Options for New Financing Mechanisms for the Middle East and North Africa

Transcription

1 The World Bank Group The Islamic Development Bank Group Options for New Financing Mechanisms for the Middle East and North Africa Background Note 22 September 2015

2 Table of Contents I. Background... 3 II. A Call for Action... 4 III. Proposed Financing Mechanisms for the MENA Region... 5 IV. Main Advantages of the Proposed Financing Mechanisms for the MENA Region... 6 V. Next Steps... 8 Annex I. Financing the Recovery and Reconstruction of MENA Countries... 9 Background... 9 Financing through Special IBRD Bonds... 9 Bonds Financing Structure... 9 Initial Estimated Pricing Islamic Finance: Leveraging the Strong Partnership between the WBG and IDB Group Expanding the Lending Envelope of MDBs through Donor Guarantees and Grants Annex II: Providing Concessional Financing to MENA Countries Impacted by Refugees Background Structure Mechanics of a Co-Financing Scheme through Prepayments

3 Abbreviations and Acronyms 1 BPS CAR IBRD IDA IDB Group IDP IFC ISA MDB MENA SDC SPV USD WBG Basis Points Capital at Risk Notes Program International Bank for Reconstruction and Development International Development Association Islamic Development Bank Group Internally Displaced Persons International Finance Corporation Implementing Support Agency Multilateral Development Bank Middle East and North Africa Sovereign Development Corporation Special Purpose Vehicle United States Dollars World Bank Group The findings, interpretations, and conclusions expressed in this paper do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. 2

4 I. Background 1. The Middle East and North Africa (MENA) is in severe turmoil that threatens both its shortand long-term development. Conflicts and instability throughout the region have caused extraordinary damage to physical infrastructure, as well as to the livelihoods of millions of people. The immense scale of these conflicts has created humanitarian and development crises that need to be urgently addressed in order to mitigate the risk of exacerbating future conflicts and instability becoming the long-term norm. 2. The intensity, duration and destruction of the civil wars and conflicts in MENA are unprecedented. In addition to the enormous human, social and economic loss experienced in those countries currently in conflict, these conflicts have far reaching repercussions, both geographically and over time. The cost to rebuild war-torn Syria has been estimated at USD 170 billion. Libya s infrastructure needs are estimated to be USD 200 billion over the next ten years. Another estimate notes that the output lost from the conflict with ISIS in the Levant stands at USD 35 billion. While reconstruction needs for Yemen have not yet been estimated given the ongoing conflict, humanitarian needs alone are around USD 274 million and rising. 3. Conflicts have had important consequences both inside and outside the borders of the conflict countries, as over 15 million refugees and internally displaced persons (IDPs) have flooded across the region, putting immense pressure on countries throughout the region. To this end, the conflict in Syria, as well as the unrest in other countries, have triggered the biggest forced displacement crisis since World War II. 4. Instability has also resulted in severe economic downturns affecting various countries across the MENA region. Many countries are grappling with chronic youth unemployment, undiversified economies, and a significant lack of investment. The slowdown in economic growth threatens long-term development prospects, as well as the overall stability of the region. Estimates further indicate substantial amounts of additional investments throughout the region are required to restore economic growth: USD 10 billion in the fiscal year, and USD billion over the next 15 years in Egypt 2 ; USD 6 billion per year in Jordan 3 ; USD 20 billion over the next 5 years in Morocco 4 ; and USD 10 billion over the next 5 years in Tunisia 5. Therefore, at this juncture, additional investments in the recovery of countries economies are critical to support broader peace and stability efforts. 2 Gulf News. 2015, September 12. Egypt needs more investments to boost its economy. 3 Mansur, Yusuf Discussion Paper: Overcoming Barriers to Foreign Direct Investment in Jordan. Free the World.com. 4 Meet Middle East. Morocco s multi-billion-dollar makeover. 5 All Africa. 2015, September 10. Tunisia: Development Plan Aims to Raise Growth to Five Percent. 3

