0 - o~~~~~c G3 c GS] i iD g;. ca:D ign( IFC and Its Role in Globalization Highlights frnm TPGC's Particinants. Mpptingr * W. ahingtn, D.CG June 6-7, 2001 Copyright C 2002 The World Bank and the International Finance Corporation 212 Pennsiiiylvaniai Avenue, IN. vAv. Washington, D.C. 20433 USA www.ifc.org Al! rights reserv Manufactured in the United States of America First printing, May 2002 ISBN 0-8213-5179-6 The findings, interpretations, and conciusions expressed in tnis study are entirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. IFC and the World Bank do not guarantee the accuracy of the data included in this publication and accept no responsib-illity wh'atsoever f0r any consequence of' their use. To order additional copies by mail, write to the World Bank, P.O. Box 960, Herndon, VA 20172-0960, USA; by phone, 1-800-645-7247 or 703-661-1580; by fax, 703-661-1501; by e-mail, www.books@worldbank.org. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Copyright Clearance Center, Inc., Suite 910, Rosewood Drive, Danvers, Massachusetts 09123, USA. Telephone: 978-750-8400; fax: 978-750-0569; web address: www.publisher@copyright.com Library of Congress Cataloging-in-Publication data have been applied for. Table of Contents Preface vii Suellen Lambert Lazarus-Director, Syndications and International Securities, International Finance Corporation Acknowledgments iY AbhrPviantinnc ani Arrnvm.m v SECTION I At the Center of Globalization Chapter 1 The Unique Role of the International Finance Corporation 3 Peter L. Woicke- Executive Vice President, international Finance Corporation, and Managing Director, Private Sector Development, World Bank Ch' -. apter 2 The Global implications of Pover-1, 7 James D. Wolfensolin-President, The World Bank Group Chapter 3 Globalization as an International System 10 Thomas L. Friedman-Foreign Affairs Columnist, The New York Timnes Chapter 4 International Financial Stability and Sustained Growth 21 Horst Kohler-Managing Director, International Monetary Fund Chapter 5 The Consequences of Globalization for Asian Ranking 27 John T. Olds-Special Advisor to the Chairman, DBS Bank, Sinlgapore SECTION 11 The International Finance Corporation and Our Market Environment Chapter 6 Update on Financing Operations 37 Assaad J. jabre-Vice President, Operations, International Finance Corporation Chapter 7 Portfolio Performance and Future Plans 43 IaiudA 1xUalU Laua-Vice PresidnIt, rtIfLIlIIo dIlU isk1V1d1IdMaa 1LLt, International Finance Corporation Chapter 8 Trends in Syndicated Lending 47 Siipllpn T amhprt T a7zrus-DirPctor yvndicatio,ns and Intprnational Securities, International Finance Corporation Chapter 9 Restructuring Problem Loans 54 Mary Elizabeth Wv^v'ard-Manager, B-Loan Management Division, International Finance Corporation SECTION III Enhancing Value: Investing in Sustainability and Corporate Governance Chapter 10Sustainabiiity: A Portfolio Manager's Perspective 59 Julie Fox Gorte-Senior Environment and Technology Analyst, The Calvert Group Chapter -111 Sustainablit:14 A dCommlercial Bank1's PeseAie6 ,IIaJL. I I 3U L iLnaUiiiIJLY . r-1 1.,U1I1L1d L I dfiK n E VFNpC;-L1VU U'± Bart Jan Krouwel-Managing Director, Sustainability and Social Innovation Group, Rabobank Nederland Chanter 12 Corporate Governance: A Call to Artion 69 Peter H. Sullivan-Chairman and Chief Executive Officer, Lombard Investments, inc. Chapter 13 Corporate Governance: Its Impact on Investment Flows 77 Peter C. Clapman-Senior Vice President and Chief Counsel, Invrectme,,t, TeahrsT- Insurance -an- - Annuit A-AcAto........ Retirement Equities Fund Chapter 14 The International Finance Corporation's Focus on Corporate Governance 81 Mike Lubrano-Senior Investment Officer, Financial Markets A J . _ _ . I ' - 1 -- tIUVInOy IJUCdleIICIIL, 1ILMUella0llal rihiaiie oUrporaLton SECTION IV The New Basel Capital Accord: Implications for Bank Lending to Emerging Markets Chapter 15 An Overview of the New Basel Capital Accord 87 Jonathan L. Fiechter-Senior Deputy Comptroller for International and Economic Affairs, Office of the Comptroller of the Currency Chapter 16 Country Risk in Basel 2 96 Frans Cornelissen-Seenior "Vice President11, iieaU VI CoVuntry Riskb Management, ABN AMRO Bank Chapter 17 Basel 2 and Emerging Markets 100 Ernest Napier-Managing Director, inancnral Services Group, Standard & Poor's iv Chapter 18 Basel 2: Possible Impact on the International Finance Cornnration's B-Loan Program 105 Dirk Muller-Partner, Financial Services Consulting, Risk Management, KPIVRG SECTION V The Business of Project Financing Chapter 19 Dealmg ,^,tth Vti Polm: Two Cases Part (a): A. 0. Volga, Russian Federation 111 Jyrki I. Koskelo-Director, Special Operations, International Finance Corporation Charles Van der Mandele-Chief Special Operations Officer, International Finance Corp-ora1tt-0ion Anke Avderung-Director, Global Debt Origination, Dresdner Klienwort Wasserstein rrainrcis Hamilt-SenioC Adviser, Syndicain, InternationalC Finance Corporation Part (b): Tuntex Petrochemical Thailand 122 rirc JouirrdanPt-Senior Tnvpet.mpnt C.fficer ,l Oi, Ga, nd Chprmicals Department, International Finance Corporation Alma Ourazalinova'-Participations Officer, Syndications and International Securities, International Finance Corporation Vera Reusens-Senior Manager, Global Export and Project Finance, Fortis Bank Chapter 20 Investing in Environmental Projects 133 Louis Boorstin-Manager, Environmental Markets Group, Brooks Browne-President, Environmental Enterprises Assistance Fund James D. Westfield-Managing Consultant, PA Consulting Group SEC IUI' 'V'I lflnnovailons Chapter 21 The B-L oan Website I 47 Andy McCartney-Managing Director, eHatchery, LLC James Smouse-Project Manager, B-Loan Website, International Finance Corporation v Chapter 22 investing in Education: INIIi Student Loan Program 155 Guy Ellena-Technical Manager, Health and Education Department, International Finance Corporation C. N. (Madhu) Madhusudan-President, Strategic Aliiances, National Institute of Information Technology (USA), Inc. Nicholas Vickery-Investment Officer, Financial Markets, South Asia Departlm,ent, Tnternational Finance Corporation Program of Meeting 166 List of Attendees 173 vi The International Finance Corporation (IFC) syndicated its first loan in 1959. But it was not until the late 1980s that mobilizing commercial bank finance, alongside our own loans, grew into one of the central fea- tures of the A,Corporation's b-usiness. Ily then, we were syn(dicating B3-loan participations to almost all the world's leading commercial banks, and to many smaller financial institutions. IFC has introduced banks to coun- tries and sectors that otherwise they would not have considered acceptable risks. With the rapid growth in the v nolume and variety of project risks being shared, inevitably some policy and implementation issues developed. Eleven years ago we invited a few of our leading partners to a one-day meeting in Washington, for a general discussion of the main aspects of the B-loan program. This first Participants Meeting, in April 1991, was attended by some 25 bankers. who supported the idea of making it an annual event. AL ILS nIICtpLtIon Wte hlaU litleC IInoti 01 WhICer tills mOdUSt inliLiative would take us. The meetings are now evidently a fixture in the diaries of many leading international project financiers. Attendance has grown to over 200 representatives from 100 financial institutions, based in all the world's major markets. Many more would like to attend, if we had room. ,he range of topics and -pakr,- the- ___-_n ofdea_;ile-nor.ainpe A. it t~l IE LVF`at~ al`t aF "afA1, tIt. allIVilULIL VI UL,LaIitlk,1111131 IIaLISJiI F`I sented, and the publicity generated by the meetings have far exceeded our early expectations. For senior banks working in emerging markets project finance, it is a conference of considerable importance. But the central objective is unchanged: to provide a forum for a frank and open discus- sionenbetwen IFC and our B-lenders, WAe are also pleased to reciprocate some of the generous hospitality we receive from so many of you through- out the year. We give the facts on portfolio performance, market trends, internal IFC policy changes, and some of the major transactions in our pipeline, but we also ask for, and heed, the opinions and recommenda- tions of our Dartners. For examDle. [he B-loan sales website described in Chapter 21 is an innovation based on requests from our participants for increased liquidity. For those who have been working in this field the history of project finance is one that is not well documented. The lore of excruciating proj- vii ect structuring exercises and restructurings that continue for many years ic npcase nn frnom hbnn tn bank, hiut seldolm recnrded. FEah vyer at the Participants Meeting we discuss some important case studies. Contrib- uting to a recorded history of project finance experience in emerging mar- kets was part of our motivation for producing this volume. The 2001 meeting was our best attended and most comprehensive, so much so that we also considered the main proceedings to be worthy of publication. The topic of globalization was explored in detail by Tom rriedurman in 11hi lascinaig expUsitio0n on0 he role 01 goUUalization in transforming world affairs, by Horst Kohler on the changing role of the International Monetary Fund, by Jim Wolfensohn on the importance of alleviating poverty, and by Peter Woicke in considering IFC's role at the center of the globalization debate. The present volume is designed, there- fore, to recordzntwrAh a n il ndL as asn eler.ent o4f cntLy vvi the 2002 meeting, to which I am now happy to welcome delegates. Suellen Lambert Lazarus Director, Syndications and International Securities International Finance Corporation viii Acknowledgments We thank the many contributors to the book for their excellent pre- sentations to the 200i Participants Meeting and for their careful reviews of the transcripts. I would also like to acknowledge and extend deep appreciation to Venka V. Macintyre, Alison H. Pefia, and Henry Rosenbohm, who each contributed to making this book a reality. Special appreciation and gratitude goes to Deborah Barry whose striving for per- lUctLUon dllU tiUiliniess's Kept tUle UUbok 01 track, anLU tu rtouancis Tlamiltolln who organized piles of text into a coherent and readable format. The staff of the IFC Syndications and International Securities Department work tirelessly to make each Participants Meeting a success and I thank them for their exceptional efforts. ix A- LE.... 2. - - - AbbreviauiEons andu Acronyms ACGA Asian Corporate Governance Association BCGF Brazilian Corporate Governance Fund CalPERS California Public Employees' Retirement System CCL Contingent Credit Lines CMCG Capital Markets Consultative Group Committee Basel Committee on Banking Supervision CP-2 Second consultative paper of the Basel Committee on Banki_gSuer__o EAD Exposure at default ECA Export credit agency EdF Electricite de France EPC Engineering, procurement, and construction GEF Global Environment Facility GMS Good Morning Securities 1i '^., lTterlnadLtU1Idn 'nandceLt orUlpUrdatUI IIF Institute of International Finance IMF International Monetary Fund IRB Internal ratings-based IT Information technology ITICs International Trade and Investment Corporations LGD Loss given default ~LIDBOR Lond'on interbank offecred' rate NGO Nongovernmental organization NIIT National Institute of Information Technology OECD Organisation for Economic Co-operation and Development PCS Preferred creditor status PD Probability of default x PRI Political rkl insurance PSAG Private Sector Advisory Group PTA Purified terephalic acid PX Paraxylene REEF Renewable Energy and Energy Efficiency Fund SMEs Small- and medium-size enterprises SOU Special Operations Unit SRF Supplpnmenta! Resrve Facility SRI Socially responsible investments TIAA-CREF Teachers Insurance and Annuity Association-College Retirement Equities Fund TPT Tuntex Petrochemical Thailand TTC Tuntex (Thailand) Public Company, Limited WBTRCSD NATnr]A,l Rcinpcc fr,iinrl for Cuictninih1p ThPxjlAnnment xi At II C r u I At the Center of Globalization C H A P T E R 1 Th I e %UUniquwe Ro'e ofU the erna:iona' Finance Corporation reter L. VVUIice Executive Vice President, International Finance Corporation, and Managing Director, Private Sector Development, World Bank Of all the complex forces driving the world's economies today, global- i7a1tion is surplv nuimnher nne. Fnr thlosep who lhavp Pmhrarpcd it lnhioAli,q- tion has generally worked well. For those who have not, things have gone badly, creating a growing gap between the richest nations and the poorest. About 250 years ago the "wealth ratio" was 5 to 1. The richest nation was five times wealthier than the poorest. Today that ratio is approaching 400 to 1. Some people might call this ratio an index of despair. Developmental bankers would call it an index of opportunity. In our eyes, globalization represents an opportunity to add local value to erneriging rnarkets. That opportunity is the underlying theme of this volume, which brings together in edited form the papers and comments presented on globaliza- tion at the International Finance Corporation (IFC) Annual Participants Meeting held in Washington, D.C., on June 6-7, 2001. TUC' sees itself at the very center of th 1e giobl-zah-o- proess Nothe Ii. '., 3. IL3IL Lt L.A.I .f L IAJttt Lilt u,l.JLA `nAtliJ Flt` aao3 If) ~JL,1LI financial institution stands at the dividing line between the entire devel- oped world and the entire developing world, between the public sector and the private sector, between economic, financial, and environmental realities on the one hand, and government policy objectives on the other. B ecause of its status, because it nmust deal wzith the issues surrounding IFC and Its Role in Globalization globalization every day, and because it always operates through partner- s1_1ps with other finanial institutions, I - is in a unique position to take the lead in grasping this opportunity. Equally important, IFC has an impressive track record, with successful investments throughout the developing world. A number of its member countries-such as the Czech Republic, Hungary, the Republic of Korea, anld PolnA_5Ind conmP zPctnrsz in it,, mpmhpr conintripe in T atin Amprica; have recently graduated from the institution's support. IFC is proud to say that it is no longer investing in certain countries and sectors because they can generally be financed by the private sector alone. In other words, IFC's business model seems to be working. At the same time, the model is changing. as IFC moves increasingly to frontier countries, regions, and sectors, each of which has an effect on the way IFC does business. That is why, in the coming years, IFC's luaU s-ynudications wiH Lecorne ever II.ore innovative, both as a virtue and as a necessity. Of course there will always be major financing needs in the advanced economies, and right now the world's major commercial banks and infra- structure companies do their core business there. However, the truly transfo-rml.laonal oporuite lie --e,l-rn rrakts.IC's ir.vest tiai L,uu,i I UFF0' tLLIILIL3 11~. II ~I j.n ni fh Il..3 IL II t- ments today cover the spectrum-from factories to power projects, and from banks to schools and hospitals. In the energy sector, for example, IFC recently closed syndications on two very large Electricite de France-spon- sored steam-generation plants in Egypt. These projects are supported by 17year Bloai c ts, lA-In-pet R-laanc in T1C',c hictnrxr 1AT1irilh wPrp nvprcilh- scribed by 25 percent. IFC is also finalizing financing of a high-impact pipeline project in Chad and Cameroon. Though initially subject to a good deal of contro- versy, the project eventually received strong support from banks and bilat- eral agencies hecaus,e of IFC's value-added involvement and the imnrove- ments that, as part of the World Bank Group, it has promoted in environ- mental and social areas, including financial transparency. These improve- ments will reduce risks for the sponsors and IFC's financing partners, and will be of real benefit to the people of Chad and Cameroon. IFC is also doing important work in the transportation sector, partic- ularly with airports. In 2001 it closed a transaction that will allow Costa Rica to rehabilitate anud expand Its rnain airport. A sillHUdLilta tion involving the Metro Manila Airport is of special interest because of its 4 Sectioni I At the Center of Globalization longer tenor. At a time when markets are moving to shorter tenors, par- ticularly in difficult country environments, IFC is pushing toward the 10- to 15-year range because of the importance of longer-term financing to infrastructure projects. iFC is able to mobilize loans of such tenors because of its track record and its participants' confidence in the B-loan program. Another high-profile example of the range of IFC's business comes from Mozambique, which only a few years ago was one of the poorest ~~ 1-_1 -__ _J- : countries in thiie worldJ, UevastateU by civil war adIU II uire need o Uetter infrastructure. Based on an IFC partnership with other investors and bilat- eral institutions that recognized the opportunity provided by Mozambique's natural resources and location, a US$1.2 billion project was launched for a state-of-the-art aluminum smelter, named Mozal. Even more impressive, the project came in under budget and ahead of schedule. The plant is now a player in the world market, and management is asking IFC to finance an expansion that would double the smelter's capacity. Where else in the world is there such an opportunity to rise from absolutely nothing to a world player virtually overnight? Furthermore, the snnnsors of Mo7zl nre in it fnr the Inng rumn determined to gain frnm the project, but also to benefit the local communities. In addition to provid- ing jobs for local people, they are providing traditional safety and Training programs for their staff, and anti-malaria and anti-AIDS programs. The sponsors are also helping other local companies, mainly small- and medi- um-size companies, by actively seeking their involvement as suppliers to Mozal. The company worked with IFC to put these value-added measures ino Its UUbsiICss pidla, dlU It WUorks! IlICy mIae iLt ad fdi UCettCI LrolIlpady, one that will undoubtedly improve shareholder value over time. Government ministers have indicated that Mozal has put Mozambique on the map. Before its inception investors said they did not even know where Mozambique was; now they are willing to go there and invest their rnoney in partnership .with the, - ontr; This is pvtr--plh, -cit-ing, -n -1l1S. 11FJa 111-1--. VII- -,l t'JIIL . ..111 1 -0 .. tfLtf1. .. tnii ,~ (Il overnight success, with the private sector learning a new way of doing business. It is learning from the globalization debate that successful busi- ness should also be socially responsible, and social responsibility means financial sustainability. 1PC ic holninc rn-mnniniPc Alervlnr, mnc iep thic mcdepl-h.ut thp tnz& iz not easy, and IFC needs help. Without financial partners, without lenders, 5 IFC and Its Role in Globalization IFC's impact is limited. That is why it is turning away from the old model 01 of : dong b u sine s s, theV "i-1drewCarei loe.'CangecleWi model the "gospel of wealth." The idea was to earn one's money first, then to accept one's responsibility for inheritance and taxes through philan- thropy and through grants. The problem with that model is that it creates a delay in sharing. The new model, the model that IFC promotes now, is completely dififerent t -nt. It rnis the speed and the nes ofthe new mi!- lennium. Responsibility is needed as wealth is created, not just afterwards. That means protecting the environment today and looking at this not as a burden, but as a value-added activity. IFC's true mission is to be a leader in promoting sustainable develop- ment Puht simnl;v this means actively nromoting financially sound and profitable projects that will be assets for everybody, including the local communities. To be an asset to the coCu-l nIity a project rnust have sound corporate governance and transparency and be respectful of environmen- tal and social standards. This is taken for granted in some parts of the world, as a sound business practice that is necessary to reduce risk. However, sustainability is the same everywhere, even in the developing countries. ThIle cla'llenge is to maLU thLIs IIr IIUUl VVUIn III eIy sectr,i every region where IFC and its partners do business today. Examples of its successful use, which can be seen in a number of projects, clearly show that the model offers a means of adding value for the private sector, increasing developmental impact, and reducing the risks for IFC and its business partners All of these issues are at the intensely busy crossroads of globalization today. Private finance must not circumscribe this market, which needs to support those seeking new investment opportunities around the globe. IFC can help private finance do just that. In developing countries these investmnPnt, rpquire power, roads, water Internet connertions, schools, hospitals, and social services. Private finance needs to support local enter- prises. These local suppliers, vendors, and buyers will help build stable domestic capital markets to meet changing and expanding financing requirements. By working together, IFC and its partners can create enormous oDDor- tunities for all, including the people in developing countries. This is our unfinished agenda. 6 C H A P T E R 2 The Global Implications of Poverty James D. Wolfensohn President, The World Bank Group Instead of commenting on the latest techniques of B-loan lending and Ltl r UIarkable iaiiatves LhiaL IIave LVIlL out VI parLtn.IrIhaips ubLvveenI Lthe World Bank, the International Finance Corporation (IFC), and other institutions, I would like to take this opportunity to muse about some broader issues that tie in with globalization. Many of these issues are of such grand scale that one might say they are fundamentally insoluble nroblimec The nroblenme that weTP arp dlain wnth AA7tl, f course, ncxrprtv growth, and-ultimately-peace on our planet. As a result, the concerns of tne woricd Bank Group' are spread across 80 percent of the world. Our concerns lie with 4.8 billion people out of the 6 bil- lion who inhabit the earth. Those 4.8 billion account for only 20 percent of the gross domestic product (GDP) of the world. Here is a colossal problem in itself: there are many, many more people in the developing world with mucn less money than those of us from the deveiopeu worlu are blessed with. It is roughly an 80-20 split: 80 percent of the people with 20 percent of the GDP, the other 20 percent with 80 percent. This situation presents us with a moral and economic dilemma. It is clearly a social challenge. When we look more closely at the trends within the so-called develop- ingr adIl tranitionIl coVuntries th'at account foril only 20 perce,,t of vVorld GDP we find that the gap between the rich and poor is expanding, not diminishing. The rich are getting richer while the poor do not do as well, and in many cases are growing even poorer. This gap is also a worrying 7 IFC and Its Role in Globalization phenomenon for those of us in the developed countries. That is why the issues of development touch all of us on this planet. This is where global- ization-and what it means-hits us dead center. Many inside our institutions and many of our shareholders recognize that poverty in the developing world is poverty for everyone. The issues of development and the issues of globalization are very closely linked. We look at globalization and we reali7e that all 6 hillion of us are connected by many factors: the environment, crime, migration, drugs, health, social and political conflict, trade, and rlnance, to name but a Lew. As we all know, things that happen in developing countries can shake our own markets, and can affect our interest in financing local projects. That is why we who work in finance and development need to recog- nize that our imperatives today have a new dimension. We can no longer treat thle mlloal andU socidal issues 111 Gi-voping countries as thoughl thillY exist only in remote parts of the world. These are issues facing the entire human race. They are emerging in a world that is ever more unified and where one cannot say that the responsibility for what happens out there in developing countries is no longer relevant to us. It is relevant-to all of us. A, .ve look, f-r,-A -nt- see anor 2 bl-nrlonfp livi nn the plan- et in the next 25 years. The world's population will increase from 6 billion to 8 billion. Of that new 2 billion all but 50 million will be found in devel- oping and transition economies. That means that by the year 2025 or 2030 these economies will be struggling to support not 4.8 billion people out of 6 billion, but 6.8 billion people out of8 billion. There will be enormous social stress and tension, and the differences between rich and poor will become even greater, as the pressures on resources and the environment mount. It will become necessary to dou- ble our food production, a tall order in itself. Equally worrisome, 40 per- cent of our planet already has inadequate water-what will it be like in 25 or 30 years? Then there is the question of space, and where we will put all these people. How will we be able to meet their health and social needs? Countries of the developed world will have changed, too. Europe will have a smaller and older population than it does today. The European mar- ket will probably expand, but its national characteristics will change dra- matically. There will also be an older United States, but its population will L ---IA :, - _.