Increasing stringent capital requirements on banks has the market looking for alternative means of funding. In the developed economies, the Basel III accord aims that banks will increase the amount of capital that they hold by 40 per cent, by 2019. The next accord, Basel IV, will likely increase this still further and move from using a bank's internal assessment of risk to standardised, industry-wide capital models. Largely because of this pressure, global project finance lending volumes fell 17 per cent between 2015 and 2016. Banks are developing innovations to allow them to continue to fund longer-term investments such as infrastructure projects, for instance, the wider use of non-payment insurance (NPI) policies (not to be confused with credit default swaps). Such policies can also have the impact of increasing the creditworthiness of a project by reducing default risk. Banks are also reducing the period for which they hold loans, by selling them to institutional investors instead of holding them until maturity.
Capital markets have been expected for some time to take a more prominent role in financing infrastructure development in Africa. Bonds could be especially relevant in African markets where fluctuations in commodity prices have compounded liquidity issues. In West and Central Africa, capital requirements imposed by central banks may restrict the possibility for regional banks to finance projects on a long-term basis.
In a world where acceptable returns are hard to find in developed markets, emerging markets are becoming increasingly interesting to institutional investors. While loans of various types (procured very often by development financial institutions) still make up the bulk of global infrastructure financing, it is very likely that as a long-term trend, capital markets will become more established as a mainstream source of finance for infrastructure development.
Project bonds are now well understood in developed markets such as Europe and the United States. They have also been used in emerging markets in other parts of the world. This paper examines their potential for funding infrastructure investment especially in the OHADA markets of central and west Africa.
These countries have a common organised legislative framework and financial market. This makes it possible to develop and promote project bonds on a regional basis. This is important because each country, individually, is too small a market to viably promote project bonds on its own.
From a legal, financial and economic standpoint, several of the prerequisite tools are already in place. Others still to be addressed are needed to create a favourable environment for project bonds.
- Legal, financial and economic factors favouring project bonds • The common legislative framework • A common currency framework • A regional stock exchange: the BRVM • An established banking sector
- Avenues to improve the environment for project bonds • Role of banks • Pensions funds, retirement schemes and insurance companies • Bond regulations • Risk perception • Suitable projects
Legal, financial and economic factors favouring project bonds
The common legislative framework
OHADA (Organisation pour l'Harmonisation en Afrique du Droit des Affaires, or the Organisation for the Harmonization of Business Law in Africa) is a system of business laws adopted by West and Central African nations on 17 October 1993 in Port Louis, Mauritius. The member states are: Benin, Burkina Faso, Cameroon, Central African Republic, Chad, Comoros, Côte d'Ivoire, Democratic Republic of Congo, Equatorial Guinea, Gabon, Guinea, Guinea-Bissau, Mali, Niger, Republic of the Congo, Senegal and Togo. The purpose of OHADA is to facilitate and encourage both domestic and foreign investments in the member states.
The laws promulgated by OHADA are exclusively business-related and are named Actes Uniformes (Uniform Acts). A Uniform Act is law containing all relevant legal norms needed to ease business in the member states. Such law is directly applicable in the member states without any further need to transpose it.
OHADA currently includes 10 Uniform Acts relating to the following areas:
- General commercial law
- Commercial companies and economic interest groups
- Security interest
- Simplified debt collection
- Procedures and enforcement proceedings
- Bankruptcy proceedings
- Arbitration law
- Accounting law and financial reporting
- Road freight agreements
- Cooperative companies law
The main legal provisions relating to bond issues are found in the Commercial Companies and Economic Interest Group Act.
A common currency framework
In Western and Central Africa, the CFA franc (FCFA) is the name of two currencies used in these sub-regions, which are guaranteed by the French treasury. The two CFA franc currencies are the West African CFA franc and the Central African CFA franc. They are pegged to the euro and directly convertible in euros at a fixed rate.
The West African CFA franc is the currency of eight independent states in West Africa: Benin, Burkina Faso, Guinea-Bissau, Ivory Coast, Mali, Niger, Senegal and Togo. These eight countries have a combined population of 90.4 million people (as of 2016). They form a regional monetary and economic union: the UEMOA (West African Economy and Monetary Union).
The Central African CFA franc is the currency of six independent states in central Africa: Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea and Gabon. These six countries have a combined population of 44.1 million people (as of 2014). They form another regional monetary and economic union: the CEMAC (Central African Economic and Monetary Community)
Each of the sub-regions has a single central bank, and exchange control regulations do not apply to capital movements between countries within each of the sub-regions.