5 5. The intensity, duration, and level of destruction of the conflicts and civil wars, as well as the growth slowdowns as a result of instability and violence, highlight the need for a major recovery and reconstruction effort in MENA. Given this scale of destruction, the traditional approach of waiting for the conflict to end in order to conduct a post-conflict needs assessment, and thereafter financing a reconstruction plan will not be enough. What is needed is a dynamic needs assessment and actions undertaken during conflict. Experience shows that this approach can be cost effective. Moreover, continued and additional support of countries impacted by economic volatility is critical in order to boost growth and spur investment. 6. Against this adverse background, the World Bank Group (WBG) is developing a new strategy for its engagement in MENA, aimed at promoting economic and social inclusion to contribute to peace and stability in the region. Underpinning the new MENA strategy are four pillars: (i) renewing the social contract between citizens and the state to address the underlying causes of violence; (ii) promoting regional cooperation to build economic interdependence and trust among countries of the region; (iii) strengthening the resilience of communities to foster their capacity to host refugees and IDPs and maintain and strengthen their development achievements; and (iv) mobilizing recovery and reconstruction efforts to rebuild societies impacted by conflict and unrest. 7. The WBG s strategic shift stems from the recognition that peace and stability are prerequisites for long-term development to take place. Moreover, given the large scale of conflict and violence in MENA, huge spillover effects have threatened not only the development of other MENA countries, but other regions as well. A reduction in conflict and violence in any one MENA country, therefore, will benefit the countries in MENA as well as other regions. Peace and stability in MENA are global public goods and thus a global coalition could pool resources and expertise to support peace and stability in MENA. As an international organization, the WBG can play an important role in collaboration with bilateral, regional and international partners in mobilizing the international community to form such a coalition. 8. To implement the new MENA strategy, and to address the urgent need for increased financing for the region, the WBG is seeking to mobilize the international community to: (i) support the recovery and reconstruction of MENA countries; and (ii) strengthen the capacity of countries and communities hosting refugees and IDPs to absorb the shocks to their economic and social fabric. II. A Call for Action 9. It is imperative for the international community to act now to support countries in the MENA region. As the 2011 World Development Report on Conflict, Security, and Development notes, development aid can significantly help address the costs of violence in countries immersed in crisis situations. International support in early recovery and reconstruction efforts has demonstrated that rapid and continued financial support is crucial in facilitating the transition from armed conflict into reconstruction. For example, in Mozambique USD 500 million a year 4

6 of external aid throughout the 1990s played a pivotal economic role in supporting private consumption at the outset, and subsequently in providing finance for investment and institutional strengthening that became the driving force behind Mozambique s economic growth. 10. It is critical to rethink support to refugees, IDPs and host communities, and adopt an approach that shifts from resilience to development. Given the scale of refugees (in Lebanon, they make up a quarter of the population) and the likely duration of their stay (the global median is 17 years), a major effort is needed to help these people develop assets. Moreover, as the welfare of refugees and IDPs is a global public good, the international community should help finance the building of these assets. Inasmuch as most of the host countries are middle income and therefore do not traditionally receive concessional assistance, financial assistance should be additional and concessional. III. Proposed Financing Mechanisms for the MENA Region 11. Given the extraordinary costs of conflict and unrest, the MENA region needs large volumes of financing for recovery and reconstruction, as well as financing at concessional terms. 12. The World Bank Group and the Islamic Development Bank Group (IDB Group) can support the MENA region through a toolkit of financing options, and in particular two distinct mechanisms that can be deployed separately, or combined, to provide additional resources for reconstruction and recovery and to countries affected by refugee inflows and IDPs. These mechanisms would raise additional financing to what multilateral development banks (MDB) currently provide in their lending portfolios. They are outlined below, with Annex I and Annex II providing further detail. (a) Financing Recovery and Reconstruction in MENA In support of countries in MENA that have significant recovery and reconstruction needs, the WBG and the IDB Group propose to use donor guarantees to provide additional financing in two ways. 1) Donors can provide guarantees on MDB loans or guarantee operations, thus opening up space in the balance sheet of MDBs. The amounts guaranteed by the donors would not count towards the lending envelope of the borrower, releasing capacity for MDBs to continue lending under their usual terms. 2) Guarantees can be used to back the issuance of a special type of bond that would provide additional financing at a rate more advantageous than what the countries would be offered by commercial lenders and capital markets. 5