-_1I L . M A_ A _ A_ uc larger Ubtause U1 IullllIldLLUII, dILU IL Will IIaVC d Ullu-CIIL CLUIIIc. 111. Another continent that is changing rapidly is Africa, which today is home to 600 million people. In the next quarter century, this figure is expected to 8 Section 1 At the Center of Globtalizaltion climb to 1.1 billion, despite the enormous toll that will be inflicted by AIDS. Herp too thp effprt nf globalization can be seen- in that an AIDS epniclenic in any one part of the world could easily spread to other parts. i do not mention these various issues to sound a sour note aoour mne prospects for dealing with the questions that confront us. Rather, I see in them a real opportunity to help the developing and transitional markets even as their populations grow by 50 percent. That is how we will be able to address some of the social ills present in the world today, and that are loon-iinig onL Ule IIoIIzoII. IlilS WIll Ut d UylldlillL 11101 CtL, dIlU IL Will r,IUW at twice the rate of that in the developed world, because sheer numbers will push it forward. It is a market that will participate in trade signifi- cantly more than it does today. There will be opportunities for invest- ment, job creation, and poverty alleviation. TndeeA, irf there is to be peace on our plan-It, it is absolutely essential that we deal with the question of poverty. Poverty is no longer a distant idea or a minor social issue for us in the developed world. It is an issue that has large implications for global stability and peace. As bankers, investors, and advisers we must begin looking at the B-loan program, not just as a matter of invpeting intelligently but as the fiilfilliment of a vision that equates contributing to the development of these countries with con- tributing to peace and security. Because or gloDalizaiion it is no longer a far stretch to say that. If there is no financing for these countries, instabil- ity will prevail. If there is instability, it will not be confined to developing and transition economies. Their instability will be our instability. The point I wish to press home here is that we have unprecedented opportunitiles UotL for se11i0Us investingVt , in gr0Wth mar1Nkets a_4 1o1 --on- tributing to the stability of our planet. I say this not as a sales pitch, but as a sincere call for greater private involvement in this kind of investment. There is no way today that the issue of global peace and stability can be left to multilateral institutions or to governments alone. The stability of our plan- at deends alsn on th1 private sc-tnr -n d civ ipt-, Thlt i - why we reanrd ILt 4y110111 iL "IFV - ---L-L- - t ILI VII -1I U7. tIl 110 -7 llJii the B-loan program and its partnerships as a vital step not only toward mar- ket growth but also toward greater equity, greater social justice, and greater peace everywhere. Above all, we must do this for our future generations. The World Bank Group consists of the VVorld Bank (comprising the Internatiolial Balik for Reconstruction and Development and the International Development Association), the International Finance Corporation, the Multilateral Investment Guarantee Agency, and the International Centre for Settlement of Investment Disputes. 9 C H A P T E R 3 Globalization as an international System Thomas L. Friedman Foreign Affairs Columnist, TheANewV-o,* T7-,e The subject of globalization has long been of intense interest to me because I believe very strongly that this phenomenon is not a trend, not a fad, and not a Nintendo game. It is, in fact, the international system that lhas rpnlarpc the CGld- WVr syutpm Thant is the centra! arauiment of my recent book on this subject, The Lexus and the Olive Tree. In it I explain that globalization, like the Cold War system, has its own rules, logic, pressures, and incentives. In due course this system will affect everyone's country, everyone's company, and everyone's community, directly or indirectly. While it is true that globalization is not "global" in the sense that it does not affect every region equally, nor does every region have equal entry to the system, globalization uoes touch every corner of the globe, directly or indirectly. These effects are best explained by comparing this new system to the Cold War system. The Cold War system was characterized by one over- arching feature: division. The world was a divided place; in that system all threats to and opportunities for a country or a company tended to flow from11 LIl th UUIILnty orl oUllpalLy ilowuli Wllll thiiy WerC UdViUvU. Tliat UiVisiVe system was symbolized by the Wall-the Berlin Wall. The globalization system is also characterized by one overarching fea- ture: in this case, though, it is integration. In this new system all threats and opportunities flow from the country or company to whom you are conneclted. This3 Ot1.3 37 is --blized Ibh web-the -.lV -ide VIteb. Hence, over the last decade and a half the world has gone from division 10 Section I At the Center of Globalization and walls to integration and webs. In the Cold War the United States reached for the Hot Line. the line that connected the White House and the Kremlin. The Hot Line was another symbol of that division. But, thank God, only two people were in cllarge of it: the leader of tie Uniteu States and the leader of the Soviet Union. What is especially disturbing about globalization is that its internal logic exactly mirrors the logic of the Internet. Globalization, like the Internet, represents global interconnectedness. Here, however, nobody is ;-care Al+thoughI -om Ar.mericans thi.nk, we are in -hre,w are not. III l.ld6l. XLLIIVU611aII 11SJll Llt1 l.I1 L1111XI\ Yl i. . III ~IL~ VYI. al. IL. That is why two Filipino college graduates were able to release their Love Bug virus on the worldwide web and melt down 10 million computers and US$10 billion in data on seven continents in 24 hours: because we are all increasingly connected, and nobody is quite in charge. The Tove Bug virus was to the globalization sysztPrn whrat the Cuban Missile Crisis was to the Cold War. Both these global events revealed humankind's vulnerability in a world divided between two armed nuclear superpowers, on the one hand, and a heavily interconnected world with nobody in charge, on the other. Another alarming feature of this new system is the tremendous sDeed with which it changes. When walls fall and people become interconnect- eu evFryoneC Is III evCryUonC CISeS UUsIIICnS. 11Iat 11uICt01111n1.t1o11 UIIVes Ule speed of change. As I state in my book, when a country joins the globalization system it is the equivalent of taking that country public. Its citizens behave more like shareholders, and, the leadership behaves more like management. M,,any ofl the sh-areh-oldlers froml a glob-ali,zed country are fr,om> ablroad. Therefore, to determine what would make for a strong global coun?try in such a system, maybe we should ask what would make for a strong global company in such a system. To pursue this idea I decided to look more closely at a company, but I had not yet chosen a specific candidate when one (AnrT hbckr in 1 [Q5 I hannpned across a crnm of 1Fonrhbs mnagainp in m,x dentist's office. The jmagazine, I noticed, had just named Compaq Computer the best-managed company in America. I thought, well, what better place to start than with Compaq Computer? I called the people at Compaq in Houston and asked if I could come down there and interview its ton leadershinp They said. "By all means!" I went to Houston, to the head offices of Compaq, to interview Eckhard 11 IFC and Its Role in Globalization Pfeffer, the chairperson, and noticed a framed copy of the Forbes article haqnging on the, wall.l A month later, again by coincidence, I was at Stanford giving a talk at the opening of the University's School of Engineering, with John Chambers, the chairperson of Cisco Systems. I happened to mention that I had just been in Houston profiling the people at Compaq Computer, "the best-managed comnanv in America." He pulled me aside and told me that Forbes had actually made a big mistake. It should have chosen Dell. I said, vv ny? He said, "Dell 'gets' the Internet; Compaq doesn't." Having already invested in my Compaq interviews I decided to go ahead and make Compaq the centerpiece of my book. The book came out on April 19, 1999. On April 26, 1999, the entire corporate leadership of C-om.paq Computer was firedI for m.issing their quarterly earnings 1- AA percent. That was a lesson I will never forget. Another thing that I have learned since the book came out is that the single most underestimated force in international relations today is knowledge about how other people live. That knowledge is a powerful cat- alyst foir rchnang becauseo npeopl PiprAn.AT11rp start to demannd the thiincgs that other people have. If they cannot get them they become angry. I was first exposed to this phenomenon a couple of years ago when, at the invitation of the U.S. Agency for International Development, I was part of a panel on competitiveness that took place in Sri Lanka. The panel con,idted of Garret Fit7zerald- the former nrime minicter of Trelqnd- Inoe Maria Figueras, the president of Costa Rica; and me. I spoke about glob- alization, and Fitzgerald about Ireland's recent economic transrormation. The star of the event was Figueras, though, whose presentation about how he persuaded Intel to come to Costa Rica and wire every high school cap- tivated the audience of 500 young entrepreneurs-from Bangladesh, Bhutan, India, Nepal, Pakistan, and Sri Lanka. Tis audien d e' re s po was truly W intlrgu11i. IL Wda da hIUughi bUIIIC- one had just turned up the heat in all the countries represented there by opening the door to the Internet and to all the information it can provide about life elsewhere on the planet. It is still too early to tell how this phenomenon is going to play out, but I see, It moreIL. anld rr.o VI y- r. Its eLfeLt s avei y haiard t q.juan1tify. Also, it affects different countries differently. 12 Section 1 At the Center of Globalization But it is there. And it is a real force in international relations today. The third thing I have learned to appreciate more is the concept of the "golden straitjacket." For me, the golden straitjacket is a metaphor for all the econom..% I Ule. V1 LIIo thIeUaIILaL1a1i sytLC1IJ. Ih IIC d16U1IJ-21IL UInUCerlyIng LIs1 concept is that, when a country joins the global economy, it is forced to put on a golden straitjacket. Margaret Thatcher was the original seamstress of the golden straitjacket, with buttons and tailoring provided by Ronald Reagan. It is the only model on the rack this historical season. As I said, this gonlden ctraiofrk,st is m-Ap nf a11 the r-ule -f th- Aghlobaizin sstem: rules about deficit-to-GDP ratio, inflation, privatization, and deregulation. Two things happen to a country when it puts on the golden straitjack- et. One is that economy grows, spurred by privatization, deregulation, for- eign trade, and investment. The second is that politics shrink, narrowing down to "Pensi or Coke"-that is; narrowing down to the choices approved by global markets and bankers. 1 his shrinKing or politics and of political choices is evident everywhere in the world today, even in Greece, the motherland of politics. Not only is Greece the cradle of democracy, but in the past 50 years it has had civil war, communism, socialism, capitalism, authoritarianism, colonels, and chaos. Yet the big story in Greek politics today is social security reform. G_ 1 LlI tIIicalcl i iy."tfreece may h-ave th-e lowest amouant of' forelgninve----en of- ---cunr in the European Union (except Luxembourg), but it ranks number one in the Union in the number of nights out in restaurants, per person. The Greeks are just beginning to wrestle with their golden straitjacket. The point I am driving at is that globalism may make all the economic sense in the wrorrld but it ha1 non moral forc f-r 95 percrnt of thl- -l's itants. Furthermore, it has the potential to unleash what I call the real Y zK dlisease"-overconnectecdness. What will happen When, through cell phones, pagers, and beepers, we are all online everywhere, all the time? That is the real disease of overcon- nectedness It is already a problem for the develoned world. It will eventu- ally become a problem for the developing world, too. In the later stages of tnis uisease you are always in and always on-just like a computer server. We now live in the age of what Microsoft researcher Linda Stone calls "continuous partial attention." We live in an age of the continuous partial. The continuous partial means that you are answering your e-mail, answering the phone, and helping your children with their homework all 13 IFC and Its Role in Globalization at the same time. You are continuously involved in a series of acts to which vou devote only nartial attention- This. I think. is the fundamental social disease of the globalization era. Moreover, in the next five years we are going to move to IP Version 6 internet switcnes, wnicn will allow every lightbulb in a room to have a web address. Everything, including the toaster and the refrigerator, will be online. How we manage that kind of social phenomenon is going to be a huge issue of the 21st century. Another important change that I see coming is the birth of a new kind or state: th --'ess Itt. -.--n the Co I0 ^ ]A r we h-ad Ahe kinds- ofA~ states: authoritarian countries, democratic countries, and communist countries. Under globalization we have five kinds of states: authoritarian countries (Cuba and the Democratic People's Republic of Korea); democ- racies (France, the United Kingdom, the United States); democratizing contjnries (the Czechb Republic, HuLngary, and Polnd); failed states, wAith- out the Cold War system to prop them up (Liberia, Sierra Leone); and the messy states (Indonesia and the Russian Federation). Messy states are states that are too big to fail, but too "messy" to work. They are states in which the central political authority that allocated resources and enforced contracts-the Communist Party in Russia. the Siiharto family and its extended network in Indonesia-has collapsed and has not been replaced by a new, coherent authority to enforce contracts and allocate resources. Indonesia and Russia are two of the five largest countries in the world. The other three are China, India, and the United States. India has messy features, but it is not a messy state. The biggest question in international relations today is whether China, with one-fifth of the planet's humanity, WIl uecomLUe a miessy stae. If it does thlVis wil'l afet everytLiin, 1Ull IIC dli we breathe to the clothes we wear, to the cost of living that we bear in the world. The defining feature of the messy state is that when the leaders pull the levers to make things happen the levers come off in their hands. That is the definition of a messy state: levers get pulled, but nothing happens because they are not c0n.nectled atnythin5g. How does a messy state escape this condition? Historically, there were two ways to do it. One was the way the United States escaped, because we were once a messy state. We had robber baron capitalism. We had Tammany Hall. We still have messy features, if the 2000 election in Florida ic anyr indicntion .AAT ecrscapeA it throgiiah Plurltion. 5AAP ClMAIAJ d.PilfP1fnA the institutions, the habits, and the culture that propelled us beyond our 14 Section I At the Center of Globalization messy state. Institutions such as the Federal Reserve, the Securities and Exchange Commission, and the Federal Communications Commission have helped enormously. The other way to get out of being a messy state is throvugh 1impF"i"lis1,1. This means vJI1 "ol ecmsin allu ocuiesUC Lthe state-which is what happened to Germany and Japan after World War II, or to India in the 1800s. The imperial regime imposes structures and insti- tutions that avoid messiness. The problem for Indonesia, Russia, and many other messy states today is that they are too early for evolution and ton late for inperanliscn They are tnr -1erl, For evolution becue evolu- tion takes a long time. They are too late for imperialism because no one wants to occupy countries anymore. People now know that the only thing imperialism bestows on a country is a large bill. Nobody wants the bill anymore. So that is not an option. How, then, will these countries gener- ate the internal will and the energy to escape rn(-e.iness? Indonesia, a fascinating laboratory, provides a few clues. About four years ago, when Sunarto was stili in power, i met a group of young Indonesians in their 30s and 40s who wanted to get rich without being corrupt. They wanted democracy, but were afraid to fight for it in the streets. Their strategy can be called "globalution." It was based on the knowledge that there would never be change from above. So they decided LU pro..1otLe revoluLion 110l11 UlyondU, VI glUoUbLtiVo, WhiLci 111mCe1an Ltyingr to plug one's country into every international rules-based system, whether it is the World Trade Organization, the International Finance Corporation (IFC), the World Bank, PricewaterhouseCoopers, or McDonald's. Whatever it is, they try to plug the country in and import from beyond w^.hat the country cannrot generate from aboveorbelow. I think the strat- egy of globalution, as a short-run phenomenon, is one of the things we have that will help messy states get out their messiness. In closing, I would like to offer a comment on two prevailing world- views today: what might be called "America on duty" and "America online." Those with the America-on-duty outlook see the world as an entity built around walls. The job of America, they say, is to erect walls, Dreak aown walls, and derend walls. in contrast, the America online peo- ple see the world built not around walls, but around webs. In the latter view America is at the center of the web, and for them the job of American foreign DolicV is to extend and enrich the web. bring more Deople into the web, and protect and defend the web. 15 IFC and Its Role in Globalization The wall people see the world as being divided between friends and enemies. and they care about who is on the terrorism Iit The web people see the world as being divided between members and nonmembers of the network, and they care about who is on the buddy list. I beiieve that the greatest tension in the current U.S. administration is going to be between the web people and the wall people. I also believe that the secret to success in globalization has to do with the fundamentals of life: reading, writing, and arithmetic; church, synagogue, temple, and mosque; good rule of law, gooAd governance, goodu bureaucrats, good' institutions, good' press. G'et those right and the wires will find you. Get those wrong, and nobody will find you. Follow-up session Aft4er +Ile floor was openeA to quesions one _audener____ lrase IIILI ALl IIOU vv~ULU LV 4ULI-L1U11, UIIL; CUUIC1IB- u111IUCL aMt..CU Mr. Friedman how globalization is changing issues of corporate account- ability, particularly in relation to social and environmental concerns. Mr. Friedman responded that this question ties in with the next stage of poli- tics, which involves going from national economic and political institu- tions to gIobal ones. The prnoblep Mr. Pried.man rcontinu,-A i th,;a hs a slow process. Yet many issues we now face-from the environment and the air we breathe, to financial flows and trade-are already the result of being "connected." How, he asked, can global governance standards be applied to all these issues, on which we are connected, without global gov- ernment? The answer, Mr. Friedman said, is going to have to be coalitions between enlightened corporations, enlightened nongovernmental organi- zations, and enlightened governments, all of which will come together to provide governance. For example, the Fair Labor Association is doing this in the area of sweatshop labor, where there is no government. That is the ideal model, he said. As long as agreements such as the Kyoto Treaty remain unin-111y1111CI1CU, ho-w--ver, gv11111R1IL cdll put tLings ofl fy saying they are "working on it." Corporations can also say they are working on it. Environmentalists can say, well, they are working on it too, they guess. The case of global warming provides a prime example of the kinds of choices nations must grapple with in an atmosphere of globalization, Mr. Url Ama a4A M 1y cIanT C; fI- iA A41 o not ng anA seeAA +II I IIuL11Il1 au I. I1 lLwy wal LtILLl uu ILillL1l, aLLu cLL LILLC llVlUl111l11L LUIL tinue to be damaged, or they can exercise governance to reduce the 16 Sectioni I At the Center of Globalization threats, as he would urge them to do. Mr. Friedman sees himself as a rad- ical about these issues because he travels all the time and has seen what unrestrained globalization and global warming can do to this planet. If people reifuse to duo iore tLings witih fewer goous, Ie argueu, as iinore andu more societies take on a globalization lifestyle, which is highly consump- tive of hydrocarbons, petrochemicals, and bent metal, the planet will burn up faster than at any time in its history. That is why, he added, he is happy to use his newspaper column to challenge companies that back bogus sci- ence anA use the financial c1-ot to press thne bigst-, Ji-L t powerful g-V ernment in the world to "trash" the Kyoto Treaty. Another audience member asked Mr. Friedman to comment further on the fact that nobody is in charge of the web. This speaker said he saw some distinct changes in the web, which used to look like a little city, with little roads that were alike. Nowadays, he said, the web seems to be made up of a number of extremely large cities, with main avenues, secondary streets, and dead-ends. Because everybody is using some of the main streets it seems clear, he stated, that with the structure comes power. Mr. Friedman agreed. Some of the big companies are now dominating the web, he noted, and this is a perfect illustration of what globalization does: it makes the whales bigger and the minnows stronger, both at the same time, Uecause it is UuiIlt on neIwoUs. rUthleUnIore, it is all about how one manages and uses those networks. As an example he pointed out that the company America Online "just gets bigger and bigger." It also just passed a two-dollar price increase through to consumers. Like countless others, Mr. Friedman himself just pays them the two dollars more a hhnLfl alid. saya no.wv Lnity a oil n Lto gtt bi6gge all" biggr, alit lbig." Yet the minnows are surviving. One of these is tohelca.com, a small news portal in India that recently brought down the defense minister and the head of the largest, political party in India by posing as arms sellers bribing the two men. This small dot.com did something no major Indian nPewsTzv5npr rcoild tin Mr. Fripe.n,j nntpt. It pynnzsie corrupntion at the highest level of the Indian government and brought down two of the most powerfui