Thus, in each of these sub-regions, it is possible to draw on the financial resources of all the countries being part of the regional organisation, with the same currency and with the same legal background (OHADA laws, central bank). As the local currency is pegged to the euro, there is no exchange risk except the one linked to the euro, whereas a risk of devaluation exists (as in 1994).
A regional stock exchange: the BRVM
The Bourse Régionale des Valeurs Mobilières SA (Regional Securities Exchange SA) or BRVM is the regional stock exchange serving the following West African countries: Benin, Guinea Bissau, Burkina Fasso, Côte d'Ivoire, Mali, Niger, Senegal, Togo. BRVM uses a totally electronic all-day trading. In 2017, its stock market capitalisation amounted to 7,706.27 billion FCFA and its bond market to 579.23 billion FCFA.
An established banking sector
West Africa is home to 168 banks and Central Africa to 20. Compared to North and South Africa, these numbers are still very modest — even more so compared to the rest of the world. The banking sector in these regions has undergone major reforms since the 1990s, though, when most of the banks were state-owned. Most are now commercial banks.
Figure 1: Bonds versus loans: OHADA countries
Avenues to improve the environment for project bonds
Several studies are currently under way by the development agencies to consider offering their products as credit enhancement for project bonds issues. Such credit enhancement would undoubtedly mitigate the perceptions of risk on the part of institutional investors.
Despite the fact that other kinds of bonds have been used, no project bond has yet been issued in the OHADA region. Some of the avenues by which obstacles to project bonds might be overcome include the following.
Role of banks
Commercial banks in the OHADA region are focused primarily on retail banking and not actively involved in infrastructure finance. Conversion of deposits into loans is at an early stage of development, and deposits are generally stored in foreign banks rather than deployed in local investments. According to the Bank for International Settlements and to the Banque de France, in 2014 the residents of the Zones Francs (CEMAC and UEMOA) held a total of US$14 billion in cash in off-shore bank accounts. The level of penetration of the banking sector in Africa is also low by global standards. It follows that credit is also very low by global standards.
A lack of investment banks with required know-how to structure financial products, intermediate, and invest liquidity further exacerbates the issue. Widespread use of sophisticated financial products in Africa will require the emergence of a similarly sophisticated investment banking profession across the continent.
Many such African investment banking professionals exist but most are employed in international banks and institutions. Creating attractive opportunities for them to return home and transfer their skills into African markets would help.
Pensions funds, retirement schemes and insurance companies
Local pension funds, insurance companies and other institutional investors need to be mobilized as source providers. In Europe, the project bonds market is dependent on such investors, who need to acquire assets that match their liabilities, to develop long-term and stable resources. In some countries, like Nigeria and Ghana, some fundamental reforms have been undertaken to allow and promote pension funds. In Nigeria, the assets managed by pension funds were the equivalent of US$3 billion in 2007, US$14 billion by 2011 and US$25 billion at the end of 20121.
By creating a more favourable environment for pension funds (associated of course with traditional retirement schemes), legislators can also encourage those institutions to invest in capital markets products and financing infrastructure development. In turn, the enhanced infrastructure encourages economic growth and more individuals invest in their pension funds and in savings.
The creation of an environment that allows and encourages the emergence of professional asset management companies, under the supervision of a national agency to supervise and control the activity, needs to accompany this. As with the banking sector, an entirely new African asset management profession is required to service the needs of African markets.
In Europe, teams of asset managers exist who are well experienced in the assessment and management of infrastructure assets. Some of these professionals come from the banking sector, others from the former monolines. These teams include members of the African diaspora and others who could be encouraged to form the catalyst for the development of such teams in OHADA.
Concerning the insurance sector, 14 member countries of the Zone Franc have established the CIMA (Conférence Interafricaine des marchés de l'assurance.) However, this sector remains highly undeveloped, even compared to other countries on the continent. It comprises 160 insurance and reinsurance companies but with one of the lowest worldwide penetration rates. In April 2016, the member states agreed that the insurance companies should increase their minimum capital by a multiple of 5. Earlier in Nigeria, in 2007, a similar reform required a multiplier of 202. Even more ambitious reforms, such as rendering certain kinds of insurances compulsory (such as construction, civil liability), may be required as the OHADA economies grow. And the premiums from such policies may become available for investment in such products as project bonds, as African insurance companies develop their own asset bases.
Based on the French model, the OHADA countries could even organize a Caisse des Dépôts, a state-owned financial institution, collecting savings and redeploying those as a tool for executing their development policy. An African example of this is the Moroccan Caisse des Dépôts.
It is worth noting that the transfer of funds from the diaspora in West Africa reached US$26 billion in 2016 (Nigeria being the leader with US$19 billion dollars in 20163.