7 In addition, the IDB Group and the WBG are collaborating on the design of a Sukuk (Islamic bond) structure for MENA countries that could be credit enhanced by guarantees from supporting countries. Sukuk will be structured to securitize assets and/or cash flows of the underlying projects in member countries and will provide credit enhancement through guarantees by supporting countries. Sukuk could be placed to both conventional and Islamic investors. (b) Providing Concessional Financing for MENA Countries Impacted by Refugees and IDPs In support of developing middle-income countries affected by refugees and IDPs, the World Bank proposes to blend grant resources from donors with MDB lending in order to provide concessional financing. Many of the countries in the region coping with large inflows of refugees are middle-income, and thus do not have access to highly concessional financing. There is thus a major financing gap, in which countries receive limited humanitarian assistance and do not have access to the medium- and longer-term development assistance required to address the scope of the challenge. In order to fill this gap, the WBG s proposal consists of calling for grants from donors to co-finance MDB operations and expand available resources to these countries, or to provide concessional financing to these countries, which could be used directly or bring down the implicit interest rate on MDB loans to more concessional levels. IV. Main Advantages of the Proposed Financing Mechanisms for the MENA Region 13. The proposed financing mechanisms aim at mobilizing financial resources for the MENA region with specific benefits to countries: Increased volume of financing. Both mechanisms provide a greater amount of financing, in addition to what MDBs currently provide to MENA countries through traditional lending programs. Furthermore, given the limited appetite of the private market to invest in many MENA conflict-affected countries, the proposed mechanisms offer substantial additional financing capacity. Advantageous financing terms. The increased volume of financing would be tailored to meet the needs of countries and with degrees of concessionality to achieve maximum impact. Furthermore, the financing provided would be at a more advantageous rate than what MENA countries could be offered through commercial lenders or capital markets. Focusing resources. Supporting countries would be given the flexibility to support all of the Underlying Loans or only a certain sub-set thereof. Rapid and coordinated development operations. These programs would allow for programs to be coordinated among various supporting countries and organizations, leading also to increased development effectiveness. Implementing Support Agencies (ISAs) will have a key role to play. Their expertise throughout the project cycle, from project preparation to supervision and procurement, 6

8 will increase the effectiveness of assistance and attract a larger volume of donor financing; Reduced transaction costs; and WBG market experience and IDB Group experience with Sukuk to raise large amounts of funding in the capital markets, quickly and at favorable terms. 14. The proposed financing mechanisms will be supported by both guarantees and grants. The use of guarantees makes it possible to raise large volumes of resources upfront from donors at a time of tight budgets. Donors will only be requested to disburse on guarantees in case borrowers default on their obligations. These guarantees will facilitate financing to MENA countries at below market rates. They may be deployed to fully or partially guarantee MDB loans, increasing the potential lending envelope or to guarantee a new bond issue. Grants, on the other hand, entail a disbursement by the donor, and may be utilized for: (i) blending with MDB loans to reduce the financing cost to concessional terms; (ii) prepaying existing loans, thus providing debt relief to MENA countries (this would also open up space in the potential MDB lending envelope); and (iii) providing outright grant resources. 15. The table below provides a menu of financing options in response to the various needs and specificities of countries in the MENA Region. Objective Raising large volume of financing for reconstruction operations Providing financing for the recovery of countries affected by economic downturns Supporting IDA countries with significant financing needs Providing concessional financing for countries impacted by refugees and IDPs Proposed Financing Tool Bond and Sukuk (Islamic bonds) Structure and guarantees on loans Bond and Sukuk (Islamic bonds) Structure and guarantees on loans Blending guarantees with grants Grants 16. The proposed mechanisms would require the approval of the World Bank s Board of Executive Directors, as well as the requisite approval from other MDBs involved. In addition, consultations with potential ISAs would be needed to ensure the terms of the proposed mechanisms comply with their respective policies and procedures. 17. Cross-default with other MDB loans. Each MDB acting as an ISA will need to determine if the Underlying Loans made by that MDB to a MENA country will include a cross-default 7