political figures in tne country. He drew anotner exampie from China, where a village school blew up recently in the remote province of Jiangxi. Thirty-eight children and four adults were killed. In their report to the central government local authorities blamed a madman for the incident. The truth came out shortly after, thanks to an Internet campaign 17 IFC and Its Role in Globalization that was entirely Chinese, that was started inside China. To make up for a shortfall in funding from the central government the school had been manufacturing fireworks. The school authorities struck a deal with a local nreworks manuiacturer, and during hnai of eacn day ine cnildren attend- ing the school were forced to make fireworks. One of the fireworks went off and blew up the school. One of Mr. Friedman's favorite websites is the Cairo Times, at www.cairotimes.com. This is an Egyptian magazine, he explained, com- parablIe 'Lo tLIle ELCUonUiSt, which co0 vers politics and sociall Ind-atersL , Cand is of high quality. Unable to get a license to publish in Cairo, it publishes in Nicosia and then imports the magazine into Cairo once a month. It has to go through the censor, he noted, and the censor removes anything that is critical of the regime. I T5ng brigalt reA letterc and the banner "Tin. Forbiddn Fil," h--- er, its website posts everything the censor takes out. That, Mr. Friedman said, is another minnow with real power. The thing to keep in mind is that both these phenomena are happening at the same time. Despite how strong the whales are getting, the minnows are active, are multiplying, and are doing some of the "reallv interesting things," in Mr= Friedman's view An audience member then asked whether this means that the web can give people good government. Mr. Friedman responded: "It will give tnem more transparent government." He predicted that in five years IFC and other institutions will not be speaking about "developing" and "devel- oped" countries, but about transparent and nontransparent countries. That is necessary for good government, he added, but of course it is not suiLLcient. Mil tLhI oL1the lngrICUdieLts-leadUership, eLIiLcs, ValUes-Will Still be needed. But, he said, the web will be a net driver of transparency, just as it will also be a net driver of a loss of privacy. Both will happen at the same time, and that is why he thinks one of the big problems in this sys- tem will not be just Big Brother, but "Little Brother." Little people, he explained, willb'.e '. emipovv.ered. to am.Aasa all kinlds of Feslolal daLa oni iiuni- viduals, outside of any government and social controls, similar to Big Brother. In a web world Little Brother can be as dangerous as Big Brother, he cautioned. Another audience member asked about the possible effect of global- i7-Atinn anrAllPh IA71-N nnA rnmminin;rtinn an Tclnm Mr TPrioAmnn 1FAt thont that here, too, one would see the transparency effect. Even Osama bin 18 Section I At the Centter of Globalizatiotn Laden has his own network, "a kind of jihad online" on "JOL." He did not see that Islam, as opposed to any other religion or movement, w&ould have more or less ability to maneuver the web. Globalization has yet to explode in many regions or the world, and the biggest expiosion is not necessarily going to be in China, which is where all eyes are focused. He thinks it will take place in the territory from Morocco to the borders of India. What he calls the "wrenching transition" is going to occur there. At a recent Arab Summit, he remarked, not one of the 20 or so Arab leaders in attendance L .:_11 _1__ 'l _-_ ___1 _ A- .1 liaU Ueen dUemocrat-ically electeu. Th113is is unlike an1y Other reCgion of tle world-even Sub-Saharan Africa would have at least a few democratical- ly elected leaders. That statistic, he thought, bespeaks a future full of tur- moil, although he feels some will make the transition. Again, he found the little countries in the Arab world the most interesting. He mentioned that the freest elections are -all c s as B or - -A equally important, the biggest Internet city is Dubai. Jordan just signed a free trade agreement with the United States, only the fourth country in the world to do so, after Canada, Israel, and Mexico. That is why he feels that the innovation is happening in the little countries, while the big republics riu hv thp militarv (the Arah Repniihic nf Fvnt Tran q,and the Svrian Arab Republic) are lacking in real political innovation. Sooner or later, he thinks, there will be a "reckoning:' Mr. Friedman was then asked whether he sees globalization strength- ening identities or violating identities. That, he answered, is one of the 64- thousand-dollar questions about globalization. Again, it all comes down to what happens when the walls fall. He mentioned being in Singapore AirporIL not1 long ago aidU llotciIIg two eIueIIy Inidianl womHeni wealing their traditional saris and shawls, looking like people steeped in their native culture. Mr. Friedman also noticed their eyes were glued to the tel- evision monitor in the waiting area. What were they watching? Two American wrestlers in Tarzan suits body-slamming each other in a ring! It suddenly struck Mir. Friedman that this was the perflect imllage ol globalization today: it showed two cultures in direct contact, without walls. For some countries with cultures that are not robust this contact could ignite a kind of turbo-evolution, he thought. That is why the big question about globalization is whether it will lead to homogenization- or will it, as Mr Priedm.an suspects, lead to .hat he cals "worldization"? Right now globalization means Americanization-but the most popular 19 IFC and Its Role in Globalization food in the world today, he said, is pizza. The interesting thing about pizza lhe remnrlrkA ic thiat it is a fl.t picep of Aduih on which eirerit l- ture puts its local ingredients. That is why he wonders whether globaliza- tion will homogenize only the surface. He thinks that if globalization begins to threaten a culture people will reject the system because they can- not exist without their sense of community and sense of identity-in other words. without their roots. He predicted worldization rather than homogenization, though it may be difficult to keep the latter at bay. r i 1. .1~~~~ Ai - -1 -. -. - - - I - J1 ._1_ 1~ 1 _ I A fina; question dealt withn te AD11S) crisis anu wnetner it wouiu allect the globalization process. Mr. Friedman had just returned from Ghana, where he saw the problem up close. He felt that a response to this ques- tion must come from people more knowledgeable about the subject. What did strike him in Ghana, however, was that combating AIDS would take mlore 'Ilan just iepnieatrtoiadrganthefrsofhar- maceutical companies. It would take concerted community effort. The countries in Africa that have been most effective in stemming the AIDS virus, he noted, were like Senegal: countries with strong civil soci- eties and strong village networks where they are using multiple methods, i,lnclina locral AAdrPrticina wn o urcmen'sc aropns tn crnAiict nper-to-nppr education and to care for their orphans\ Even in San Francisco, when AIDS first broke out there, Mr. Friedman said it was not the government that brought a sense of stability to the problem. It was gay men taking care of and educating gay men. It takes a village, he concluded, to address social problehsm 20 C H A P T E R 4 International Financial Stability and Sustained Growth Horst KinhIer Managing Director, International Monetary Fund This is a difficult period for emerging market economies, and for their private creditors. I would like to discuss the actions that are required from the International Monetary Fund (IMF) and from its member countries, in partnership with other international organizations and the private sec- tor, lo saerguard international financial stability and -rnmote sustne growth in the global economy. A Period of Testing for the International Financial System As a result of domestic policy reforms and strong export demand from thlie Advanced c-potnnn, mos ri- p rainff mnrnLets h reovererdA stronngly, from the financial crises of 1997-98. Now there are concerns that the slowing of the global economic activity and the associated weakening of exports and capital inlflows may trigger a reversal of these gains. Moreover, declines in equity prices and the recent difficulties in Argentina and Turkey have heightened consciousness of the downside risks and interdependencies in the world economy. Our best guess is still that the slowdown in global growth will be relatively short lived, witn a recovery beginning late in 2001, and gathering strength in 2002. What is important now is vigorous policy action to ensure that this outcome materializes. 21 IFC and Its Role in Globalization I am encouraged that the recent meeting of the IMF's International Monetary and Financial Committee demonstrated a growing sense of shared responsibility among our member countries to safeguard global econoriic gro-wth. Th le ecisive rnoves by tihe ederal icserve to lower interest rates, along with the tax cut, have increased the probability of an upturn in the U.S. economy later this year. Recent interest-rate reductions in Europe and Japan were also welcome, and we are confident that these central banks will remain vigilant. Our membership has nevertheless underscored that more ambitlous structural refornms are the key to stronger growth in Europe and a sustained economic recovery in Japan. During a recent visit to Japan I was heartened by the new government's recognition of the importance of accelerating overdue structural reforms of the banking and corporate sectors, which I hope will soon be translat- ed into action. For emerging markets it will be crucial to stay the course of structural reform and sound macroeconomic policies. Since the Asian crisis, markets have been differentiating strongly among investment opportunities- rewarding countries with sound fundamentals, and pulling back where there are major concerns about sustainabilitv. Many countries have taken steps to reduce fiscal and external imbalances and will thus be much bet- ter placued to deal with th-e current strains. in the structural area, more typ- ically, further efforts are needed to reduce vulnerability by strengthening financial sectors, improving governance, and building a good investment climate. Countries that follow through on these essential reforms, howev- er, should experience relatively good growth performance. I LaVe Witnessed, in the ITVl'S poorest memlber-countries, a growing sense of leadership, and an increased determination to address the home- grown causes of poverty. It is clear that an effective strategy to reduce poverty must start with, and build on, actions by poor countries to end armed conflicts, establish respect for the rule of law, improve governance, and fight corruption. There is alcsa rprcanitiotn that the prospi-rts for rapid growth-which is indispensable for reducing poverty-will depend on the ability of these countries to unlock the creative energies of their people and to take advantage of the opportunities of the global economy. The development of sound domestic financial sectors and, eventually, integration into intprnational financial marketr will he an imnortant part of this process. Equally, however, poor countries can and should ask for 22 Section I At the Ceniter of Globalizationi more decisive support for their efforts by the international community- through debt relief, capacity building, increased aid, and access to markets. A% RIefocusedUl 'International I'V lonetary Funda The IMF, for its part, can make its greatest contribution by helping to establish the preconditions for sustained growth in the global economy. This means we need to concentrate on IMF's core areas of responsibility: * Promoting macroeconomic and financial stability in member coun- tries0 * Helping our members develop sound financial sectors, in order to protect them against vulnerability and to mobilize financing for productive investment * Safeguarding the stability and integrity of the international financial system asa global public gnod. One of the major criticisms leveled at the IMF in the wake of the Asian crisis was that it had spread its activities so broadly tnat it could not do an adequate job in these core areas of responsibility. This criticism needed to be taken seriously. Many international organizations contribute to eco- nomic develovment and poverty reduction. The IMF also has a unique responsibility for the stability of the international financial system-if we Idil to deliver, a lot is at staLk. DrLUing- r.-y -irst yaat th.L IM1, thereflre, our membership has given its overwhelming support for our efforts to refocus. Crisis Prevention and International Financial Stability Ofl co-urse, we are nut starting n--l-l atch. During elpat -f +hree. years a broad work program got under way to strengthen the interna- tional financial architecture. The steps taken since then by the IMF and other organizations-for instance, to enhance the availability of eco- nomic and financial d'ata, to improve our analytical tools for assessing vulnerability, to cstrpngthpn deimpetic finncia! zv'tPrnv and tor clpvpoin and implement standards and codes-are helping to make the interna- tional financial system! more resilient. The IMF has also sharpened its financial tools for crisis prevention and management, by adjusting the terms of its lending and by introducing two new facilities: the Supplem.entil Reserve Facilitv (SRF) and the Contingent Credit lines (CCL). The SRF has already proved its worth in responding to capital 23 IFC and Its Role in Globalization account crises, and we intend to make the CCL operational in the com- incr mnonthe as a wav to rewardi first-class nolicies and to help couintries resist contagion. While there can be no guarantees, all of these initiatives should give us greater confidence that the international financial system will withstand the current period of testing. Nevertheless, it is clear that the IMF needs to work even harder to put financial markets and crisis prevention at the heart of its activities. Highest on our agenda for the coming months will be further work on _1__ _.._ v _+ : _ : n_ +u-: T A_ .- --- ~I- s1_ TlAXT' edrly Wdarniti O1 pUtltlldl 6113C3. Dy L111 I UU rLUL IICd11 LlidL Lllt liVir intends to become a rating agency. What is crucial is that we sharpen our ability to identify emerging problems and bring about early and preemp- tive policy action in member countries. For this, we need to combine quantitative indicators of vulnerability with judgment from the field and from the markets. To ensure the maximum"i beneficial impact it will be important for this work to move forward with the full participation of the IMF's membership. In the process, we will need to take care that our warnings about potential crises do not become self-fulfilling prophecies. The new International Capital Markets Department in the IMF will nlayv a maj1or role in this effort This depnrtrnent will serve as the IMF', center of expertise, information, and analysis on capital market issues, and as its primary point of contact with private and officiai institutions work- ing in this area. By deepening our understanding and judgment about the operation of capital markets the new department will strengthen the IMF's capacities for crisis prevention and management, and for safe- guarding the stability of the international financial system. Over time, it should play an il-mportant role in helping HIILembers gain access to interna- tional capital markets. Partnerships for Growth Refocusing the IMF also gives us a new opportunity to strengthen coop-erFation I1H LL Wi Lm other internationl organiions, such as the five organizations that form the World Bank Group, and the Bank for International Settlements. We need to make sure, through good communication and division of labor, that careful attention is paid to all issues that are crucial to financial stability, growth, and poverty reduction. I lie coL,mrilLmen1 L LhitL Jiil, VVULIfe1nIso anlu I mIadUe lastL yLar toenance.U collaboration between the IMF and the World Bank is already paying large 24 Sectioni I At the Ceniter of Globailizationl dividends. As part of our broad agenda of cooperation we are intensifying efforts to help poorer countries build a fn ftrt-r thitista - lored to their development needs. T'his should also be part of a strategy leading to their eventual integration into the global financial system, to tap this indispensable source of financing for development. Thus, we will seek to involve poor countries in the joint IMF-World Bank financial sec- tor assessment program, while mlobilizing practical, professional assis- tance in financing strategies for rural development and small businesses. The international Finance Corporation (iFC) will clearly play an important part in promoting growth and poverty reduction through its equity investments and lending, its catalytic role, and its advice and tech- nical assistance in private sector development. I welcome IFC's work on financial sector development, including the use of microfinance and other targeteU instrumi.ents to mLeet the spciIa nCUe VI poou, ldrgely rUtrl, economies. The World Bank, IFC, and IMF have recently begun prepara- tions to establish Investors' Councils in Sub-Saharan Africa, as a form of public-private partnership. These councils will bring the government together with private foreign and domestic businesspersons, to identify k ley1oslacles to private investment, and option fr removi- thAm. Tam confident that intensified collaboration between the IMF and the World Bank Group will strengthen the effectiveness of both institutions. International capital markets have been an engine of innovation and rapid economic growth in the postwar era, and they will take on an even more crucial role in the 21St century. Net private canital flows to cievelon- ing countries reached about US$250 billion a year by the time of the Asian crisis, while total official fiows-grants and loans, bilateral and multilat- eral-are less than one-third of that amount. International capital mar- kets have thus become indispensable for economic and social develop- ment. We must also recognize that markets are now much more differen- tiated and sophisticated than they were 10 or 20 years ago. The bulk of linancing no longerCU1llCZ III LIIC IUIIII Ut Udlof IUbloan, UUL thLrUUr,I UghbU- ed debt, direct investmnent, and other instruments; new instruments are being devised all the time to meet the requirements of an evolving global economy. There is obviously a need to adjust economic policy concepts to these developments. I do think this change should include building a new partnership beUtVvleen the privatC. finla--cial stor and p-Aubl nstitutns, such as the IMF. 25 IFC and Its Role in Globalization A year ago, in outlining my initial thoughts on the future role of the iMF, i gave a commitmeni To work constructively with the private finan- cial market participants. This approach is now reflected in a number of key elements of our work program-including the IMF's informal but regular dialogue with senior representatives of private financial institu- tions, through the Capital Markets Consultative Group (CMCG), and our fram.eworA k frprvt sectorLE ivllverV.IILen iII Fcrisis IV preventio andrsolu- tion. At our latest CMCG meeting, in Hong Kong, China, we considered a report on creditor-debtor relations, prepared by a working group cochaired by Stan Fischer and Robert Pozen. I believe this report suggest- ed very useful principles for enhancing transparency and good communi- cation between sovereign debtors and creditors. I look forward to dis- cussing this report with the IMF's Executive Board, including the poten- tial for taking its recommendations on board in IMF surveillance. The Hong Kong, China, meeting also examined ways that private creditors can make better use of information on standards and codes, and how the pri- vate sector can become engaged at an earlier stage in crisis prevention and resolution. This work should provide further content to the envisaged public-private partnership for international financial stability. The basic principle of our framework for private sector involvement is that a market economy requires debtors and private creditors to bear the consequences of their decisions. This means they cannot expect to be "bailed out" by the official sector. With this in mind, I do think it is right to work as mucL11 andU as long as possible with m1arkwt-OriCerted, vo-lluta-;, solutions negotiated between debtors and creditors, without ruling out the possibility that other approaches may become necessary in extreme circumstances. In all of these ways the IMF will continue to strengthen its partner- sI-ps withI ITFC anA o-t int-rnational organcizaon, a -dwith +th. v a-tt. sector, to promote international financial stability and sustained growth in the global economy. 26 C U A P T E R 5 The Consequences of Globalization for Asian Banking John T. Olds Special Advisor to the ChaIrmrTran, DUBoS ank, OiIadpuoI As the primary engine of world growth the United States has no obvi- ous replacement. Nowhere is that more obvious today than in Asia. This chapter provides an update on what is going on at ground level in Asian bankin-rg fr-oin my perspcctive as the_ chicf exectiv -+- ;e ofSigpr' ud1\1, 1jU1 1 11LI C~ a il L11 1'. 