Although the OHADA legislation regulates bonds issued by companies, in some respects the regulations are too rigid to allow the widespread use of project bonds.
Quorum and majority rules are compulsory and uncompromising, as are the ways in which security is treated. When looking at a project company, Article 780 of the OHADA Act on Commercial Companies provides that only corporations (sociétés anonymes) and economic interest groups composed of corporations with at least two years of existence and two approved annual financial statements are permitted to issue bonds.
This eliminates newly incorporated companies from being able to do so. Because many project companies are newly incorporated or specialpurpose vehicles for the purpose specifically of developing the project, these rules are an obstacle for a bond issue to finance the construction phase of a project.
French law on bond issues, which was drafted along similar lines to the OHADA legislation, has recently been amended to facilitate bond issues in certain cases, notably project bonds (Ordinance n° 2017-970 of May 10, 2017).
Besides having the necessary tools and the resources, a viable environment for project bonds also requires that perception of risk be addressed.
Typically, most of the projects in the region involve the public sector and the private sector. Revenues frequently come from the public sector and the usual political risk products are available to mitigate this perceived risk (e.g., MIGA insurance; partial risk guarantees from World Bank and other DFIs). This risk perception is even stronger when part or all of the expected revenues of a project come from end users (e.g., toll roads).
Several studies are currently under way by the development agencies to consider offering their products as credit enhancement for project bond issues. Such credit enhancement would undoubtedly mitigate the perception of risk on the part of institutional investors from both African and non-African markets that might invest in project bonds.
As a European example, the EIB has structured its project bond credit enhancement product for a similar purpose. As typical investors would require a certain rating (investment-grade), the EIB product is designed as a guarantee, absorbing the first risk of loss of a project (notably where projects are operated through a demand structure) while still being an instrument subordinated to the senior investors, thus allowing some projects to be rated as investment-grade.
There are some studies being currently developed by various stakeholders to assess whether such type of products could be structured for projects in Africa.
In the interim, rather than 'lending', DFIs might be able to develop ways to subscribe to project bonds themselves. They cannot always buy such products. It might be possible, though, to structure debt funds as are used in Europe as a vehicle for such a strategy.
With tools and resources in place and risk perceptions addressed, the final requirement is for suitable projects. Many projects in development in the OHADA region and in Africa generally never reach financial close, and development phases of projects are very long, by global standards.
Projects to be financed with project bonds therefore need to be identified and designed so as to have a reasonable development phase and a structure that makes them bankable.
Infrastructure development projects are typically divided into three phases:
- The development phase (where you analyse whether the project may go ahead)
- The construction phase (where the project got financing to be constructed and is effectively constructed) and
- The operational phase (where the project enters into operation and produces revenues).
At what point should a project bond be issued? Bond markets are typically averse to construction risk, although this has softened in Europe with the emergence of well-designed projects with project documents that allocate risks in ways that are now well understood and accepted by the market, and where the sponsors have a proven track record of successfully completing projects.
If the DFIs continue to finance the construction period, why not through a project bond or a partial risk guarantee (acknowledging that this necessitates not only a strong contractual structure but also renowned sponsors and contractors)?
In an entirely new project bond market — such as OHADA would be — this may be premature. If that is the case, bank term loans for the construction period (that could be granted by commercial banks and DFIs) could first be put in place to finance the construction phase and then be refinanced through a project bond when the project enters the operational phase. With shorter financing periods, such term loans would be easier for banks to accommodate their capital requirements, too.
The legal foundation for project bonds in OHADA already exists. What has been described here are ways in which that foundation could be enhanced, to make them more viable and attractive. Willingness also clearly exists among the various stakeholders to make them work. The next step is to develop resources with the right instruments: PRG, credit enhancement products, refinancing structure and, most important, ways of improving the delivery of bankable projects. Here too, a number of initiatives exist (such as the ASLF of African Development Bank) whose aim is achieving financial close in a reasonable time and designing bankable projects with robust contractual structures. The most difficult obstacle to overcome may be that a viable project bond market requires a strong underlying economy. The challenges of the OHADA countries (and African countries generally) as they develop and diversify their economies is well known. So too the continent's potential and the role that infrastructure development must play in unlocking that.
The development of sophisticated African capital markets will evolve slowly as the economies develop and as African finance professions develop. In the short term, mechanisms need to be found to enable products like project bonds, which have been proven in other parts of the globe, to be applied to African infrastructure projects. As has happened in the telecommunication and banking sectors in Africa, scope also exists to 'jump' over the legacy developments in Europe and elsewhere and develop new, innovative approaches to project bonds that learn from the experiences elsewhere and offer value in ways previously impossible.