9 provision with the other loans made by that MDB to the same MENA country. Whether such a cross-default is consistent with the policies of a MDB will need to be considered closely and the answer may be different for different institutions. 18. Governance Structure of the MENA Bond Facility. It is envisaged that the governance structure would allow: Benefitting and supporting countries to contribute to shaping the resource allocation strategy for MENA recovery and reconstruction financing. Those countries would play a critical role in the proposed Steering Committee, in which decisions on projects, countries of focus, and funding would be made. International and regional financial institutions to play the role of ISAs for individual projects funded in MENA client countries. Such an arrangement would ensure a focus on the quality and sustainability of projects. Moreover, this would also entail that members of the Arab Coordination Group as well as European financial institutions could play a key role as ISAs under this governance structure. V. Next Steps 19. Lima Meeting and Next steps. The proposed financing mechanisms, as well as the formation of a Steering Committee, will be discussed at the International Stakeholder s Roundtable Meeting for the Middle East and North Africa Region in Lima, Peru on October 10, It is proposed that, following this meeting, a Steering Committee co-chaired by the World Bank Group, the United Nations, and the Islamic Development Bank Group be formed with the objective of designing the details and implementation roadmap of the proposed financing mechanisms, including its governance structure, so as to ensure that they reflect the priorities of supporting countries and meet the need of MENA countries. 8

10 Annex I. Financing the Recovery and Reconstruction of MENA Countries Background 20. The intensity, duration and destruction of the civil wars and conflicts in MENA are unprecedented. Moreover, instability has severely impacted economies across the region. Given the level of financing needed for recovery and reconstruction, it is crucial to provide additional financial resources. In order to support these countries, the WBG and IDB Group have developed two structures that would finance the large costs of recovery and reconstruction. Financing through Special IBRD Bonds 21. The bond proposal aims at mobilizing financial resources for the MENA region with the following benefits: Mobilizing long-term loans to MENA countries, backed by guarantees from supporting countries, to finance the large costs of recovery and reconstruction; Providing additional financing to MENA countries at a rate more advantageous than what the countries would be offered by commercial lenders and capital markets; Offering substantial additional capacity to those MENA countries, given the limited appetite of the private market to invest in most MENA countries; Providing financing off the balance sheet for the participating MDBs, thus not constraining their direct lending capacity; and Permitting supporting countries to lower the cost of financing for MENA countries, while only needing to make payments in the event payments from benefitting countries are insufficient. 22. The World Bank would leverage its existing bond issuance infrastructure and market reputation to issue a special type of bond. This would avoid having to establish a new financing vehicle, and therefore save on both time and costs. These bonds, which will provide up-front financing to borrowing countries in the MENA region, will differ from conventional World Bank bonds in that the World Bank s repayment obligations will be conditional on receiving repayment obligations from MENA borrowers, and thereafter payment from the supporting countries that provided guarantees in case borrowers default on their repayment obligations. Bonds Financing Structure 23. The bond transaction would be comprised of the following principal steps: The World Bank would issue bonds (the Bonds ) under its Capital at Risk Notes Program (CAR) to investors and hedge its obligations in respect of the Bonds by entering into a swap or similar agreement (the Bank Fund Agreement ) with a financial intermediary fund for which the Bank acts as Trustee (the Fund ); 9