1LL~U1i WILL U bFl. DBS Group from 1988 until early in 2001. I also touch on the conse- quences of globalization in Asia and the eventual impact of what I call universal (as opposed to Western) business standards. Finally, I propose a slightly unorthodox approach to helping to solve Asia's banking crisis through a new1 Li-nA nf rfnain.rnc In aUl stress situations there are opportunities, as well as pitfalls, that lie ahead. There will be winners and losers. After 36 years in banking, many of those years in or around Asia, I still think the glass is more than half full, despite deep-seated local inhibitions, decelerating economic growth, and vet another round of asset devaluation. To many observers Asia dropped the ball just as it was about to carry it over tne goal line. TIne Asian iviiracie stopped in its tracks, anU restruc- turing has been more than a little uneven. The necessary reforms are often observed in the breach, if at all. Domestic-demand is anemic, and export- dependency at an all-time high. As a result, the region is vulnerable to shocks, whether they are made in America or elsewhere, and many politi- 27 IFC and Its Role in Globalization cians have decided there is less risk in doing nothing, even if it leaves Asia poisedU on a slilppery slope. vviLLat comles next sihlould not resemIUIle whlat has gone on in Japan for the past decade, but it may. Nonetheless, I believe Asia will eventually emerge stronger. Clearly, things will not be the same, but it is going to take some time sorting them out. The next wave of growth will likely be led by consumers and small busi- ness,no biTy crony capitalsi-s or bogus publicly qt conrportions. Overcapacity and excessive leverage are going to hold larger companies back, as out-of-date practices virtually prohibit their access to convention- al bank finance, even assuming it was available. International capital mar- kets are reserved for the most transparent and creditworthy companies. T Iltimntplv finlnninl iprvirp nroviciprm will hp forredi to rp'cnnnd to A trend that is now all too familiar, and all but unstoppable globally: electronic dis- tribution. What now seem to be pressing problems with special interests, or intransigent borrowers, or inept politicians, have little to do with the future of banking. Even farsighted Asian bankers are unprepared for the new age of electronic banking. Considerable resources will therefore be required from outside national borders, and maybe even from outside the region. That is th_ oppori LULty, alL leas, U-ld lly colledaUCe aL D pULLCU. DBS's experience as a direct investor in a number of countries since the crisis broke (and as a close observer of events in most of the others) reveals the extent of the damage done. In due diligence exercises DBS per- formed appraisals of crisis-affected assets, negotiated with overdue bor- rowers, and Alearned Ajust h1ow poor banking ---tce were. -- e depth of-+, the problems uncovered stood in marked contrast to standards in Singapore and Hong Kong, China. Many countries chose to keep score without reference to objectivity or underlying values, and many borrow- ers and lenders came to believe that governments would bail them out when danger appeared .But why shouldn't they? In more than a few coun- tries central banks published national account statistics and international reserve data with the same license-some would even say, "with the same sleight of hand." A significant feature of recent events in Asia, unlike those in Latin Amprica in thp 1980s or d1iring the second Mexican crisis of 1994; is that nobody sought to dominate them. Nobody dealt forcefully with the disar- ray or assumed a leadership role, hence nobody influenced the minds or the movers and shakers of international finance, or, for that matter, of the 28 Sectiol I At the Ceniter of Globailizationt leaders of individual nation-states. The Association of Southeast Asian Nations failed its g-retstc test,c jut as the Mivsr-,y of International Tr3de and Industry and the AMA failed in Japan a decade earlier. It is true that the Federal Reserve, which eventually lowered U.S. inter- est rates, did stimulate a partial recovery, and that the International Monetary Fund (IMF) did what it could with the rather limited ammuni- tion at hand= It looks increasingly; however, as if these were palliatives that just bought a little time. They did not correct the fundamental problem, wnicn is that Asia is out of step with the rest of the world. This is not a good thing for the region or for its trading partners. Its banking systems, the principal source of intermediation, are broken. The all-too-familiar postcrisis syndrome of denial has come, but not yet gone. In the limited remediation efforts under way from Indonesia and the Phi-:lippines to_ Thiad Ah IMF andI the 'AA31d Bak retrig-o-upr r lIFIII t~L I I IdIldildILU LIIC llVLi7 dIlU LIIt VVUIIU 1JdhI1' di t Li YI116 LU U U impose modern banking practices on bad habits and creaky infrastruc- ture. In many cases only a change in ownership opens the door to the dra- matic change in mind-set that is required. The goal of creating a pan-Asian franchise with a unified platform for the searntlc, relal-tire AdelierAy f prouA-ts and --rvc ;- an im.mense- I.., e-. I..... I.. - I tfl F.I -_t tO tf. S - ti - fI - all ta... ... &...I-- challenge. It is also an unavoidable one. Strong foundations built in Singapore and Hong Kong, China-with their histories of enlightened bank regulation, qualified management, and (the British) legacy of con- tract negotiability-may be the only hope of putting a modern regional franchise in nlace. Because the demand for hanking services in Asia will continue to outstrip the supply for a long time to come, there is a signifi- cant opportunity waiting to be grasped. Countries that delay the necessary reforms will slowly come to realize that time is not an ally. Weak trade numbers and further currency deval- uations bear witness to their vulnerability. Whether it is a matter of months or years, they will have to reexamine the most fundamental issues, sucii as h1ow to Ueal fd1airly anU FdLLLLpcticly WILIt d shoraLdg e1 UdoIf bncapital, industrial overcapacity and obsolescence; the notion that employment is guaranteed for life; and the redefinition of public sector roles and respon- sibilities. Equally important will be how to arrest a growing loss of com- petitiveness when China and India are rising, the European Community -ssrin fu the final 4etail o f it4no, -- nd- the- jAm a are- -utting 10OV L1 L, ,a tI.. L.Inn IL ¼ttU1s VJ ItO ..IJI,UIU iL- - - -aiL -LJ I F-t--b together a blueprint for the world's largest free trade zone. 29 IFC and Its Role in Globalization Although there is not much chance that the Asian tigers will slip into coLrInand econorny thilnkinlg, fre-marke isolu[ios air neithrr obvious nor compelling. Besides, it is too early in the globalization experiment to become complacent. As Asia's leaders wrestle with the essential precondi- tions to recovery, a sound banking system is a must. One of their first pri- orities should be to clarify property rights. If officials have learned noth- ing else Ar,l tedbceotheIpslfueyas,i shoul betat due 1 -15 I .-1.. i. f LII'.. -IU I - 1. 1 V III..' F.OL LIVJLI t-1o IL .1I'JIt - ,. LIIaL ILIL process, the sanctity of contracts, and the enforceability of collateral are essential to attracting and preserving long-term capital. Although some have stiffened bankruptcy laws, success does not depend on the existence of these kinds of statutes alone. It is inextricably linked to enforceability, Or nprhann mnrp nrprcislyv to finalitv Finality is the key. Note, for example, the International Trade and investment Corporations (i T iCs) in China. it has been suggested that, as semi-state bodies, they were authorized to borrow abroad and then were encouraged by the state to walk away from their obligations. However, it is quite possible that creditors' rights will, in the end, be determined not by interpreting covenants or judicial proceedings, but by arbitration. If the arUitLr is lreasonalUI aUIIU LIe IiaI (eteinUatUio equitable, so be it. Arbitration, after all, achieves finality. The only complaint would then be that if the ground rules had been clearer at the start, the opportunity lost might have been smaller. In a curious way arbitration was also the key to resolving the Latin tions were finally resolved when the private sector swapped bank loans for publicly quoted securities, a process jump-started when Mexico securi- tized a portion of its obligations with U.S. Treasury bonds. When these "Brady bonds" were freed to trade at levels determined by the market, the basnk-c' lncses rrircrystalliA and thep xrnrlA mnxrrpA n. There urc no fu-r-.I ther discussion about the appropriate discount, enforceability of collater- al, or the bill for interest arrearages. No recriminations, just finality. Another requisite for recovery and restoration of investor confidence is transparent bookkeeping. Proper accounting in the banking sphere means accurate reserving policies and clear guidelines for writing off bad debts. Having wasted the first opportunity to instill borrower discipline as a precursor to raising additional capital, the countries of Asia must try another path to bank solvency, either through some limited form of pub- 30 Section I At the Ceniter of Globailizationi lic sector bailout, or through foreign direct investment. That is where the rubbAer mIect's 'Ie roaU. There can be no traction without first clearing away the debris, no way of removing the debris and the solvency doubts without separating bor- rowers from their assets. There is neither (a) sufficient room in public sec- tor budgets nor (b) the political will to bail out more than a handful of bankc in each rnlntrAr Alth-gih 1- cnsodting the prole.m by merging troubled banks achieves a certain focus there is still a finite limit to the human and capital resources required to clear the decks and start over, on calmer seas. Another prerequisite is good corporate governance. That means pub- liclv traded comnanies. led hv independent boards of directors; not by family members or their retainers. Even where it still deserves to exist in economies such as Hong Kong, China, and Singapore, the family banking model is rapidly becoming a dinosaur. Little banks can neither attract the talent nor withstand the level of investment required to stay relevant. They will survive for a while, but eventually the market will impose a value discount on them that will be as unacceptable to insiders as it is to independent shareholders. An independent judiciary is another essential ingredient for the impartial determination of the divergent rights of borrowers and lenders, especially where politics and business interests intertwine. Building such an institution turns out to be a lot easier said than done, because it requires conurageofusic as wuell as enlihtentA jd,Aaec Can ways be found to make such international standards acceptable in these crisis-affected countries, in the time available? Asia has so much bound up in outdated practices and so-called cultural differences that the remedial actions required are often blown away before they can take root. It mav sound self-servin. hiut I suggest that the harriers to entry that have been partially dismantled since the crisis in many countries will have to be rurther reduced, if not compieteiy removed. Sooner or later dirficult judg- ments will have to be made as to which banks survive and which do not. This will inevitably raise the all-too-familiar moral hazard question, prompting decisions about which institutions are fundamental to recov- ery and which are simply too big to fail. The rest will fall by the wayside. v^vller thle polltickling udis uown W aclL is thatI L h1ave iirnpedCUU IfiC1gn1 investors from securing control positions and from shifting the burden for 31 IFC and Its Role in Globalization cleaning the closets and setting appropriate operating standards must be el,1m1inaled. People will hiave to learn tha the length of the delay inl lllk- ing such critical choices only increases the extent of the damage-to bank capital, to consumer confidence, and to business competitiveness. Until the survivors are known, little can be done to prepare for the new world of financial services, a world in which the Internet acts as both a decon- ctrucrtor onA an enbe,lor By then, even those who hear the message of the market will not have an easy time catching up, because the information technology platforms required are so complex and expensive, and because Internet banking penetrates consumers' consciousness only gradually. Therefore its effects on consumer hehavior are hard to nrecictn and mnuch of the invpetm.pnt in technology and training is front-end loaded, which makes it appear risky. Everyone marvels at the consumer's fascination with research and occasional purchases of books or clothing over the web, but for the Internet to become the channel of choice in financial services, fancy front- ends, broadband networks, and unrestricted access are only a beginning. In effect, companies such as America Online and Amazon shine a narrow U dllI oI tFa Latl Lt thei LU[LU. IIITy dar 1llelIrctlLLodels, as rcent events reveal. Things such as voice activation and affordable handheld communi- cations devices are aspects of the next phase of development, and their pro- liferation and impact on simplification of use will lead to greater consumer acceptance, eventually, but we will probably experience a lull or two before nA--+r;Ar- --f increase anAr -. ve l]A.- -A 1-1- 1 -.;- -wro --]; ty. Inflation points in technology are very hard to predict. Investing in electronic infrastructure for individuals and corporations, large and small, is undoubtedly a much better way to transmit best prac- tices than by publishing treatises on accounting transparency and stan- damrds, of hoard governance, or by revamping bankruptcy laws. That's because the feedback from technology is so positive. The most practical approach to banking in Asia lies in the creative application of technology, so getting ahead of the curve and doing something useful is the best solu- tion. If cofinancing could be redefined it might help rebuild Asia's infra- structure, something that is at least as imnortant to Asian economies as is recapitalizing a handful of miscreants, or publishing a bushel basket of good practice guides in glossy covers. Please understand that I am not denigrating transparency and good 32 Section I At the Center of Globalizationi governance. I think much of the medicine that is being offered by the West either does not get swallowed or, worse, provides excuses for those who would readily deny Western practices for cultural and other reasons. IL la illst. L..e to avvay LiUllI teL tereLoltypi cLal prescF.riflpti-'fLons a1n Ia,s labels. It is time to focus on the fundamental requirements of banking in the 21st century, requirements imposed by the realities of global competi- tion, consumer behavior, and technology. Focus the solution on purchasers of financial services, not the suppliers or old elites, who have no intention of relinquishing their prerogati.es or the politicians they have elected. But make no mistake. This is about power, the purchasing power of people, a revolution that is just beginning worldwide but that is just as likely to flourish in Asia as it has in Europe or the Americas. In fact, curiously, the backroom is just as much the Achilles' heel of develoned-countrv banks as it is of banks in Asia. Long neglected by peo- ple who believe in the primacy of manufacturing banking products, elec- tronlc Uisirli-Uuoti w- not w ocCur WitWout LIal- Lil piOtXSSihg CengmesC. And real-time transacting is impossible without straight-through pro- cessing. That makes it necessary to get deep into the plumbing of a bank to deliver products and services in the modern era, and to spread the investment over the broadest possible geographic area. TF7 J- an], -v +_ -.t +1,- 1,,+t]o C- Al e near-fs an, m`ndsof. corncsumenr 11i ualIN3 al LU VVlll tL. VaLL. 'M. LLL_ n..a, toll. 111111 SS. worldwide against monoline providers (those insurgents that focus solely on processing credit card transactions or presenting bills), they will have to form utilities with other banks or possibly with accountants, or with com- puter equipment suppliers. Most banks still cling to their old habits and outdated infrastructure, however, which is why so many people think the incumbents will eventually lose the battle to the insurgents. The domestic banks that are so desperately out of date and out of funds have a great opportunity to be among the first clients of these new superprocessors. Even if domestic regulators seek to protect their national turf for awhile, the only viable response to~ the growing demand for transaction services will require them in time to, relinquish direct control of the infrastructure and encourage local batiks to siiiLt the UUIUCII L) Utoathe qUippeCU Lo Uo tLIe joU. In fact it is already happening, not just with credit card transactions or bill presenters, but also with custody and trade services providers. The obvious solution is for the incumbents to combine their transac- tion flows with responsible international institutions that have the capital, 33 IFC and Its Role in Globalization the technology, and the ability to deal with skyrocketing real-time trans- action volumes and the need to ensure finality. Properly constituted, these new utilities will also have the wherewithal to invest in the software to prevent fraud and to monitor capital Io-veIIIIIts. That wa-y, the consumer is protected and central bankers need not relinquish their ability to inter- cede when problems loom. This is not going to happen overnight. There will be delays. Some delays will be caused by attacks of paranoia, others by political maneuver- ing, or obusaton Bud not confuse teprayradboc- orxe- ll1r,, ULMJI L~LaIuOaLlU.JI. LaUt VLM J I M... -AJ1 LI. LnnJ,aIF 7 1J.LJ,n n A~1. phobia with the strength of the underlying revolution. Once the battle is joined between the forces of progress and the old elites, it will become obvious that a local solution is not only inadequate, but inappropriate. In the new world networks are not circumscribed by geography, nor are theyv definei hv the niiumhr nr lncitinn nf thp nnoe.- Networks arp extensible and ultimately limitless. That is what makes them so interest- ing, and potentially so useful. Beyond the standardization of processing platforms lies a more chal- lenging environment in which banks use their licenses to serve customers as aggregators of financial products offering limitless choice and acting like true service organizations. The role of the intermediary will thus be totally reulefilned, fIrst y theC crislbs adlU the11n uy thC ouppoLtuniLty. TheC lUec financial institutions might play in this scenario is wide open. Bankers can dismiss the vision and watch from the sidelines, or they can choose a part- ner and join in. They will need patience and a strong stomach. Building the infrastructure and getting the kinks out of it is at least as challenging as preparing fou Y12K , although in a -way it is al1s like sting frsh Leveraging banking expertise and legal systems will require significant renewal and adaptation to survive. Asia has the potential, and consumers will not wait. If banks do not fill the void, others will. For the moment, though, it is their business to lose. T16 repeat, Asia i an envAron.ment nf nnonrt-nityr and nnt oF threat. Success demands enthusiasm, flexibility, and a willingness to redirect a portion of the money bet on traditional cofinancing in Asia to the infra- structure that is so essential for Asia's growth and future development. I foresee many ways of participating in this opportunity, and a healthy, well-fuinctioning financial sector is at the core of all of them. 34 SECTION 11 The International Finance Corporation and Our Market Environment C H A P T E R 6 Update on Financing Operations Assaadu J. Jabre Vice President, Operations, International Finance Corporation The International Finance Corporation's (IFC's) operations for the fis- cal year ending June 30, 2001, reflect both good news and some not-so- onnod news. Thei- gnood npwz is that IFC^'" tnta! crn,mmitrnpntc includiing investments for participants' account, rose about 8 percent. IFC's own account investments went up even more, increasing by some 14 percent. Commitments, of course, are what matter to clients, participants, and to IFC itself. The not-so-good news is the 8 percent drop in IFC's total investment approvals in the past fiscal year. This decrease is due to the decline in approvals lur loans tlat IFC will rnake ior participants' accounts. A vari- ety of factors are responsible for this decline, as discussed in the following chapters. An important factor, perhaps, is that some banks have become more cautious about the uncertainties in the world's emerging markets. Another factor is undoubtedly IFC's own investment strategy, which is moving a little more tovard the frontier markets. IFC's increased focus on frontier markets this year reflected imple- mentation of the investment strategy that it introduced in 2000. It includ- ed an emphasis on priority sectors: namely, infrastructure, financial serv- ices, information and communication technologies, small- and medium- sie7 enterpricpc (SMFe) nan thesocnrial ector.c In keepring writh thic ctrat- egy we also introduced a number of new products; started a sustainabili- 37 IFC and Its Role in Globalization ty initiative; and worked hard at closer and better coordination with our coll--.ges at theW...orld Ran,. The approval figures reflect the changes that have occurred between IFC's fiscal years 2000 and 2001, and give an idea of business in the months to come from a participation point of view. One noticeable change is a decline in Board approvals for investments in Africa. Africa re.mains a priority for IFC, but we did not have as many large projects approved as we had in fiscal 2000, such as the Chad-Cameroon pipeline, which, along with the opening of Nigeria, contributed quite a bit to the increase in IFC's investments in the region. IFC is continuing to invest in Nigeria, but this year our approved investments there were a bit lower than in fiscal 2000. We currentlv have two large infrastructure Droiects in Africa that are expected to be approved next year, one of which is the DU)jaga11 Hiydropower Project in Ugadaua. hiis souldu help sustain a rea- sonable volume of investments in the region. Investment approvals in Asia, on the other hand, went up, owing to the increased activity in China and India. Approved investments in Central Asia and Europe also increased substantially. By contrast, there was a mlaarked decrease of approvals V i Latin m..erica, mainly bIecause -If decline in B-loans after IFC's strategy in this region began focusing more on middle-market companies, which are not necessarily of interest to the bank syndication market. In addition, size of investment in such projects is not necessarily big enough to syndicate. In the Middle East, however, IP"c' nraranm IAlTC very prominPnt with invpetmnpntQ risina frnm lpec than US$100 million in 2000 to something like US$1 billion in 2001, not the least because of what IFC has accomplished with Meditel in Morocco and with Electricite de France on two power projects in the Arab Republic of Egypt. IFC has given priority to infrastructure; financial services, and infor- mation and communication technologies, which represent about 70 per- cent or our investments. Although the social sectors nave also occome a high priority they are not tabulated separately, mainly because IFC is still proceeding cautiously in this relatively unfamiliar sector. We do not want to do something that is inappropriate or that will come back to haunt us in the years to come. leet'e ssI-Cernais At til _- e a r t o .c Ou _- S_ AA _dL 1 g_' lu e c a u s e- _.k INtVUI UlXCZ IlIiIUVdLUUll lCl11d111i dl [111 IlCdi I Ul UU1 bLidL>5y, UgLdUNt that is what will keep IFC relevant in the challenging business environ- 38 Section II The Interntational Finianice Corpora tioil an1d Our Mav-ket EFvirolnoment ment facing our developing-member countries. One new endeavor of the past vear that reflects this strategv is the develonment of lora1 crrrency products. Already there are about 12 emerging markets in which we can nave access to locai currency througn the swap markets and other means. We have also introduced the use of partial credit guarantees to help raise financing for our clients in local currency, thus expanding our ability to offer this kind of fundini. Two transactions along these lines have taken place in India: one for BhartI Ielecorn anld thle othier for Ballarpur. IFC partially guaranteed IIca bond issues made by these two companies, thereby helping them get bet- ter ratings and access to institutional investors who can invest only in AA- rated or similar paper. This product-guaranteed local bond issues-is proving very useful, especially for clients who want to mitigate exchange risk on infrastructure or do.mestic market projects where revees are in local currency. It is certainly a much safer way to go about this. Although the product is still at an early stage of development, IFC has great expec- tations for its success. Among its other interesting activities in the past year, IFC approved financing for student lnons in India with Citibank and the Natinnal Institute of Information Technology. When the proposal for this financ- ing first came to iFC's investment Committee tne idea of becoming involved with student loans met with some skepticism, and concerns were raised about the impact of such a line of business on our profitability, at least if we were to entei this field on a large scale. Nevertheless, we were able to develop an innovative and prudent structure that has the potential to bec replicated elsewhere. Th-e transaction was structured more or less as LU LI 1 l}ILdLt Il VVl I I l11 Llal LLiU1 4 LU.UC lU~LII~ a securitization. Basically, our partners agreed to take first loss, while we were involved mainly in second loss, making it possible to securitize the balance of the financing. Another new area for IFC is distressed debt. We are testing these waters in the Czech Republic "nd the Slovak Republic, and we will be assessing carefully the outcome of the transactions and the potential for replicating them in other markets. We want to do this with players that have had experience with distressed debt. In the Czech Republic, for instance, we joined Goldman Sachs in an effort to buy such assets. We also offered our servicer to a! nreniqalified hidders on another npckyage of distre-zsed debt in the Slovak Republic. It is clear that IFC has to go a little beyond its tra- 39 IFC and Its Role in Globalization ditional approaches in helping to reform financial systems in its develop- Yet another interesting new product concerns small- and medium-size enterprises (SMEs), which play a major role in our developing-member countries and are at the center of IFC's strategy. IFC's early experience with SMEs, which consisted of direct financing, did not go terribly well, and our collection rates were not up to par, at least wIAhen w7Pe were financ- ing smaller enterprises (which fortunately involved modest amounts of money). Nevertheless, we learned some important lessons along the way. The fact is we cannot stay in this business offering only long-term financ- ing and not having a retail network. So we decided to do things different- lv. involving more local financial institutions- We have already had Drac- tice financing SMEs through financial intermediaries experienced in this sector. This product has done well, and we expect lending through finan- cial intermediaries to continue to increase. But the institution is also moving in a new direction, by approaching corporates to help shoulder some of the SME risks. Many corporates already active in emerging markets have an interest in working with MIL.Es. AfILer all, SMivEi are an LiILterl palt of thei; suFply chnaill. Corporates can provide services to those SMEs and can help us assess their risk and share in it. IFC has approved three such transactions so far this year. In one case it is sharing the risk with Edenor in Argentina, and in another it is working with Ispat Karmet in Kazakhstan. In the third case,, w,hich ,*,!1 be. -ong to IPC's Brd-A of Dircstors -fhrtl,, -nA ,-vhic has been mentioned in the press, we will help finance some of Shell's con- tractors in Nigeria. This product appears to have considerable potential. Another important innovation, highlighted in chapter 1, is IFC's sus- tainability initiative. By that we mean we would like to be able to measure ourselves monre according toa triple bottom line: (a) the financial viabili- ty of the corporation and its projects, (b) the economic soundness of our projects, and (c) our projects' contributions to environmentai and sociai sustainability. Although IFC has certainly been concerned about all of these issues for some time, it probably has not approached them as sys- tematically as it could. The idea is to build sustainabilitv into the very fiber of the institution, to make sure that everyone in IFC-every investment otficer, every engineer, every syndication ofiLcer-focuses on inose tnree objectives. That is to say, all three must have equal importance throughout 40 Section II The ILiterlnationial Fintiance Corporation A -, -Aur Ari-t 1viro:,:-,e1-t the process-when appraising projects initially, conducting due diligence, negotlating w-It, the clien, and ..I iILriroject lementation. On the environmental and social fronts, in particular, our approach so far has been to emphasize compliance and to insist, somewhat authoritatively, that the clients meet some of our environmental and social standards. There are other ways to add value, and to show our clients how to benefit from adopting best environmn.ental and social practices. In fact thiprpe is a grow- ing market for people who cater to eco-friendly constituencies. 