a particular discrete/uncertain future event or series of future events. These include certain explicit contingent liabilities (such as guarantees and indemnities which are commitments to accept the risk of loss or damage another party might suffer) and implicit contingent liabilities (such as ensuring the solvency of the banking sector and net obligations of future social security benefits). The IMF recognises that some of the most significant fiscal costs for countries have in fact arisen from contingent liabilities3.
The IMF factors the existence and extent of contingent liabilities into its Debt Sustainability Analysis (DSA). DSAs are important for the IMF's assessment of a country's long-term fiscal policy, macroeconomic status and debt stability. As a result, IMF-supported programs are now heavily dependent on the outcomes of DSAs and are an integral factor in determining access to IMF financing. Moreover, the IMF actively encourages other creditors to take the results of DSAs into account in their respective lending decisions. Hence, DSAs have become popular among lenders and donors to decide the form and amount of financing that is sustainable to the particular country in question4.
• The IMF recently highlighted undisclosed debt in the form of power sector guarantees in Kenya totalling US$3.4 billion or 5.4 per cent of GDP which involved (as is commonly the case) a minimum demand/revenue guarantee and which were supported by letters of support and underwritten by World Bank Partial Risk Guarantees5
• The National Treasury in South Africa recently issued updated reports on the national contingent liability position which resulted in US$13 billion of additional liabilities reflecting Eskom's obligations under the REIPPP program and ultimately impacting South Africa's balance sheet6
As a result of this and a generally increased focus on balance sheet and debt stock management, many sub-Saharan African countries are increasingly reluctant to create contingent liabilities on their balance sheets by offering government guarantees or similar government support.
MIGA cover is different from multilateral guarantee cover described above because:
- MIGA covers equity as well as debt (up to 95 per cent of debt and 90 per cent of equity; exceptionally, up to 99 percent of debt and up to 95 per cent of equity7
- MIGA requires approval of the relevant country, but not agreements as is the case with multilateral guarantees8
- MIGA pricing depends on the relevant country as well as project risks associated with the guarantee9
MIGA is not the only source of multilateral political risk insurance. The Africa Trade Insurance Agency (ATI) offers a political risk product which also deals with key risks including payment default cover.
Certain countries have also established bodies to specifically provide political risk insurance to their nationals. For instance, the United States established the Overseas Private Investment Corporation (OPIC) which offers a broad range of political risk mitigation products to those who can establish a US nexus. Japan has established the Nippon Export and Investment Insurance Agency (NEXI) which offers PRI policies and political risk mitigation products to Japanese entities.
4. Private political risk insurance
Political risk insurance is also available from private insurance companies. In theory, free of eligibility requirements, private political risk insurance is available for a broader range of projects and risks and can be 'tailored' to the project and risk appetite of the insured — albeit at different costs.
However, practical concerns mean that private political risk insurance is not as commonly seen as is public political risk insurance. In part, this is because of the perception (and sometimes fact) that private political risk insurance is expensive when contrasted with public political risk insurance and usually offers tenors significantly less than the usual term of a power purchase agreement, for example. In part this is also because the very existence of private political risk cover is required to be kept confidential as an actual condition of coverage.
5. ECA cover
Export Credit Agencies (ECAs) are increasingly providing (and now recognised as key providers of) critical capital and credit enhancement for the financing of capital-intensive projects globally and in Africa in particular. ECAs can provide direct and indirect assistance, with direct assistance either relying on commercial banks to provide funding or the ECA lending directly. Where commercial banks are involved, often the ECA will provide support through a guarantee or insurance policy, and this has the effect of mitigating risks associated with borrower default for commercial lenders.
ECA involvement has a material bearing not just on the kind of documentation required, but also on the dynamics of the negotiations. Although in certain cases of indirect assistance, ECAs are less involved (since they are not party to the loan documentation), in the majority of cases, ECAs will become involved with negotiations in a meaningful manner, notwithstanding the kind of support being provided. ECAs also generally require strict compliance with their policies, and this can be challenging for borrowers and commercial lenders alike since not all ECAs have policies and procedures which are publicly available.
6. Involvement of development finance institutions, multilaterals
Multilaterals and DFIs such as the International Finance Corporation and AfDB also play a key role in mitigating risk and maintaining stability.
Apart from providing financing, their involvement is viewed as having the effect of mitigating risk by deterring governments and government-owned entities from defaulting given the potential impact that this may have on the much broader relationship that these institutions have outside of the affected project in question. The suggestion is that poor behaviour on a project in which these institutions are involved could have a direct impact (through crossdefault and withdrawal of funding) on other projects.
7. Contractual comfort
In addition to the measures described above, international investors and lenders will often mitigate risk by sensible structuring. This includes:
- Contractual protections. There are a number of contractual provisions which would be helpful to include in power purchase and government support agreements. These include international arbitration as well as stabilization and contractual protection from the impact of change in law and political events
- Investment structuring. Investments can be often structured to secure the benefit of international investment agreements, and multilateral or bilateral treaty protection can provide an additional layer of comfort
- Private investors and lenders need credit enhancement and support in order to successfully develop power projects
- Sub-Saharan African countries are reluctant to give direct guarantees to support power projects. Such support may need to be reflected on the country's balance sheet, and this would likely have an impact on the country's ability to borrow and its perceived creditworthiness
- It would be helpful to see clearer guidance on when and what kind of government support needs to be reflected on the country's balance sheet, how contingency is to be determined and if a broadly consistent approach could be agreed upon. This could greatly assist public stakeholders in their evaluation of the risk v. reward of supporting a particular power sector transaction
- A broad range of tools and risk mitigation measures are being increasingly used in sub-Saharan Africa. These include liquidity support, multilateral guarantees, public and private political risk insurance and involvement of ECAs, DFIs and multilaterals
- The importance of internal structures and regulatory frameworks to mitigate against the risk of an offtaker failing to fulfil its contractual payment obligations should also not be underestimated, although clearly such a solution is a long-term one requiring the buy-in of all relevant political stakeholders