11 Under the Bank-Fund Agreement, the World Bank would pass the proceeds of the issuance of the Bonds to the Fund; The proceeds would be managed by the Fund in accordance with a governance framework that will include, among other things: (i) decision making rules, and (ii) the scope of the use of funds by accredited ISAs; The proceeds would be passed by the Fund under financial procedure agreements to ISAs. The ISAs will then make loans to countries in the MENA region ( Underlying Loans ) on the agreement that all receipts under the Underlying Loans will be passed back by the ISAs to the Fund; The cash flows received by the Fund in respect of the Underlying Loans would be paid by the Fund (less any amounts retained by the Fund to meet its fees and expenses) to the World Bank under the Bank-Fund Agreement and used by the World Bank to pay principal and interest on the Bonds; Each supporting country would enter into a legally binding agreement with the World Bank (a Financial Support Agreement ) under which the supporting country would make payment to the Bank in the event of any default in the payment of principal or interest on any Underlying Loan; If a default occurs on any Underlying Loan, each supporting country would be obligated to pay its pro rata share of the defaulted amount based on its proportionate share of the aggregate amount guaranteed by all the supporting countries under all Financial Support Agreements. If any supporting country failed to pay its pro rata share, the World Bank would have the right to make up the defaulted amount by calling for additional amounts from the non-defaulting supporting countries (limited by the total amount of each supporting country s guarantee). World Bank Capital at Risk Notes Program In 2014, the World Bank created the Capital at Risk Notes Program (CAR) to facilitate risk transfer solutions for the Bank and its clients using the capital markets. Under this program, the World Bank can issue notes where some or all of the investors principal may be at risk. CAR notes are issued under a special supplement to the World Bank s Global Debt Issuance Facility and receive the same tax and securities law exemptions as any other IBRD bond, but do not carry the same credit rating. Using CAR notes, the World Bank can issue bonds that pass some or all of the risk of a project or underlying loan to a client to the capital markets. 24. Provided the aggregate amount guaranteed by the supporting countries under the Financial Support Agreements is at least as large as the amount of principal and interest due on the Bonds, the credit rating of the Bonds should be based on the ratings of the supporting countries. As long as the supporting countries are investment grade countries, an investment grade rating for the Bonds would be possible. 25. The commitment of the supporting countries would need to be legally binding, and timely payment of all amounts due would be essential. The Bonds will be repaid first from the Underlying Loans and, if those flows are insufficient to repay the Bonds in full, then supporting 10

12 country commitments will be drawn down. The nature of the commitments of the supporting countries would be materially different from traditional donor commitments. They would need to be unconditional, legally binding obligations that require the supporting countries to make immediate payments in the event of any failure to pay on the Underlying Loans. 26. The transaction can be structured with no anticipated draw down on the commitments (absent failures by borrowing countries to pay on the Underlying Loans) and allow a great deal of additional and cheaper financing to MENA countries than currently available from commercial lenders and capital markets. Of course, if the supporting countries allowed some of their committed funds to be drawn annually, this type of subsidy could be used to further reduce the cost of the loans to the MENA countries so that Underlying Loans could be made closer to MDB style concessional rates. 27. The issuance of the Bonds should be timed to correspond closely to the disbursement of the Underlying Loans. The cost efficiency of the Bond mechanism is predicated on rapid disbursement of the proceeds to MENA countries under the Underlying Loans. If cash remains in the Fund pending disbursement on the Underlying Loans, those amounts will incur a negative carry that likely would need to be covered by drawdowns on the commitments of the supporting countries. Therefore, the Bond mechanism is appropriate for funding rapidly disbursing loans (such as the World Bank s Development Policy Loans), or for multiple issues with each individual issue timed to correspond with specific disbursements on project loans. 11

13 Initial Estimated Pricing 28. For illustrative purposes, a hypothetical portfolio was composed of pledges from supporting countries with strong credit, at an average rating of AA. Based on this hypothetical portfolio, the Bonds could be placed at between LIBOR + 40 to 50 basis points (bps). 29. The funds raised would be on lent through various ISAs. It is assumed that the funds would be lent out on a ten year bullet repayment basis. Taking the World Bank as an example ISA, the World Bank would charge approximately 60 bps per annum above its funding cost to make a 10 year, bullet repayment loan. Therefore, it is assumed that 60 bps would be the amount charged by the ISA's for on-lending the funds. 30. It is further assumed that the Fund would have bps per annum of administrative costs. The World Bank, as Trustee of a financial intermediary fund, charges on a full cost recovery basis. Therefore, the actual per annum cost in basis points will be dependent on the size of the Fund and the amount of work needed to be done by the Trustee. This estimate is based on the costs of the MENA Transition Fund, and assuming a notional size of the Fund of USD 1 billion. Finally it is assumed that there would be 20 bps per annum of bond issuance costs, including the cost of the World Bank managing the issuance operation. 31. In the aggregate, these costs would result in an initial estimate financing being in the area of LIBOR to 155 bps. This is a rough estimate based on current market conditions and the assumptions noted previously. This hypothetical pricing also assumes the funds can be onlent immediately after the bonds are issued. To the extent, funds remain in the trust fund pending disbursement through ISAs. Moreover, those funds would be subject to a negative carry that would add additional costs. 32. Although this rate would be above MDB concessional levels, it still should allow the funds to be on lent to countries at well below their market rates. Based on current market rates, below is an initial estimate of how those loans would compare to current market levels: Interest Rate Compared to Private Market Iraq Jordan Egypt Tunisia Lebanon Morocco 500 bps cheaper 250 bps cheaper 250 bps cheaper 200 bps cheaper 200 bps cheaper bps cheaper 12