'Whether this approach works will ultimately depend on whether we can persuade our clients that it makes good business sense for them to join us in this initiative. Some big oil companies and mining companies are already engaged in,such initiatives. They are not doing it for philan- thropic reasons, but because it makes good business sense for them to do so. The Cusiness case mlay be moIC uifi'uii to Illaxe wIIenI it cOrllcs to our middle-market and small clients, although some early projects here sug- gest that it can be done, but certainly not overnight. Sustainability cannot be achieved without good corporate governance, meaning that our clients must adopt "best practices" in areas such as accounting, Ing ar operati,on a-d tLatnIIMI Io lu JlI.IlLy shaehoder. IFC is concerned about corporate governance for two reasons. First, IFC has a large equity portfolio, and good corporate governance is crucial to the success of our equity investments. Second, and perhaps even more important, corporate governance has great bearing on the institution's developnrnnt misinn FC iis well aware that it cannot meet a!! the needs of developing countries or of their private sectors. Our clients must be able to attract private money in order to realize their own growth potentiai. Corporate governance greatly affects their ability to attract that money. To help us better meet our strategic objectives we have stepped up our cooperation with the World Bank. The latest strategic discussions at the Bank have made improvement of the investment climate one of the Bank's strategy pillai-s; another pillar is direct poverty reduction. There is grow- ing recognition in the Bank that private sector development is essential to growth and poverty reduction, and we at IFC are convinced that we can make a bigger difference by leveraging the Bank's resources. As a result, IFC and the Bank have been working to coordinate their country strate- _:es m.ore closel.'vr recntl preare join staeisfr som.e of IFC's1 r 1 l~I.U~ y. VVL; 1kekLL1Lly jJCpICP,1U )UIlIIL 3L1aLVr,1V3 IkJI U1~ ) 11' - 3 main client countries. The joint IFC-Bank departments created last 41 IFC and Its Role in Globalization year-the global product groups-have made a good start, although they ha-ve yet to realize their full potential. As should be clear by now, IFC today faces some enormous challenges. One is how to encourage participants to take a greater interest in emerg- ing-country markets. Some banks, I am disappointed to say, are leaving those markets. We would like to see them come back. We would also like -o ee,nsttutonal inv,estors enerngtese m>arkets ingraestnth The countries concerned and IFC must do everything in their powers to persuade participants that this is the right thing to do. That is why IFC is constantly reviewing its products and investment strategy to determine what transactions and deals will be of interest to its participants and to the mArkptz in cpnprnl The second challenge that we are facing relates to the implementation of our sustainability initiative. We must continue to work very hard at translating it into operational objectives to ensure it succeeds. We also have to balance our frontier strategy with greater attention to profitabilitv. Profitabilitv and development imnact clearlv vo together I do not know of any loss-making project that makes a great contribution to ue-velopment. One oi IUC's main contributions to development is to show that it is good business to invest in the developing countries. In tack- ling its new initiatives IFC is finding that it must do many more things than it did before in terms of technical assistance, advisory services, and the like. Those new initiatives are costly, and we need to find a better way to finance th1e,.. IFC will also continue to work very hard on its problem loans. We are not yet happy with the results, although we have had some successes in this area in the past year, notably, in the case of A. 0. Volga of Russia (see chap- ter 19a). The participant banks got all their money back, and so did IFC. T net 1but nnt leasct nrc. -r,ust -nrtinu. to --rkI on our resonsieness to clients. We need to offer products that the clients want, not just those that we have and wish to impose on them. We need to find a way to make investing with IFC a more attractive proposition. With our operations more decentralized, with most of our regional directors now located in the field, and with our focus on new product develop.ment we will make good progress in this area in the coming months. 42 C H A P T E R 7 Portfolio Performance and Future Pians Farida Khambata Viice Prnesident, Portfr,lin and Riske MAna,,ement International Finance Corporation This presentation will introduce the International Finance Corporation's (IFC's) portfolio by region and sector. It will also touch on portfolio performance and our plans for managing the portfolio in the future. I' Cis portfolio dIlIVUHL, Lu dUtLo L a JbPJ I UIIIoII, wich has suban- tially increased from US$4 billion in fiscal 1990 and US$7.5 billion in 1995. This own-account portfolio comprises loans, equities, and quasi- equities. The separate, B-loan portfolio (for account of participating financial institutions) stands at around 90 percent of the A-loan volume. In 1b,t A -lons -A B-loan- tle, T i;n A -meric region is thesngle largest exposure, followed by Asia. Africa is the region where IFC has deliberately tried to increase its exposure, though not in B-loans. Recently, IFC has made a deliberate effort to r educe its exposure in Latin America, since it was felt that the need for IFC in some of the key countries was not as signific2nt as it once was. For this reason we reduced the A-!oan expo- sure for Latin America from about 48 percent of the portfolio to about 40 percent. But conditions in world rinancial markets have now changed, and the flow of private capital to emerging markets has been significantly reduced. As a result, IFC is considering increasing its exposure to Latin America again, but this will probablv be done through investments aimed at the Andean region. 43 IFC and Its Role in Globalization In terms of ranking, Argentina and Brazil are prominent recipients of bth04 A-loans andA B-Iloans. Meco:_ is thir on the --At and A- Th n rnk's uuuil r~1uaII aiu ",IaI.ItA I LO1I Un LIIV; L13L, allU Iiilaulaiiu Ia1,NA somewhat lower, although Thailand is a very important country for the B- loan portfolio. The breakdown by sector is also interesting. The three most important sectors (manufacturing; financial markets; and oil, gas, and chemicals) are the, esame for lbothi A-!oans anA B-!oans, Nbut thep rankLingy is QsoMeP.A.ht dif- ferent. A-loans have their largest exposure in manufacturing, followed by financial markets, then by oil, gas, and chemicals. B-loans have their largest exposure in oil, gas, and chemicals, followed by manufacturing, and then by financial markets. Incidentally, financial markets make up about 40 nercent of TFC's anDrovals on a yearly basis. IFC exDects this trend to continue. Credit quality has been a rnajor concern for IFC. To address this issue, it developed a credit-rating multivariate model to rank the credit quality of its projects by taking into account factors such as country, market, green- field or other kind of project, capital structure, management, finance to date, and financial projections. Each project is scored on a scale of 1 to 7, iLhL 1 bUeing1 oJutarndiIngly godJU anLU i at Lthe. UotherI endU oI L1F s - trum. These credit ratings are key inputs in IFC's Monte Carlo simulation loss-provision model. Looking at current credit quality by region we find that Asia has several projects with a high credit-risk rating. Some of our large projects in Asia are currently experiencing problems that are taking ti.me to resolve because of legal and jurisdictional issues. This picture is improving somewhat now that these markets are beginning to get over the recent crisis. Overall, Latin America remains our most profitable region. In terms of write-offs, our levels have historically been low: since IFC's inception in 1956 they have been less than 5 percent. This is primarily hrcaiuse of IFC's philosophy not to write off, but to work on difficult nroi- ects over many, many years, until we get it right. There have been some spectacular success stories, sucn as A. u. voiga, which took much time and work but proved, in the end, to be financially very satisfactory for both IFC and its B-loan participants (see chapter 19a). Not surprisingly, Asia now has the highest nonperforming loan rate. Europe's record is adverse- ly affected by two factors. One is the former Yugoslavia and a number of problems inherited from previous regimes. ITe ouler is a -very large proj- ect in Europe that recently went into nonaccrual status. Latin America, as 44 Section II The Inter-niational Finanice Corporationi a.nmd Onur Aitrk-ot P,,iraonmioent mentioned earlier, has done well, as has the Middle East and North Africa. S,ih-Sharan Afrir narnpprC to be dlirnc, we!!,A iN1t it iC Adffi-riit to know it this time how much of this performance is attributable to the sharp growth in the portfolio in the past couple of years. Some operational changes may also be having an impact on the over- all performance of the portfolio. We now have a Credit Review Department, which we recently strengthened. This clenartment prnvides a second pair of eyes to look over each project during the appraisal stage. It glVeS rmallagemeIt input from a gloDal perspective, since it vets all tne projects that go through the system. We have also created dedicated port- folio units in each of the departments. The portfolio units' main function is to be more actively involved with IFC's portfolio companies and to maintain high-quality supervision. In m-ar.y cases our porttfolio -nits now have spcilit inthefnacasco to handle the specific problems faced by financial sector companies. We need this expertise both for new operations and at the portfolio level. What does the future hold for us? For one thing, we are going to be actively involved in overall portfolio management, not just at the transac- tion level This hac csveril dimPnsions.c Fr p,rnnlp e we now, lha,ven IaPi- cated equity 'sales desk. Now, if it is cleemed that IFC's developmental role has been fulfilled in a project, the project is passed on to the equity sales desk to make the divestment decision. From time to time we also write derivatives on our equity portfolio. These are all covered calls, because we never take naked exposure. We are also looking at our overall portfolio, by sector and by region, to see if we sIould alter our exposure through credit derivatives. In addition, we have a Risk Management Unit that is increasingly looking at IFC pric- ing based on a risk-oriented framework. The Special Operations Unit (SOU) is much more actively involved in difficult problem projects. Its philosophy regarding workouts is to maxi- mL fil- the reut for 'IF and its participan-t banks with th leas+ fallout possible. We are strehgthening SOU in terms of both people and resources, and it is working more proactively with our operational depart- ments, often just as problems are beginning to surface, so that we can ben- efit from this department's global restructuring expertise. Vet another area of activty involves " c'n," which :-efers to an equity investment where our developmental role is completed and 45 IFC and Its Role in Globalization there is little upside potential. In most of these investments IFC has writ- ten o" its equity but+ cotiue to be ashareholder of: record4. Thisa expos- ...1 L LUL ~.UX1LI11U~.a LO UC. a ~1aiLar1 iuuIu 1Iuu es IFC to potential reputational risks. IFC is actively involved in divesting from these investments. In some cases several multilateral development banks each hold small separate equity positions in the same company, making the individual investments unattractive for a potential sale. In such instancPe wp are cnnsidpring conmlinina our enuityr hnldings en that, collectively, we have a critical holding that might be of interest to a poten- tial strategic investor. Finally, we are seeing ever more innovative financial engineering tech- niques in developed markets. It is IFC's hope that we can bring these tech- niques to our clients in the developing world, so that they too can enjoy the benefits of innovation. 46 C~ U A D T E R 8 Trends in Syndicated Lending Suellen Lambert Lazarus Director, Syndications and International Securities, International Finance Corporation Jverall riows My aim is to provide an overview of trends in syndicated lending to emerging markets-a snapshot of what is currently happening in the market and how it is affecting the International Finance Corporation's (IFC's) B-loan syndication activity. To_ b-egin, lect us loo'- at: priat debt flwA o -.rg ar-sb iLlUk ,1 12 u lo'A dL Frr`Vat; UCUL HUVWZ~) LV 11LI6II111, IlIdI NCLL Uy region over the last five years (see figure 8.1). These are net aggregate amounts. The main feature is the dramatic drop in net flows to Asia (from about US$120 billion in positive flows to US$60 billion in outflows) between 1996 and 1998. Since then, the Asian trend has recovered and lay be positive -gin n 2002, l-rglyr breiica of flrn-,c tn China. In Latin America, after falling to near zero in 1999-2000, net flows were expected to be strongly positive in 2001, but this has failed to materialize, largely because outflows from Argentina have exceeded inflows to Brazil. The cri- sis in Argentina is having a harsh effect on flows to the region. On the other hand off, iial flowc (that is; flows from multilateral and bilateral agencies, and governments) are projected to increase in 2001, because of international Monetary Fund programs to Argentina and Turkey. Private equity flows are expected to remain stable. This is due to several large acquisitions, including Citicorp's recent purchase of Banamex in Mexico. 47 IFC and Its Role in Globalization Net PA4vate De,bt ow. s to Em": e;IAL g Mar, Lts by Region (US$ billions) -70 ] _sMdlg °!- l .*Aslal 60 1i 401 \ +S -80 1996 1997 1998 1999 2000 2001| [ Sour i 2 * 700aA; Figure 8.1 Net Private Debt Flows to -Emerging Markets by Region Souirce: Institute of International Finance, Inc. 2001. "Capital Flows to Emerging Market Economies." April. Figure 8.2 disaggregates private debt flows between bond financing and commercial bank lending. It is projected that bond financing will again decline in 2001; in all likelihood this decline is related to the inability of several major borrowing countries to implement economic reforms in accordance with mnrlcpt Pynpctationn Commercinl ahnk- ouitflnwc are beginning to stabilize, and the good news is that 2002 will probably see positive inflows from commercial banks to developing countries for the first time in five years. The other benefit for emerging markets, as shown in figure 8.2, is that spreads are narrowing, overall. This is largely in response to the Federal Reserve's interest cuts in the United States. which tend to affect spreads elsewhere. Figure O.j snows new commercial bank lending activity for the years 1996-2000. These are not net figures, but are rather gross new flows in syndicated loans to emerging markets. One of the marked changes in 2000 was that commercial bank lending to developing countries was up, although this was related to increases in a few countries, rather than an overall increase in a broader range of Lcuntries. 48 Sectioni 1 The Intern(tionial Finance Corporationl and Our Market Environtnent I Let Pr-ivate Debt rlUoWS to E1x lerr4l M 1ar-ket | ~~~~~~~~(I J!i billions)l ioofl l 20 0 flnmI XFI Bar& O l I lil O Rnml T1nI nl 20 IH =5 - 16 -80I w | 1997 19 1"9 2000 2001 Source: IF 2001 * Esrfmate Figure 8.2 Net Private Debt Flows to Emerging Markets Source: Institute of International Finance, Inc. 2001."Capital Flows to Emerging Market Economies." April. The !nternatinnal Finance Cnrnnrantinn sand the Rank Marketplace Compared with the' commercial bank market, IFC is a small player: its B-loan program represents only about 1.5 percent of total syndicated flows to emerging markets. The importance of our impact, however, is that commercial bank long-term lending is very limited in many of the frontier countries in which IFC sDecializes. In these countries we can be a very important player. This year we ha-ve f0und thiat there is a limiteu inarket for UroadU Uis- tribution through general syndication. More frequently, financings are arranged as "club" deals, among banks in the finite universe of banks that are interested in the transactions from the start. The market is often not much larger than what you see and are aware of initially. This has affect- eU hiow we hsave structured our syndiCcationus, rel-yin more on a core group of underwriters or arranging banks. The second noteworthy trend is that, as in the commercial loan mar- ket, our spreads have come down this year, although not as dramatically 49 IFC and Its Role in Globalization Iyncucatec toommerciai hanK Lencmg 160 250% 14o~ To meg gM rkt1 | 120 / 200% I - t i r v 100 . ~~~~~10n0 X 8nJ | ; | Ij 100% +Spreads I OI * Iinl I I * I * I * 10% 1 1 Calendar Years (Source. BIS) TPiourp R 'A qxrnicrted (7nmm.nprrcial Rani T pinAiind to Torvcrmnc A-Ma-r Source: Bank for International Settlements. 2001. BIS Quarterly Review March. as for the overall market. This is largely due to the fact that IFC's tenors are considerably longer than those for most commercial bank loans. Third, the fundamentals driving syndicated lending are much the same a., they have always been-only more so. Relationship lending is more important than ever; and strong project fundamentals are an absolute prerequisite to syndicated iending. An experience that we had in Turkey earlier this year illustrates this fact. To raise term finance for a top- tier Turkish corporate, which was financially strong and highly respected for excellent management but not well known internationally, we had planned initially to go to the institutional investor market. However, it soon becamle clear thlat thi'ns imarket w-as closeud tthe `u1 rkish private sec- tor. For institutional investors, their opportunity-cost is the Turkish sov- ereign spread over U.S. Treasuries. Relationships with project sponsors and related business is not a consideration. Thus the spreads required by the investor market, together with the other costs of the issue, were too 1115i IVI 4 11i LU l IsVV te. IllOLCad, Vwe Vrc abU LU to arrange a substanllldl VUI- ume of B-loan financing through the bank market-at a time of general 50 Section II The Initernationial Flinance Corporationl anid Otir Market Enviroinment market crisis-because of the company's strong relationships with com- mercial banks. Loans can be made in difficult markets, but relationshiy lending remains fundamental to successful lending. I shiould rention, bri lly, tLII IIew DB,l IAccUoU, Uis-Ussed III Utdetal In other chapters. As currently proposed, it will certainly have an impact on our syndication activity, just as it will on the work of major banks that play large arranging roles. Syndication activity will be further constrained if smaller banks are forced to exit the project finance market as a result of nex,cessi-le capit.a.l Neq-luireMIenttS ass.ociatled wvith thfis l business line. The prospect of the new Accord has also begun to generate the use of sophisti- cated capital allocation models and a more cautious use of balance sheets. Increasingly, IFC's responsibility is to ensure that banks and their man- agements understand the risk-mitigation features of our products. These features reniiire more in-dlenth analsviz thain for xyan-nple thos-e of noliti- cal risk insurance (PRI). Insurance has an obvious appeal to banks, since it provides clearly defined contractual protection and, in the case of PRi, in some institutions may result in excluding the insured loans from country- risk exposure calculations. This simplifies the risk analysis considerably. Therefore, it is a challenge for IFC to make sure that banks give full weight to the risk-mitigation features of B-loans. IFC has also been working close- ly wlith solllC of thie jIV pivaLeL Lrediti inurers to se w11ie Lere1-s scope lour our products to complement each other. We recognize that fees are a vital component of banks' calculations of overall return, and-particularly in our larger transactions-we are increasingly reliant on fee-earning arrangers and underwriters. In larger deals we are also linking our syndi- cations to export credit facilities, whe- possible, since we know that -o-nrt credit agency (ECA)-backed business is attractive to banks. The commer- cial risk coverage yet lower spread of the ECA-loan, together with the risk mitigation features and higher spread of the IFC B-loan, provide an attrac- tive risk-return profile for banks. This packaging together of export cred- its with B-loans has berome an important structure for our clients. Within IFC there has been a general push to get closer to our clients in member countries. 