14 Islamic Finance: Leveraging the Strong Partnership between the WBG and IDB Group 33. The IDB Group and the WBG are collaborating on the design of a Sukuk (Islamic bond) structure for MENA countries that could be credit enhanced by guarantees from the supporting countries to finance sovereign and MDB projects. A Sukuk structure is an assetbased securitized bond which has been successfully utilized to mobilize funds for development by multilaterals such as the IDB Group, the International Bank for Reconstruction and Development (IBRD), and the International Finance Corporation (IFC). Sukuk could be structured in several ways depending on the nature of projects and underlying assets. 34. The Sukuk structure to support MENA countries could be potentially designed as detailed below: The proposed structure is based on securitization of projects where the investors or Sukuk holders participate in the cash flow and outcomes of the projects; Credit enhancement is provided through sovereign guarantees by supporting countries similar to the proposed guarantees for conventional bonds; Due to securitized nature of Sukuk structures, a trust in the form of a special purpose vehicle (SPV) is established to protect the interests of the investors, who are issued participation or ownership certificates by the SPV; In order to overcome potential issues with ownership rights to the investors, it is proposed that in select country cases, a dedicated government entity, a Sovereign Development Corporation (SDC), is established. The SDC would ring-fence the pool of underlying assets and projects to be securitized; The proposed structure would be flexible to provide funding for either IDB Group or WBG projects; and All contractual agreements among issuers, investors, the SPV, and the SDC would be required to comply with the requirements of Islamic Law (Sharia). Expanding the Lending Envelope of MDBs through Donor Guarantees and Grants 35. Donors can also provide guarantees on MDB loans or guarantee operations, thus opening up space in the balance sheet of MDBs. The amounts guaranteed by the donors would not count anymore towards the lending envelope of the borrower, releasing capacity for MDBs to continue lending under their usual terms. There would be a limited use of capital to reflect the increased exposure to donor s credit, but it would not be significant, as guarantors are expected to be highly rated sovereigns. An advantage of this alternative is its simplicity in terms of mechanics, as donors could guarantee loan amounts as they get disbursed, avoiding any cost of carry. Another advantage is that the additional financing made available to countries would be priced at the MDB pricing. 36. Some donors could face constraints in providing guarantees, as these instruments generate contingent liabilities and could require a complex appropriation process, preferring instead to provide direct grants. These grants could be used to reduce the cost of financing of MDB lending to more concessional levels. An efficient mechanism to achieve this goal is through the partial prepayment of outstanding MDB loans. 13

15 Annex II: Providing Concessional Financing to MENA Countries Impacted by Refugees Background 37. The WBG can support developing middle-income countries by blending grant resources from donors with IBRD lending. Many of the countries in the region such as Iraq, Jordan, and Lebanon coping with large inflows of refugees are middle-income, and therefore do not have access to the International Development Association s (IDA) concessional financing. There is thus a major financing gap, in which countries receive limited humanitarian assistance and do not have access to the medium- and longer-term development assistance required to address the scope of the challenge. 38. In order to fill this gap, the WBG s proposal consists of calling for grants from donors that would in effect provide concessional financing to these countries, by bringing down the implicit interest rate on IBRD loans to IDA s concessional levels. 39. As some donors could face constraints in providing guarantees, given that these instruments generate contingent liabilities and could thus require a complex appropriation process, they may instead prefer to provide direct grants. These grants could be used to reduce the cost of financing of MDB lending to more concessional levels. Structure 40. Donor grants could be applied in different ways to meet donors and recipients preferences, reducing the overall cost of the financing to a pre-agreed level of concessionality: Grants are applied to the partial a prepayment of an MDB loan, either upfront or over time (in which case, funds can be maintained in a trust fund or foreign investment fund account); Grants are blended with MDB loans as part of the financing package; and Donors make payments over time to the country or MDB directly (on the borrower s behalf) to buy-down the interest rate. 41. If donors are prepared to provide upfront grants, a prepayment may represent a more efficient way to bring down the effective interest rate on a loan. This would release headroom in the process, and would be more effective compared to an interest buy down fund where the expected investment returns would be lower than the interest rate on the loan. 42. For example, in the case of the WBG, a USD 100 million future IBRD loan would mean at current rates that an approximately USD 32 million grant would bring IBRD to IDA concessional terms. In terms of grants this would mean that USD 100 million in grant contributions could bring down approximately USD 310 million from IBRD to IDA terms. These donor funds could thus be employed to bring down the financing for existing IBRD loans. 14

16 Mechanics of a Co-Financing Scheme through Prepayments 43. One of the alternatives to blend regular MDB loans with grant funds to reduce the overall cost of the financing package to highly concessional terms is through prepayments. Under this type of arrangement, donors would make grant payments to the MDB directly as a prepayment or to a trust fund, which would be used to partially prepay MDB loans, and effectively reduce the cost of servicing the loan to a pre-agreed level of concessionality. A partial prepayment reduces the outstanding principal amount of the loan, providing interest savings on the loan over its remaining life. 44. The concessional financing mechanism would be comprised of the following principal steps: A Trust Fund agreement is set up, including the payment of administrative fees; Donors make payments into an IBRD-administered Trust Fund account to cover the initial buy-down of outstanding loans, as well as projected disbursements on new loans. Amounts can be deposited upfront (and invested by the Trust Fund) or replenished over time, as new loans disburse, depending on donors preferences for the appropriation of funds; IBRD invests the funds in high quality assets on behalf of the Trust Fund; As new disbursements on pre-selected loans materialize, the Trust Fund makes a payment to prepay the MDB loans on behalf of the borrower (subject to a prepayment premium, if applicable); The borrowers continue repaying the MDB loan with the reduced notional, at the original interest rate; Once the selected loans are fully disbursed, the Trust Fund can be closed. Donor 1 Donor 2 Donor 3 Grants Investment Trust Fund Investment Returns Prepayment on behalf of borrower MDB Debt service on remaining outstanding loan High Quality Assets Borrowers 45. The following would represent the outcomes of the aforementioned concessional financing mechanism: The effective financing cost of an MDB loan is brought down to more concessional levels (e.g. IDA terms); The prepayment releases the country lending envelope for the MDBs, increasing overall financing capacity for these countries; 15

17 Donor funds are channeled to projects sponsored by the MDBs, in line with their usual policies and procedures (i.e. procurement, safeguards, etc.); Administratively, borrowers interact with only one stream of funds (the MDB loan) over the life of the loan. World Bank prior experience implementing similar IBRD blending mechanisms: China (2002): China needed to expand its efforts in the diagnosis and treatment of tuberculosis, to reach more of the country s poor population. In order to implement the project successfully, China needed to fill a financing gap of about USD 100 million at highly concessional interest rates and very long tenors. The United Kingdom Department for International Development (DFID) was willing to provide USD 36 million in grant funds and work with the World Bank to support China s efforts. Combining DFID s grant with a regular IBRD fixed-spread loan would provide a means to soften the financial cost of the overall package. The USD 36 million DFID grant was used to prepay the IBRD loan in phases as the project disbursed to reduce the interest burden of the overall financing package. The structure was replicated in two subsequent China projects. Mexico Energy Efficiency Program (2010): This co-financing scheme allows the World Bank, the Clean Technology Fund (CTF), and the Global Environmental Facility (GEF) to jointly support Mexico s National Climate Change Strategy. The customized financing package for the Mexico Efficient Lighting and Appliances Project involved blending a USD 50 million loan from the CTF under concessional terms with a USD 250 million IBRD loan and a USD 7 million GEF grant. Funds are being channeled through NAFIN, a state-owned bank, and through the federal government. The project may also generate future carbon revenues, which could be reinvested in the transformation initiative. 16