'We have rapidly expanded our presence in developing countries and decentralized out of Washington. We have adopted a simi- lar approach with our syndication partners. We now have two senior syn- dications officers in London and two in Sinoalnore. In SinsaDore. where we are working with banks on many of the restructurings in the region, 51 IFC and Its Role in Globalization one of these officers is a restructuring specialist. His responsibility is to ensurP that thie hbnL- in the rpainn nrp reaglairly infnrmed abouit .rhalt iC happening on each restructuring and that their input is fully taken into account in developing the restructuring plan. We are also looking at local currency structures, including syndicating guarantees for local currency loans or bond issues. The International Finance Corporation Syndication Activities in 2000-01 Turning to IFC loan approvals for our fiscal year 2001 (to end-June 2001), A-loans alone, which are the senior loans held for IFC's own account. are exnected to reach about UIS$2 hillion and B-!02ns about US$1.7 billion. This is a decline from last year, and largely reflects IFC's current strategy of moving more into rrontier markets and reducing our activities in the more developed countries in Latin America, which have good access to international financial markets. For many years Latin America had been IFC's largest syndication market. Signings of A-loans this year are expected to be about US$1.1 billion, andA of B-loans ab-out TTS$1.A billion, whic is a 1 slgh decline 1-r ls aiu .1 1. I 1 LUi. uJI4l .' U1111Ull WilIt-1 lb a bM1r11L Ur-1-11 IIII~ 111 1bL year. In this case, timing is the main cause: several large B-loans that we expected to be signed in June ended up slipping into July. Last year, Latin America and the Caribbean accounted for 62 percent of new B-loan signings, and Asia another 22 percent. This year is a very d.A .iffOet stry. The Midd.le l/not anI a. N'.J1 rthna Aiii.a fergil Trt.FJJI %.3Li1 AZ percent of new B-loan signings, a dramatic increase, while Latin America and the Caribbean represents only 27 percent, and Asia 9 percent. The numbers in Sub-Saharan Africa for this year have also risen considerably, to 12 percent, which is another success story. As noted earlier this changed npttern rPflPrts IFC's dpei-inn tn musd thip frnntipr and tn entpr new mar- kets. It was noteworthy that these deals were so successful in the Middle East and North Africa region. The Electricite de France power projects in Egypt, and a major telecommunications project in Morocco, involved large B-loans with unprecedented tenors. In Sub-Saharan Africa major syndications were the Chad-Cameroon pipeline and a telecommunica- tions project in Ghana. Again, these were precedent setting. T ne sectors in wnicn our activity took place tnis year also tell a changed but interesting story, reflecting market conditions more than 52 Section 11 7The Interniational Finanice Cor-por-atioln ,iA nlu OU1 ark't F!ni,roinle,,t IFC's own internal strategy. Last year our biggest syndications sector was finanrcil inctitutitnsc accounting for 38 p,rcepnt of uiir buiin,cc foilloedArA by oil, gas, and chemicals at 24 percent of new signings. This year finan- cial institutions will represent only a small component of the program, although business for IFC's own account in financial institutions is quite high. Historically, IFC has been very active in syndications for financial institutions in Argentina and Turkey, and the decline reflects difficult market conditions in those two countries. Over 75 percent of our pro- gram this fiscal year will be in telecommunications, power, anui mira- structure. Next year, however, we expect to bring very little to market in telecommunications. For all of us the world is rapidly changing and this directly affects our business mix. There has also been some change in the roster of financial institutions tlat were m.ost active 'ViLth us this year. Diresdne co e te orJ11II1 LV l VUL largest single participant, and HypoVereinsbank remains number two. They both did a substantial volume of new business with us this year. ABN AMRO moved to third place, and Barclays Bank and Deutsche Bank moved up. Among other interesting developments, Mashreq Bank partic- inntoA in a-in R-lrsnc -c e rlrprt rpciilt nf ouir inrrncPrI nrpiyrom in thp Middle East. Citibank is also coming up the league table, as are several Spanish and Italian banks. Activity with Standard Chartered and 'WestLB has also increased. To sum up some features of our syndications in fiscal year 2001: one- third had underwriters or co-arrangers plaving significaint lead roles alongside IFC; 70 perceht were oversubscribed; spreads were down to an average of 2.31 percent' compared with 2.74 percent in iUscal 200U; anu tenors were up substantially. Our average tenor of B-loans in fiscal 2001 was a remarkable 10 years, in contrast to seven and one-half years in 2000- and this was at a time when market tenors generally were shortening. Deals in the pipeline for next year suggests substantial activity in the power andU mining sctUI. i bus UU3incss aiuuUItI Lt abouL U .8 Ulliiuin. In terms of regional distribution we expect to see a return to Latin America, at over 55 percent of upcoming deals, and some recovery in our Asian pro- gram, although not to prior levels. While next year we expect to revert to the traditional pattern of Latin America and Asia dominating our B-loan activ- can change quickly in today's unpredictable world environment. 53 C% U A P T E R a Restructuring Problem Loans Mary Elizabeth Ward Manager, B-Loan Management Division, International Finance Cornoration As of March 31, 200i, the internatiorial rFinance Clorporation's (IFC's) portfolio consisted of 274 B-loans, representing a committed portfolio of US$7.4 billion. This is a decline from the level at the end of the last fiscal year, when B-loans numbered 285 on commitments of US$8.1 billion. The reduction in the participant loan portfolio reflects that, on an aggre- gate basis, tie portiLUio is paying d1own-through regull-arl alliVi Llc1LIV,13, prepayments (in some cases related to the successful closing of restruc- turings), and cancellations-at a faster rate than new business is being booked. Thirty-seven of the 274 B-loans are currently nonperforming,' totaling US$1.1 billion, or 14.9 p--nt of IF-c rmrmittA RB-loan nortfoio. It is noteworthy that three loans accounted for 60 percent of the total nonac- cruals. As in the case of the A-loan portfolio the most important story continues to be Asia, accounting for about 78 percent of B-loans in nonaccrual status, with the region itself representing 33 percent of out- stantlina IFfC R-!nsn. Three cnuintries in the reginn-Tndonesia, PNki-tan, and Thailand-contain the bulk of the problem loans in Asia. More important, two large B-loans in the region account for 46 percent of the total amount of all IFC nonperforming loans. Both are in late phases of restructuring or settlement, and should soon reduce the nonperforming figuressignificantly. 54 -- 54 feciion 11 Tlie Interniationial Fitnaice Corpor-atioil -a d, OuAlf' -bet E vir- on; Fifteen percent of the nonperforming portfolio is in Europe, predom- inIatLey attibIutaUbk Le) I LugsI a VI no IInIiaccruals, CIIIU n IIlaIr,g proJject is in Central Europe. Only 7 percent of nonperforming loans are in Latin America, the region that accounts for approximately half of the B-loan portfolio. The trends in the A-loan and B-loan nonperforming portfolios are similnr ^ATith hiiahpr rnnrPntrationn in th-e Acia loraIn portfolio. The nu.rn- bers for the Middle East and North Africa and Sub-Saharan Africa port- folios look strong, but exposure in these regions continues to represent a small (albeit growing) proportion of B-loans, at 6 and 5 percent respec- tively. Only 2.3 percent of committecl loans in Latin America are nonper- forming. Argentina and Brazil account for over half of the B-loans in the region, yet defaults have remained low, even in the face of economic pres- sures in these countries. Despite the current level of nonperformers IFC has proved to be effec- tive in facilitating the restructure and recovery of problem B-loans. We currently have 32 B-loans in restructuring, amounting to US$940 million, and involving 197 individual participations. We have already discussed regionall , dstrib1ution. In terms ofp :1industry concentration oAefth I5 UIIa ILI IUL, LI I 1 iL III I 1 LUUL LU i aLLi dlUl 3U14I~V L til largest deals are in the power sector, and in the oil, gas, and chemical sec- tor. Agribusiness and cement projects also figure prominently in terms of number of deals, although the aggregate outstandings and deal sizes are relatively low. As of June 2001 wire have closed 14 B-loan restructurings covering US$728.5 million in rescheduled or prepaid exposure this fiscal year. To accomplish this we obtained unanimous consent from i 15 participants. By comparison, in fiscal 2000 we closed just eight restructurings covering US$184 million in B-loan exposure, and with 31 participants. IFC has achieved particular success in leading restructuring efforts in some of the most complex projects in Asia. Our Special Operations Unit has com-imitted significant resources to restructurin-gs in the region, with an experienced team of workout specialists based in Jakarta. We also post- ed a participations officer to Singapore this year, to provide quality client service to participants, ensure timely information flow, convene partici- pant meetings, and obtain their unanimous consent on restructurings. 1 _In st years ArtAc1pants Meein we de iae A- SAS-11 - 1_ AtAAA+A A I11 Id t yC i UllpdJll2i IVLLLL1IIS WC uLUlILu a bCziIUul LU LIIC restructuring of Thai Petrochemical Industries in Thailand. Earlier this 55 IFC and Its Role in Globalization fiscal year the restructuring agreements were finally signed, and I am pleased to report that debt service payeients nave resumed. irFC continues to play an active and leading role on the creditors' committee, which gives us-and in turn our participants-high-level access to information. Another restructure of interest is the Tuntex Petrochemicals deal in Thailand, which is discussed in detail in a separate chapter (chapter 19b). Asia ia Inot the only area VVIIere restructuLIring have coe,HMwVV%.%r. lvAvl have also succeeded in closing restructures in Argentina and in the Russian Federation. This work would not have been possible without close cooperation, frequent communications, and, ultimately, the unanimous consent from niur nnrtfirinntz WnAring rnnn,pritivplv nn rPeztriict-irinYc wAritl nilr nnrt- ners has been essential to bringing a good number to successful closings. I FC defines a loan as nonperformlng when any amount due to it is 60 days past due 56 %a-% I EwiEU son Enhancing Value: Investing in Sustainability and Corporaute Governance C H A P T E R 1 0 Sustainability: A Portfolio Manager's Perspective Julie Fox Gorte Senior Environment and Technology Analyst, The Calvert Group Sustainability is a difficult concept to pin down. Many definitions have been proposed but most do not work. Y'et everyone has a general iuea of what sustainability means, and, as the old saying goes, you know it when you see it. Many indicators have also been suggested, but all are imperfect. Since financial firms deal with imperfect things all the time-as proxies for the information we seek-the best way to handle these imperfect indi- cators is 1e tv Use aa iiiaiiy as ULL of te a FaspIUIsi LU Ut UnLdeLsta Lid ItIIi iLma- tions, and beyond that to use a fair dose of judgment. Our indicators and our definitions are affected by the fact that we are living at a timne when we know more than people have ever known, yet we do not know as much as people will know in the future. Hence what we tli;nk- we know about sistainability will change. Just look at the changing views toward forest management, for instance. A generation ago, when a forest was cut, the best thing to do was to clean up the site afterward, to get rid of all the slash and bark and other things that did not go to the mill. That clean up is now frowned upon. It is regarded as more environmen- tally beneficial to leave as much of the hiomass on the site as possible in order to provide for nutrients for the next generation of forest manage- ment. Views of good forest management have changed-and it is no dif- ferent in the financial field. 59 IFC and Its Role in Globalization The point is, it is very difficult to know when our investments are sus- tainable, bu v o kovv wha isussanbenohr words, we 1 ow I LiUl. UU VL Ut aLJV VYalat 13 4,,33taJJLM UIC. Ill VLHCL V uL3 Yr. lJSV what not to do. The challenge, then, is to figure out what to do to develop the indicators, the right matrix, the knowledge, and the ability to make sound judgments. This is not so much a matter of knowing exactly where we want to go, as of arriving at a place we will recognize when we are thIprp and juict rnnL-inc cnntinuous,ne midcrsnrep rcorrections Pn rcute. Ideally, a sustainability matrix should measure both stocks and flows, or, in other words, both output and performance. Many of the measure- ments used today are strictly for stocks: they measure the amount of car- bon dioxide in the atmosphere, or the amount of ozone in the strato- sDhere in certain Dlaces. What is not known in many cases is the rate of change in these measurements. InIforn-ation is neeueU on both output and perfordlulace, yetL IIULI 01 what is available is based on input. Take the case of forest management again. We know what is spent on it, but do we know what it is accom- plishing? This is much more difficult to quantify, yet everyone wants as many quantitative indicators as possible. I 1113 alpulie to sL%ialy responsible IIi VL3LIu3\.JX (SRI). 1Accoding Lu figures for 1999 the United States invested more than US$2 trillion in SRI portfolios during that year. That means about US$1 in every US$8 of equi- ty investment went to some form of SRI in the United States. The rate of SRI may be increasing even faster in Europe, and it might grow faster in Asia, in the futuire A anng Adeal ofthis ic in cpnarnte arrnicnte byr thep ,nA,,, ne nonncA to vehicles such as mutual funds. These investors are high net worth indi- viduals who want to put their money in something that fits their values. A broader set of investment products is now available for the growing num- ber of households with about US$50,000 to invest. These individuals are not going to hire n ortfolio manager or a separate account manager. Until recently the competitive performance of SRI was quite vigorous, although stock-market dives of late have made a major impact-some- what like a bomb crater-on SRI in our business and in everybody else's. Nonetheless, most SRI products are growth products. Morningstar ratings and the weights of SRI firms in various categories indicate that they are doing fairly well in the areas where SRI is represented. Another indicator of ho-w thiey are uding iomIes 11fr 11111o0VetL, an agncly Liat coIIIpIetes SLd- tistical and industry research and provides reports for investment man- 60 Section lIH Enhancinig Valtie: Investing in Sustainiability an?ld Cnrionrnte Conern iirce agers, among others. A number of in-depth studies there have included some quantitative analysis of whether there is a statistically verifiable double- or triple-bottom line, that is, whether it can be proved, as many SRI nirms believe, that tnere is a rinancial bang out or managing the work force, or out of an improved impact on the environment or human rights. On the basis of its research Innovest ranks the environmental perform- ance of corporations within an industry. For example, it will look at elec- tronics industries and rank every corporation in that industry. Its uni- verse, I 1A1 A_. is + 2_ n __ cant V:1onC, I uCi:V-, I LIlC StallUdLU ax rk)UL b JUu. In one yearlong study of SRI performance Innovest back-tested the AAA-rated portfolio against the average portfolio, and then did the same for an A-rated portfolio. It found that the higher the rating, the greater the spread between the performance of the average portfolio or industry and theit sampnle of hglnybi ratedI~rn, firms.Backtesing oif portfolio that passed some proxy or metric for environmental performance has produced quite a bit of evidence of this kind. At The Calvert Group we have subadvisers who use such research to measure SRI performance. Not all SRI firms do this. We have 14 portfo- lios that are socially screened All of those with the excention of our hond portfolio, are managed by outside subadvisers. They do the financial due miligence and the research, and then they call us and asK If tne company is a candidate for investment based on our social screening. As a result, we put every company in our portfolio through a comprehensive analysis that compares the comnpany to its industry in terms of environmental impact, workplace practices, human rights, the community, product safe- ty, andu indigenous people's righl-ts. We look at a company at a moment in time and at everything leading up to that moment, all of which means maintaining eternal vigilance over it. We monitor the company's behavior. We watch with whom it merges, who it acquires, and its performance on all the social and environmental icciipsc All of this renquirec an entirol, n-p-, bottnm-upn tntlyis. Tbst in turn, means we must constantly update our information. When it comes to screening we have both positive and avoidance screens. Avoiding the so-called sin stocks-nuclear products, gambling, alcohol, tobacco, and the like-is one of the main screens for SRI assets. Oiir main goal is to investigate companies thoroughly If we want to determine whether a particular company is good for the environment or 61 IFC and Its Role in Globalization has a lower environmental impact than its peers in its industry we con- d4uct extensiv anlyis Even _ -he -we - -oll e -n up - hain to-exercis UULL ALK:1131VC ailaIyS1S. £,VC1 LIICII Vyl- OVU111-L1I1Ca KALU Up~ 11dIVillr, LU 2AiL1 our judgment because the screens are hard to implement and it takes a fair amount of time and expertise to perform this analysis. That is why funds requiring this kind of scrutiny have higher fees. Another aspect of SRI that I should mention is shareholder activism. lAk,- en a compann hi nrprblemc nr XAT11Pen scompthing has hapnnend thalt concerns us, we enter into a dialog with the company; this can go on for years. if we reach an impasse witn a company and it no longer seems to be responding or is just not going to go anywhere with us, we may file a shareholder resolution, which is straightforward and easy to do in the United States. If we get a 3 percent vote in the first year, we can refile it the next year. If we get 6 percent, we can refie it tile foIlowing year. If we get 10 percent, we can refile it again. And at 10 percent-sometimes even at 3 percent- we usually get management's attention. Then the dialog can proceed. But we may still reach an impasse; and in some cases when we get to this point we just decide to divest. 1r_ get the informlation necede to rlaaethis kind, of7 --vetrmen+ requires a formidable amount of research. That is why we subscribe to dozens of journals, search services, and both proprietary and public data- bases. In the United States we are extremely fortunate to have a great deal of information available publicly. For example, details on the environ- mpntal nprfornmnce of eieryr r.pnnnir writh an nffcp in tie TjnitdA States are available to the general public from the Environmental Protection Agency and Virofax. To my knowledge, the only other place where this is true is Canada. An additional challenge, then, is to obtain this kind of information on companie' that are headquartered here but have estabhishments offshnre or on companies that are headquartered overseas. That is a much harder task, in part because the United States has dirrerent standards, aithough the bottom line for everyone everywhere is "Do you obey the local laws?" At times obeying the local laws is not enough for us, but it is an absolute minimum in every case. And since laws differ, we also need to have con- siderable local legal knowledge. vve also ha-ve sorm-e trouule with nidu-cap anu small-cap comifpanies, because there simply is not much information available on them. Again, 62 Sectioni III Enhiancinig Value: Investing in Sustainiability and Conrponrate Goverr,,,,c,. that involves extensive data gathering. Some people might wonder if all thalt work is worth it In oiur v1pw i't, iA iTPsll lAworth the trro,,ip in the sameip way that financial due diligence separates managers with mediocre per- formance from those whose records are consistently better. Are there linkages between social and financial performance? In the past, the general view was that SRI had diminished returns. Not any more. It is not difficult to find a socially resnonsible product that will give a return that is competitive with a product that is not socially screened, especially in growt'l iniuustries. However, my parting question is, Can such products do better than the competition?" That, I am afraid to say, has yet to be established. 63 C H A P T E R I I Sustainability: A Commercial Bank's Perspective Bart Jan Krouwel Managing Director, Sustainability and Social Innovation Group, Rabobank Nederland The~ ~ ~ _A fiania secto ned topayaky role Jin achieving a sustainable 1it 11 1 allUid A 1U1 11VUa LS.J Fiay aL I~ UI,. r Q1I LV L. Iu a, ul,. society. Fortunately, the International Finance Corporation (IFC) has been putting sustainability higher and higher on its priority list. To this end, it has been changing its criteria to meet the demands of sustainable equity management. With many of society's demands also changing there ic an increaCing prncciurp for banlrc inciirannr rnmnfniPc npncinn finAc asset managers, and others in the financial sector to include sustainability in their initiatives. More of us in this sector must lead the way in setting trends. We have to change the world in developing new products and serv- ices related to sustainability issues. I would like to talk about how we are doincg that within Rahnhbnk= Before I address the way we are addressing sustainability, let me give some background on our institution. Rabobank is a cooperative, wnicn means it does not have shareholders, only members and stakeholders. It is the largest bank in the Netherlands's domestic market, and the third largest international bank from the Netherlands. Hence what we are doing within the Netherlands seems quite different from what we are doing out- dUC tLIe (coUIItI y. III bOtI SphCeCre, hoUweverI, we are coristantly lookling for ways to cooperate with other financial institutions all over the world, for 64 Sectioni III Enhancling Valie: Investinig itl SUstainiability altic I."Utpuruu kuuIfrLu,ance~ ways to use the instruments we have in products and services in order to support a sustainabUle society. In fact, we have a special group for this purpose, the Sustainability and Social Innovation Group. As managing director of this group I am direct- ly linked to the chief executive officer of our company. The group has a department devoted to green banking, which was set up a few years ago -hen thep ruitch, --,rrln-nt -reateA r-,t- fnr areen financing. TheCs rulep make it possible for depositors to participate in a so-called green fund, which means they do not have to pay any income tax on the return on their investments. Since income tax can be avoided in this way almost everyone has begun putting money into a green fund. The fund nrovides p very chean form of finance that we can nrovide to ____7 -I -- investors, to the initiators of green projects. This money can be invested in different kinds of green projects in the Netherlands. it is also possible to provide green money for projects in developing countries. This is, in the- ory, one way to offer cheap money to countries in Central and Eastern Europe, Africa, Latin America, and Asia. However, things do not quite work this way in praciice. Because this money is so cheap it becomes a probleLmu it we, thle bUadiKS, 11dave to cover all the riSIKS t r disks cur-Lrenc.y risks within the very low rate of interest. We are not willing to do that. The question, then, is how can we find nongovernmental organiza- tions (NGOs) and other companies to which we as Dutch banks can make this very cheap green money available, so that local branches of their own, or of ot her baonks in dAve1opainrr countrines can provnside the mnoneyt direct- ly to their local project's? We also have seed capitai-green seed capital-for sustainable devel- opment. To help channel this capital into worthwhile projects we have a number of experts in different fields: sustainable agriculture, sustainable construction; renewable energy. and the like- These exnerts join uin with the bank's commercial people-with the account managers and others- to advise customers ab'out now to set up new activities reiated to sustain- ability. If a customer of a local bank says, "I'd like to set up a new compa- ny or a new building, how can I do it in a sustainable way?" we are set up to advise them how to do that. Rabobank has four societal funds, donating money from its profits to Uicffrent kinds of projects -w-ith a speciai goal: to set up ne-w LUUpetLIVC initiatives, especially in developing countries, but also for other purposes 65 IFC and Its Role in Globalization within the Netherlands. We are also establishing a department for inno- vation and' developm,ent, wIIose sLcienistsL WI'' assessb Lthe Ue,IHas IUI Rabobank's financial services five to ten years down the road. The inno- vation platforms will be established by groups of young managers with high potential from a management development program. They will cre- ate new products and services, if possible with sustainability in mind. The- bank also has an ethics comtmnittee, w.hich oversees various ethical problems related to financial deals. For example, it might be called on to look into a bank-to-bank deal earning a great deal of money using the dif- ferences between the tax systems of different countries. The committee may ask whether it is ethical for a bank to do that. Because we have a code of cornnrate social re,nnnsihility we are cornmitte'd to examining the ambitions of our group, of our financial institutions, to make sure that what we are doing meets our "Tripie-P" goais: goais that involve peopie, planet, and profit. One of our important departments, as I mentioned earlier, is the Green Banking Department, or Rabo Green Bank. On the Triple-P side it is doing extremely well, not only in making profits but also in investing WIC, Ly tI givepeo LeI th pprLtunitLy to stL up new CLMI)IIIIL, dctivities. The social and ecological-or planet-side of our activities also receive special attention, through the Department of Sustainable Development. In the green financing area we have already contributed more than E600 million to projects such as forest and nature reserve development. As everTy\on I!tExA7O Idle XTeF150r1 A, l- 1n - -a -----1>1-- A+ Tl>lE_0 LVWISII Vzl. xIflJVVa bilL JL-LsII-I IQAII 1103 intatny 51A..IIIIJLuO. IlL LsaLJVJIi LII Bank we are looking at "Green Label" greenhouses, which are new types of greenhouses using less energy. Many different projects have already received cheap green money from Rabo Green Bank. Nearly 50 percent of our funded projects involve organic farmers. Organic farming has become important in recent times, in view of agri- cultural problems such as foot-and-mouth disease. As a result, many mainstream farmers are changing to organic farming, and they can be financed with green money. We can finance green projects outside the Netherlands, too, although I believe that so far a total of only I 0 nroiects abroad have been financed on a green basis by the Dutch banks. These include wind-energy projects, usually financed against security provided witnin tne Netnerlands. in our domestic market Rabobank has a market share in green projects of about 66 Section III Enhancing Value: Inivestinig in Siustainiability ai (f nd Crporat e Governanrce 50 percent. Part of my group is Rabobank International Advisory Services, a cu1ILting groupytat is actLive in rural dcov.lopmLent, .specially III dJVevI- oping countries. A very important development in the financial sector today, in my opinion, is that we are working to set up alliances between different organizations in the interest of protecting the environment and promot- ing sustaiinale development. Some yrs ,ago Rabobank,, along with other banks, signed the United Nations Environment Programme statement on environmental and sustainable development, and committed itself to such development. About 190 banks all over the world signed the statement, but some large banks did not. In addition, Rabobank is a member of organizations such as the World Business Council for Sustainable Development (WBCSD) and of the European Partners for the Environment. Tihis is wnat more oi us snouiu be doing-sitting together- as financial institutions, signing the same statements, or being a member of the same organizations, and developing financial products and servic- es for a sustainable society. One outcome of this development is a recent workshop in Geneva hosted by the WBCSD. The International Finance C-orporatiorn (IFC) was represented th-ere, along with other financial isi %..upulLl I I1'. % vvaL l tC I 1tCI I C,di11 W tH l ULIC Ild CdI 1IIIZLI- tutions from around, the world sitting together for the first time, dis- cussing how we could cooperate at a global level. One of the main problems for such endeavors-and I do not know which organization to turn to for advice here, perhaps IFC, the World Bank, or the Organisation for Econnrninc Coonprntion5n and Development_ is how to harmonize the world's myriad financial and tax rules to avoid barriers to achieving this sustainable society. Often, interesting financial products and services are tax-driven-but different tax rules in different countries create barriers that make it difficult to stimulate private indi- viduals to buy these products. As financial institutions we have a duty to inform our customers of these possibilities to buy sustainable products and services to support their efforts to achieve a sustainable society. What deters many people from looking at these possibilities, even within my own company, is that they do not believe it is possible to earn money from sustainability. Many think that sustainability is only for gurus or idealists, but not for busi- nesspersons . I UClICeC I cadll pIUVC ohrLIIC1WlC. IIn IdfL, act .1l6C geLd caL earn substantial money on sustainability projects-and of course it is 67 IFC and Its Role in Globalization necessary to earn money on them, because if we did not we would not su rvi.v as financial institutions, an if e caonnot su -rv -I - cann pro= vide. In conclusion, I urge financial institutions as a starting point to sit together with other financial institutions, governments, and NGOs to try to achieve a sustainable society. We have reached a point where it is essen- tial to make common products and services for such a society. It is our duty, and our corporate social responsibility! 68 C H A P T E R 1 2 Corporate Governance: A Call to Action Peter H. Sullivan Chairman and Chief Executive Officer, Lombard Investments, Inc. Corporate governanice matters. It matters a great deal to a Drivate equi- ty firm contemplating an investment in a distant country where the laws, regulationis, andU tradUi,ions dIt qUiLt UdifIfereL 110111 LthUos ot VIh Lirr'iti home country. Quite simply, this is because good corporate governance does enhance enterprise value, while the lack of good corporate gover- nance amplifies risks for the prospective investor. A colleague of mine likes to say that "governance" is a threatening word t o mr..ost+1 pe o p le. -JkfCh i A a1d a-atr e wit their paets: when they playing the approach of parents-governance-means games must stop and misbehavior end. Adults, too, have negative associations with gover- nance. Imagine a husband and wife driving along a freeway. What does the driver do when the spouse says a police car is behind them? The driver will immediattelv slow down and check the speedonmeter even if hp or she i not speeding! And some managers fear governance, because they equate it with regulation and new controls on business-and inevitable new demands on money and time. Corporate governance should be seen only as positive, however, because its objective is to strengthen and sharnen financial performance and corporate management. Although there may be some losers in the process there is no dtouUt tnat tne inaJority of managers, Doard members, and especially shareholders will benefit from good corporate governance. 69 IFC and Its Role in Globalization1 What is Corporate Governance? in recent years there has been considerable discussion over wnat tne term "corporate governance" means, and how far it should extend. The term can be defined narrowly-to include only issues relating to man- agers, board members, and shareholders-or it can be defined more broadly-to include issues involving stakeholders (such as customers, ellylplyL2s, ce1U1L%ors, LIIe UUsiJnCe LAoI1LIIUniILY, VI sUociLy). IIn Lthe fUoIIIme case corporate governance relates to the fiduciary responsibility of man- agement and boards to protect shareholders' rights. The latter, broader definition would include the responsibility of management and boards to act as good corporate citizens, and to contribute to the betterment of soci- ptyr Pprcnrnallir T nrpfpr thp lntt9r Aprinitcfn h,,t rn -A rL-c t,-,A- -011 focus for the most part on the narrower interpretation, because our topic concerns enhancing shareholder value. In any case, the elements of good corporate governance are compatible, and certainly not mutually exclu- sive, under both definitions. If we view cornorate governqnce as the fidiiciarv responsibilitv of management and boards to protect shareholders' rights-and in the process to ennance snarenolder value-then the key concepts are riduci- ary responsibility and shareholders' rights, and the key actors are man- agement and the boards of directors. Fiduciary responsibility means, in effect, that the board and manage- ment of a company must act as trustees of a company's assets and capital. ThIey have a duty to -_rcs loyalt to -hrhles to- __-nete sst I IIy iiv aUULy LVUJIALULInC LUyd1ty LuJ MW1d1V1U1UI,, LU I111d11d6r LIIC dNCL prudently, and to monitor performance. Shareholders, in turn, have the right to expect that management and the board will be accountable and transparent, that the company will be run equitably, that voting methods will be fair, and, crucially, that share- holder value will be rnaxi...ized. Elements of Corporate Governance There are a number of factors that constitute or define good corporate governance. One way of viewing these factors is to use the definition of good governance adopted by m-ny forrn er - ni-, the Asian Development Bank. That definition focuses on four critical elements: (1) Accountability, (2) Transparency, (3) Participation, and (4) Predictability. 70 Section III En han cinig Value: Inivesting in Suistainiability and Corporate Governiiance Accountability Managerm-ient must be accountable to a board of directors, and both the board and management must be accountable to shareholders. A bal- ance between board and management, with both striving to uphold share- holders' rights, would be the ideal world. In reality, however, this is rarely the case. More likely, management-and especially the chairperson-con- trols the boarA, and board r.,en'bers are often either executives of the company (and so are not independent), or friends, relatives, or close con- tacts of management. This is especially true in many Asian countries, given the closely held nature of many Asian corporations. The Korean chaebol, the Japanese keiretsu, and the Chinese family company are exam- nles of thece closelv held cornnr:tinns. Mnnagement that is not rigorous- ly supervised may too often act solely in its own interests. How to resolve this 'problem? One solution is to aim for the inciusion of independent directors on each board, and independent board commit- tees-audit committees, nomination committees, and compensation committees, for example. Independent board members do not necessari- ly have to be in the majority (although that helps), but they must be pre- paredU to worLk hadl arud t Lo remaldin indUepenUent, andid tiey mLLust Iave access to information, power, and respect. Shareholders need to play a role here, also: they can and must act like owners, and ensure thai the board is properly representative and includes outside, independent directors. The presence of strong institutional irnestors-such as the International Fin ance Corpora.,tion (IFC)-can be a very valuable asset in this regard. Such institutional investors have the "clout,' experience, and know-how that small, individual investors lack. An active, involved set of shareholders and a board that includes active, capable, and independent members can go a long way toward ensuring arcountability on the part of managernent Transparency Investors, shareholders, and the board of directors must have confidence involved. This includes financial information, and information on corpo- rate vision, mission, and structure. While accounting standards may vary from market to market, international standards are now being widely adopted. Good corporate governance requires use of internationally accept- e. accountin A --udtin tandrA. Nothfing else should be accetable. 71 IFC and Its Role in Globalization Participation All shareholders deserve equal treatmenit, whether local or foreign, majority or minority. Minority shareholders' rights, in particular, must be carefully observed and protected. Voting methods must be transparent and fair, and shareholders have an equal responsibility to participate in annual meetings, to request information, and to play active roles in over- see.ng tLIll. F91 IlllaillA Uo tLLir corlhFaiIJL,. Prpd,rtahiliti, Understanding the rules of the game is critical for a shareholder, an investor, or a board member to make an informed decision. That means the rules of the game should be set out in a clear and timely manner. A number of steps may help in this regard: * Codes of best practice. Each market needs a code of best practice for corporate governance to define the relationship between manage- ment, uoaru, dnu shIldlaeulUers. 'UcII d bUUC silUUIU dIso seit I1111 legal, accounting, and other standards that companies must meet. Companies should adopt such codes as their own guidelines. In the absence of such codes in a given market companies should develop and publish their own codes. CorporasA A Vsiorn' ir;AniXr ssio4,an val ues.Boaqrds -A -_ mn A s10111nA. _ ¼,lVifUtJI L14C. V t3tUfUI rit3JtJrull l A VH . fJaJ . aI .. ..lalla6s..nnaL ILLIlJ l formulate long-term strategic visions for their companies, mission statements to set forth how to accomplish the vision, and value state- ments to outline the ideas and principles around which the company culture will be built. * Cnrinranto ctratey aind ctriirtiro A miscsin ctst,ament helpsc to dl-x17 op the corporate strategy, and the corporate structure in turn flows from the strategy. Both the board and management should play active roles in developing these elements. An !nuactnr's FvnEriene- with Corporate Governance The firm I am with, Lombard Investments, actively invests in the developing markets of Asia. We have participated in private equity invest- ments in economies ranging from the Republic of Korea; China, includ- ing Taiwan and Hong Kong, China; to the Philippines and Thailand. We are actively working with IFC, the Thai government, and anumber of institutional investors in Thailand, to put together a Thai Equity Fund that we expect will close in the near future. We have established a $252 72 Section III Enhancing Valie: Inivesting in Sustaina(ibility and Corporate Governa-ce million Asian Private Investment Company cosponsored by the Asian Developmnent Bank. Our major source of capital is the California Public Employees' Retirement System-or CaIPERS-which is notable for its activist role in sponsoring corporate governance. All of these institutions are extremely valuable partners in helping to assure the practice of good corporate governance in investee companies. Working with an institution such as IFC nrovides additional benefits. beyond its size and experience, due to its links to its public sector affiliates . 1 _ - 1- A. T_ I1 M - _-_ 1- r !_~ __ __- 1_ _ l I I I I 1 15_ I _ __ -_ -- _. _ -_ -I _ l_ _ _- _ I InI Lthe vvorli DalBk Group. Thie vvorlt Dank call proviuc policy-Dased loans in the public sector, which help governments of emerging markets develop the legal frameworks, laws, and regulations that are necessary to stimulate, nurture, and sustain good corporate governance. The feedback from IFC's own investment experiences can help in an iterative process to get those lavvs anl regulatfonso ri g. We have observed a wide diversity in standards of corporate gover- nance in our investment activities in Asia. Unfortunately, diversity is not always good. We learned quickly, through an investment in one company where the board did not have sufficient independence and where account- ing and auditing standards proved not to be up to internationa! standards, that we would have to play an extremely active role to protect our inter- ests, although we were only a minority shareholder. We have had to build coalitions of other shareholders to replace management and part of the board in order to develop good corporate governance, and have had to expend substantial amounts of time and energy to try to rebuild the com- pany to recover our inyestment. A 1- ~-L 1~ f L A tA hiappier eXdIample WdS dla illVStl1ltllL IridUC shorl uy dILCI the AIsian cur- rency crisis in Korea's fifth largest securities firm. As a co-investor with Hambrecht & Quist Asia Pacific, we have changed the make-up of the board, and, working with new management, we have helped to implement best international practice in corporate governance. We have set up inde- pendent com.-.-i,t+ees or. grn a ---nce risl- compince, -n co-n-ensation. A promotion system based on seniority was replaced with a new one based on merit; many other changes followed. Management of the company- Good Morning Securities (GMS)-firmly believes in corporate gover- nance, and indeed GMS itself now actively sponsors the development of cornorate goveornance throughout Asia D t pay off? AIeul, T onmbanrd recently sold 20 percent of its holdings in GMS for a 352 percent gain. 73 IFC and Its Role in Globalization Lombard believes so strongly in good corporate governance as being crit- ILdi 101 sIhrCIIUder Vd1UC tlullancement thllat -wve have -a lngthy ChICCL-'ISL on corporate governance issues that we use as a basis for evaluating each possi- ble investment we may make. We talk through the concept of corporate gov- ernance with each potential investee company's management, and require agreement on any improvements necessary to existing arrangements. In a cr.pnny,, in the Philippies for exrr.pleh, wer agreed, before n,r...k ing an investment, on a series of steps to improve corporate governance. These included introducing an outside chief financial officer into the management of what was until then a closely held family corporation. The management-previously all family members-have welcomed our advice and assistance in helning to restructure a family corporation into a company that can be taken public with an outstanding record for corpo- rate governance. This is not always easy. The corporate governance standards we demand often exceed those of the market we are in. This may mean an investee company may have to make financial disclosures to the public, for example, with adverse tax consequences, while its competitors do not ma.ake suchi disclosures. kIn this regardu, perhlaps Llhe definiLion of corporate governance approaches the broader definition that involves being a good corporate citizen.) This obviously makes the investee company's task in the marketplace more difficult. But, in the long run, we believe this will not only raise the standards of the community or market we are in, but will al.so providle grater fintncial returns to us from the in,to,-nr,nrn, We believe in this so strongly that we helped to establish the Asian Corporate Governance Association (ACGA)-a Hong Kong, China- based, not-for-profit organization launched in 1997 with support from business leaders from seven Asian economies-and we continue to pro- vide ACCGA financial support. Thisi asnciatinn helps persuade Asian com- panies that corporate governance makes good business sense; it dissemi- nates materials, hosts seminars and conferences, and provides advice and assistance to Asian firms. The Rnttnm I in: Does Corporate Governance Enhance Shareholder Value? Does corporate governance enhance shareholder value? I answered this question in the affirmative at the outset of this presentation, and I 74 Section III Enhancing Valiie: Inivestin1g in Szistaiiiability a!id Cornorate Governance hope the few examples I have cited from Lombard's own experiences help to demonstrate why I did so. Let me also note evidence from the work of others, which supports the proposition that investors who take corporate governance seriously will be rewarded. Between 1992 and 1995 CaIPERS asked two financial consulting firms-Wilshire & Associates, and The Gordon Group, Inc.-to study the relationship between active shareholder-investor pursuit of corporate governance, and an improved bottom line. Wi 1lshire &- Associates, whYich looked at iv companies at which CalPERS had been proactive in corporate governance issues, found that: * The stock price of 42 companies targeted by CalPERS between 1987 and 1992 outperformed the Standard & Poor's 500 index by 41 per- cent. (Refinements of the study suggested the outperformance was * In the five-year period before the active involvement by CalPERS these same companies had trailed the index by 66 percent. The Gordon Group studied the issue of corporate governance more generally, and concluded that: * "The overall evidence... shows that over the Dast several decades active investment strategies have consistently led, on average, to sig- nificant value increases." An article by Philip Day in the Mlay 1, 2001, edition of the Wall Street Journal described a recent survey of 495 emerging market companies, with the findings demonstrating a strong linkage between good corporate governance, earnings, and stock values. TLo;nbard' -w ---ith corpate. goverac hIas convinced us that good corporate governance, and a willingness of management and board to maintain or improve corporate governance, are fundamental requirements for any future investment we will make. This is not altruism. As a private equity firm we know we are ultimately judged and rewarded by the returns on our inestrm.ents-that is, by the extpnt to which the enterprise value of our investments is enhanced. A Call to Action The importance of corporate governance-whether to the bottom N r t tl.p rcnmmiinitxr_r nnt hIP iIi ]rpetimatpA It ic hcth n mnPin- ingful issue for investors and shareholders, and one that is vital for the marketplace. 75 IFC and Its Role in Globalization To ensure good corporate governance, shareholders must assert their rights to protect their interests, and board mem.bers m.ust assert their independence from management. For the rest of us, the following steps will help: * Influential investors and lenders should actively pursue new corpo- rate governance standards; * Governrnents shoild be encouraged to adont or promote cornor2te governance regulations; and * Governments, investors, and lenders snould support tne adoption of uniform auditing and accounting standards and practices worldwide. I know that international organizations such as IFC, and investors such as Lombard, will be willinz agents for these changes, but I sincerelv hope you will all join us in promoting the development of good corporate gov- ernance. It Udoes enhance value-for all of us. 76 C H A P T E R 1 3 Corporate Governance: Its Impact on . v __ _~_ - _ ,._ _ invtstment rOuws Peter C. Clapman Senior Vice Presidrnt and Chief Counse!, Investments, Teachers Insurance and Annuity Association-College Retirement Equities Fund The primary hat I am wearing in my remarks about corporate gover- nance is that of the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), probably the largest pension system in the world, with more than US$300 billion worth of assets. About two'-thirds of those ass etLs consist of equ ity asecuritis, r.aiIIIy 111 th.L public markets. Approximately 20 percent of these equity divestments are diversified abroad. As is true of any mutual fund, TIAA-CREF is judged on how it does in comnparison with averages and with its competitors. After all, we are selling; our products in a competitive marketplace. For our organization good corporate governance refers to the manner in which shareholders, management, and the boards of directors relate to each other, in terms otf their roles and responsibilities. In the U.S. context that means wanting a substantial majority of outside directors on boards, having boards that fuhction in a true sense rather than those that just reflect the views of the chief executive officer of the comnan;v and having key committees of the board (such as compensation, audit, and nominat- ing commiitees) consist of entirely outside, indepenuent uirecrors wno know how to do their job to the benefit of their shareholders. In the case of TIAA-CREF, which invests in some 5,000 companies worldwide, we are, of course, unable to be in the boardroom of our investee companies. 77 IFC and Its Role in Globalization Instead, shareholders rely on the boards of directors to successfully man- age thpcp rconannipc Culturally, corporate governance in our organization goes back about 30 years, although 10 years ago our program did not yet have a global con- text or global scope. At that time, the idea of working with different cul- tures that have quite different ways of looking at governance was a little daunting. We were not sure what a U.S. investor could do abroad. and how we could possibly get across messages that we think are important to IInVCsLlo in a way thaL wouIU iiun Ub 111isrepxVeseted locally. Ill otII words, the question we faced was how to effectively maintain a corporate governance program abroad when we are acknowledged foreign investors. A couple of significant events then took place that led us to examine the foreign markets more closely. First, we found in many instances, even inlAvetr ..... e that cotrlln shrhodr took , adanag ofdis Ill VV'.3L~111 tLUIU}JL, tLaL LVIIt LLLVII.r 6 3IOlLIJtf.l IAJ'.JJ a. ~avlILaE,L ul a1 parate voting rights to effect unfair merger-and-tender offer situations to destroy outside shareholder value. Furthermore, local investors raised no opposition to this. The key question for us was, "Why did that happen? Why were other shareholders who were being disadvantaged the same way that we xA7ere not uitterino a npep?" We quickly learned that many countries of the world have been very slow in developing their own institutional investor constituency. The essential ingredient for us-namely, "a home-grown constituency" for corporate governance or for fair treatment-was missing. Until it was there. we were voinp to vet nowhere. However. the landscane was chang- ing, especially in Western Europe, because institutional investors were beginning to appreciaLe tna to be a global investor, which very orten was their ambition, they had to give credibility to the market. They had to show that within their countries they were enforcing shareholder rights, were interested in the same issues that concern any shareholders, and were willing to take a stand on those issues. Jecond', as th'e comlpany beCL-alne ,llore ino.e inVk: Ill global scene, we: began interacting with other organizations. For example, we began work- ing with the International Finance Corporation (IFC) on a couple of major projects in emerging markets, and we became part of the International Corporate Governance Network, an organization of investors representing 26 countries around the globe. Corporate gover- nance is now a leading issue for the members of this network. 78 Section III Enihanicinig Value: Inivesting in Sustain1ability anld IC,Voraotet Gov:)rn.ancc The fact is that global investors such as TIAA-CREF are not required to ine,sct flinAThprP in th1P wTror1l-r1 nA if tihep Ad not invest in a ronlntr- r a company, there is no need to explain to anybody why they are not doing it. They just do not do it. People are beginning to notice this, and to realize that corporate gov- ernance affects the flow of money into a country, the success of the com- panies in that country, and ultimatelv the success of the econonyv As a result investors are now looking for explanations why poor investment occurreu during a pei-iod when corporate governance principles were ignored. In effect, corporate governance is now being appreciated as hav- ing a definite nexus and connection with the entire investment process. Another realization is that, while the World Bank and IFC are strong and important, in the long run it is private capital that will significantly affect the economAlics of difUferIeL cuntUiesII. DUL Lildtt riVdate LdpiLdl is, not gUoing LU fiUW in until basic issues of corporate governance are understood and resolved. Peter Sullivan, in chapter 12, reviewed many of the corporate gover- nance issues that are important to his firm. Those concerns are very sim- ilar to our own. We believe, for example, in fair treatment of shareholders, rnfPifngi "nn,e chare, one vontp" It is ;rry hIrA to see h.-,A -ny - clture c-n treat shareholders fairly unless there is one share, one vote. We also believe that majority sharehoiders owe a fiduciary duty to minor- ity shareholders. That is a fundamental principle in the United States, but it has yet to be adopted in most other places in the world. We also think there should be no barriers or restrictions to effective voting riphts Manv narts of the world have such barriers. In addition, we strongly uphold the concept of accounLa'oiiLy. It shoulu De maiie crystal clear tnat direciors are accountaDIe to somebody. We think that they should be accountable to the shareholders; to some extent, they could also be accountable to other stakeholders. An equally important issue concerns public governance. That is, a country may have its codes, but if its courts do not enforce those codes, if +t,h regulat-ors do not effectively regui'ate, and if t"ere is a lac'k oU credibil- ity and fairness in the investing society as a whole-investors are going to find out. They may discover it after some hard knocks, but they will soon know it and will not invest there any longer, which is the key message that needs to be conveyed, especially to emerging market countries. This is what we tried to do recently ini Brazil, in collaboration with lFC. We brought together meetings of institutional investors, the head of 79 IFC and Its Role in Globalization Brazil's Securities and Exchange Commission, and a number of compa- nies -ith -ipa-t voin igt , such --at A,aort sarehold1Aers coul take advantage of minority shareholders in takeover situations. At our meetings we noted that the country's economy is doing all right and direct private investment is coming in, yet public equity is going out. We made it clear that as long as there is unfair treatment of minority shareholders, and this kind of majority control situation ic in effect, investors are just not going to come in. What we found encouraging, however, was that a group of public offi- cials attending the meetings understood these issues and saw that some way had to be found to modify their corporate culture to encourage investors to come in. These meetings have already had some imnortant results. For one thing, a listing standard, known as the Novo Mercado, has ueen estabiish1ed. Tle INo-vo Mvercado is based on sorne key corporate gov- ernance principles, including fair treatment and good accounting princi- ples at a high level. To be listed on Brazil's stock exchange, a firm must now comply with these principles. What Brazil is now doing is permitting its institutional investors to investL a 1igerperen`g of their salles~-agailn Lthat nexus with the1inst- tutional investors of the home country-in companies listed on the Novo Mercado. How this system will eventually work is still uncertain, although it clearly has the backing of governmental officials. The uncertainty relates in part to cultural issues. By way of example, one corporate official in Brazil told a WAall Street Journal reporter that "dealing with shareholders is like inviting the maid to sit at dinner with you." Obviously, that kind of patronizing attitude has yet to be overcome. The message of our presentations is a consistent one: corporate gover- nance is not an abstract issue. It has great relevance for investors and their returns Moreover- it has. imnortant imnlications, for a countrV's econom- ic success. Many countries that are suffering extreme poverty are unable to attract the long-term capital tney need to get back on tneir reet, in part because of poor corporate governance. The burden rests with govern- mental officials to improve public governance practices and to meet the standards that investors demand. The corporate culture also needs to change. Whether it can do so remains to be seen. However, the enormous progress tilat hlas been rnade in Just the past 10 years leadUs me to look ahead with optimism. 80 C U AP T E R 1 A The International Finance Corporation's Focus on Corporate Governance Mike Lubrano .renior investment OLuitiucer, rinancial IViarKets Advisory Department, International Finance Corporation The International Finance Corporation's (IFC's) activities in the area of corporate governance dovetail nicely with the work done by the World Bank Gr up asa hle in thls area. As an Tnstitutina! investor IFC i deeply concerned about corporate governance for a number of reasons, prime among them portfolio risk. Obviously, investing in a company with weak corporate governance is a serious risk for IFC. Our experience with company failures has all too clearly shown that poor corporate gover- nance can lead directly to noor corporate performance= Even when a company's financial performance is not affected, other kinds or problems can arise. in a recent case in which we were involved, poor protection of minority shareholders enabled the controlling share- holders to delist the company, making us a low-ball bid to take us out. In a situation like this we either have to sacrifice all liquidity, or accept the low-ball bid and get out. IrC is a UditLL prdLLcLIUtion III LUin j)U1dC c r UVp1111gLac III quite a fCW companies around the Iworld. When IFC makes an equity investment it is not uncommon for us to negotiate for the right to nominate a member of the board of directors. We do not exercise this right in all cases, but where we do (in about 200 out of 300 companies where we have such a right) it 81 IFC and Its Role in Globalization is mostly in bank and nonbank financial institutions. Obviously, we want th diirICtLOIS wCe 1--om-lCnate as well as tII other directoris to kno-VV w-1-wat t1hey are doing. We want them to contribute to their company's operations, and we want them to be aware of the liabilities implicit in what they do. Another factor that concerns us is reputational risk. If a company has massively ripped off its shareholders or has a serious internal control problem, it will not go unnotliced in th pres -- a IFC+ is an -nvestor, ,iC V ~ .JL LllIl'.JLII.A.A. I II'. jF - 0. til L . 13 aL l . IV.. L'J, that is the case. Instead, we want the companies in which we have an inter- est to be in the newspapers as examples of international best practices. Good corporate governance is not only an integral part of company success-it also has an important effect on the development of capital markets There is an important role to be played by good companies in developing deeper and broader capital markets, and IFC wants to be part of that. On the capital markets side iFC has a long, and, I think, fairly glo- rious history of investing in the development of local financial markets institutions. We are a founder of the emerging markets committee of the International Organization of Securities Commissions, and the unit that I work for is more or less the successor to the IFC global capital markets uepartmlent thLat was set up in the 17/Vs. Let me present a brief inventory of seven areas in which IFC con- tributes to better corporate governance and related aspects. 1. One thing we have always done to some degree is to appraise and monitor the corporate governance of our investee companies. Our most recent activity here was to create a checklist, or scorecard, for IFC investment officers. to hel_ them take a more organi7ed and structured approach to assessing the governance of companies in whiicii we invest. This cneckiist, which was developed by one of our regional departments, is now being "road-tested" in the field. It will probably need to be tailored individually to the regions and to the different types of investees: public companies, private or family- owned companies, and start-up joint ventures. The results of this tcsting will eventually have llllica1iJn for ouvernance super- vision methods and our cooperation with co-investors. 2. As already mentioned, IFC frequently nominates company direc- tors. About a year ago we began a program with the U.S. National Association of Corporate Directors, offering training for individuals 82 Section III Enhan1cinig Vallue: Inivestinig in Siustainability and Lorporate G'oveiIiCiUtce in the specifics of director service and director performance. We are also providing IFC rinvest.ment ofL.cers and other staff with iI-Ioic comprehensive training in corporate governance, to include some of the lessons, both good and bad, that we have learned in recent years. We are currently putting together a database tracking IFC's work with investee companies that has improved their corporate gover- nanrep and in turn tlh eir financ- ial pPor-lr man cne and mrn et valua, ation. 3. We have compiled some specific case studies. One of these (prepared with a former IFC staffer, the Harvard Business School, and the Yale ShlUII o1 MvdanagemdC1ent' ) concerns IUM)ub, dll Uil comlmpUlly III LIIC Russian Federation that had a notoriously bad reputation for cor- porate governance, but that is trying to turn that reputation around. 4. 'vve are planning a specific training course for IFC investees and other companies, to combine corporate governance monitoring work with human resource management in Latin America. The course is scheduled to take place in Rio de Janeiro in the fall of 2001, in collaboration with the Brazilian Institute of Corporate r1vrnne nA 11 Govenance andu hurlian resource experts at tie orud IvIotor Company and the United Nations Development Programme. 5. We have a series of grass-roots corporate governance projects that derived from the hliass privatization programs that iFC supported in Eastern Europe. These are large projects aimed at turning newly pri- vatized enterprises into functioning corporations by giving them charters; setting up their boards of directors; explaining how share- holder meetings are managed and how accounting works; develop- ing university cu.ricula fo d managemrrent, legal, accounting, and investor education; and providing technical assistance to regulators. 6. One well-publicized aspect of IFC's work in this area is in promot- ing portfolio invesiments tnat give due recognition to corporate governance issues. A case in point is the Brazilian Corporate Governance Fund (BCGF), which will be managed by Bradesco- Templeton. This is a public fund, not too large, that will invest in companies in Brazil that demonstrate good corporate governance. One of its *missions is to identif-y com-npanies that want to practice good corporate governance, help implement the changes necessary 83 IFC and Its Role in Globalization for them to do so, and signal to the markets that such companies nave improved their governance. Brazil was an ideal place to start, because it is currently develop- ing mechanisms to this end. One of these mechanisms is the Novo Mercado, which is a stock market listing segment for companies that agree to certain verifiable and objective criteria of good governance. Tn this way Brazil Jis encouraging copaie to - gie -.+ksbete Ii tIII IJIOLLI i1 C;1kVItII 6 Uii,i1i~, IIFIdIiii23 LU rIV IllariN;La Uq-LLVI signals about what they are doing. Peter Clapman and the Private Sector Advisory Group (PSAG)' have contributed enormously to the development of market-sensitive mechanisms for this purpose. IFC will be investing in the BCGF, therefore, and we feel that the rcas ctudiesc ~nA olir otlher .^orLr in cnrnnrate gove7rnance will cnn- tribute to the success of this fund. 7. Finally, I should say a word about the technical work of my depart- menti iII I'%-. vv iihave aivvaya ue LILL. thciintai uniLt for Ltehiiiiial assistance on securities market work, although our regional depart- ments also perform such technical assistance. An integral part of the work is advice to member-countries' regulatory authorities and stock markets on improving corporate governance. One such proj- ect, in Chile, consisted of advising the authorities on tender offer legislation. We have also provided similar advice in Argentina and Brazil, and are currently working on corporate governance code projects in various countries in Africa. IFC's work in the area of corporate governance can hest he smrnmed up in the words of Ira Millstein, chairman of PSAG: The task is to provide emerging and developing economies with insurance that capital is more likely to flow to those countries and companies that demonstrate responsiveness to corporate gover- nance issues. The Organisation for Economic Co-operation and Development and the World Bank Group, along Witome - dnr, cn,,tries has esabhlished the Global Corporate Governanre Foriim (wwwv orgfnr) to coordinate their work in fostering better corporate governance in emerging markets. The Private Sector Advisory Group (PSAG) comprises business leaders and internationally recognized experts on corporate governance, who advise the Forum from a private sector perspective. 84 SECT:I"ONR ill %VFpI IR1,I1 IV The New Basel Capital Accord: Implications for Bank Lending to Emerging Markets C H A P T E R I 6 An Overview of the New Basel Capital Accord Jonathan L. Fiechter Senior Deputy C UompL 1 I pt I UIoIIer UoI ItLeIrInILIUona al UL'.nd HUnomi c IA ff airls I, Office of the Comptroller of the Currency In January 2001 the Basel Committee on Banking Supervision' (the Committee) issued a second consultative paper (CP-2) proposing major revisions to thei originni Basel Cainia! Accordi that hadi hpen issuedt by the Committee in 1988. The goal of the 1988 Accord, a relatively straightfor- ward capital framework, was to establish uniform minimum reguiatory capital standards for large internationally active banks. The proposed 2001 revisions to the 1988 Accord are far-reaching, complex, and, in some areas, controversial. My presentation examines the lanuary 2001 proposal from a regulatory perspective. TLhe 1988 Cd,apital AccordU Wda a UUUC dLLeIIIt L LU IIILnUUU(d 11rs-bUdsCU capital requirements that would apply to all internationally active banks in the G-10 countries (the 11 G-10 countries are Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States). The 1988 Accord was intentionally kept sismpl -1 -and a ppieb U rI g I T ato to a!l insured IU I epostor institutions. The 2001 proposed revisions to the 1988 Accord are intended to make the Capital Accord more risk sensitive; consequently they are much more complex. The proposed Accord seeks to establish a regulatory capital requirement that more closely mirrors bank managements' own interna! analhysis of how much capital is needed to operate the bank. 87 IFC and Its Role in Globalization In applying the 1988 Accord the focus of bank management has been on cor..pliance with tLhIe ctlJlal reA4uiremnIL. VVIL1iI LIIth 19700 Acorlu imposes a capital requirement that banks are required to meet as a regu- latory matter, most banks have established their own internal capital tar- gets on a very different basis. To the extent that the 1988 Accord imposed capital charges against assets and activities that differ from banks' own internal assess.ments of the necessary capital banks have restructured their operations to minimize the regulatory capital requirement. For instance, the requirement under the 1988 Accord that 8 percent capital be held against all private sector corporate debt has led banks to move high-qual- ity debt (against which the market requires far less capital) off their bal- ance sheets while, at the sme time. banks have retained low-quality debt on their balance sheets. The result is that the current Accord may encour- age banKs to hold a risKler portfolio or loans. A major objective of the proposed revisions to the 1988 Accord is to narrow the gap between the levels of capital that regulators require a bank to hold, and what bank management itself believes is necessary. The chal- lenge facing the Basel Committee in achieving this objective is to create a r uiC Lildi lb UULIenI ~IIMVC LUP LIIC Ilildly lIbrb IdLI11r, UanII'. dIlU LlidL IUtVr, nizes the significant institutional and national differences among interna- tionally active banks and supervisory regimes within the G-10. The proposal issued in January 2001 (the product of lengthy Basel Committee deliberations over the last several years) is a complex docu- ment that includes a draft rule of m. ore than 1701 pages, *.vithi 33 paes of accompanying annexes. Developing this new capital Accord has been a massive undertaking, and one that remains very much a "work in progress." A number of the components of the proposed capital rule are still being developed. The proprocPd ('P-3 rpviions hnuv fuiir bhipctives 1. To maintain current capital levels in the bankinZ system. The intent of the revision is not to raise the overall level of capital held in the bank- r.ig sis+ 1-+k0 -A - + -1-AFk ;+>1, -,IA - 1 ;r- -o;+ar I; Lt111, UUL i aLlhlt LU 11lant tLlb taFlLai La RL lilJLt 1101 II3IlLIVL- 2. To make the Accord more eauitable. Banks with different amounts of risk should have capital requirements that reflect that risk. Because of the simplicity of the 1988 Accord banks with very different risk characteristics may face identical capital requirements. This puts 88 Section IV The New Basel Capital Accord: Implicationis for Banik Lendingc to Emereine Markets banks with low-risk balance sheets but high-capital requirements at a competitive disadvantage. 3. To narrow the gap between regtulatory capital requiremuenits anid whiat bank management believes is the appropriate capital level. Regulators would thus limit the incentive for banks to restructure their nortfo- lios simply for regulatory rather than for business purposes. 4. To apply the principles of the new Accord to all banks in all countries rather than only to inte-nationally active banks in the G-10. A'Te rec- ognize that, given the complexity of CP-2, the proposed Accord is unlikely to be adopted over the near term by emerging market supervisors, however. The nroposed Accord has three parts, or "nillars" (see box 15.1). Pillar 1, the key pillar, is a formulaic approach to determining how much capital a bank needs. Put simply, the first procedure consists of identirying vari- ous classes of assets or activities, applying a formula to the asset or activ- ity to derive a capital charge on the basis of perceived risk of default, and then adding up all of the capital charges to develop an overall capital requirement. Pilar 11 recogniLzes that t1he iFormulas and m11ethodological framework under pillar I are crude and are unlikely to fully capture differences in the risk profile of banks. For instance, some areas of risk, such as interest-rate risk or liquidity are not captured under pillar I. Pillar II, therefore, sets forth the basis on which supervisors should assess the adequacy of the ov-r1 rcaital rPeqiren,p,t rcomriipte iindAr nil!ar I In essence, it rreates a framework under which experienced supervisors will assess the results of pillar I against the perceived riskiness of a bank, and will adjust the cap- ital requirement accordingly. Pillar III takes into account the complexity of bank operations and the limitations of any supervisory assessment of risk bv seeking to encourage more informed market~ discipline-through the rating agencies, market analysts, and counterparties-by means of expaiided bank disciosure requirements. Under pillar I the capital requirement may be calculated in one of two wavs: either under a standardized auDroach or an internal ratings-based (IRB) approach. The standardized approach expands the number of risk 89 IFC and Its Role in Globalization * Pillar 1 (regulatory capital charge): Formulaic rules that establish minim urn capital requirements. There are t'wr annnrrhes nresentPed in the Annrdci * Pillar 2 (supervisory review): Supervisors need to (a) ensure that bank's capital position is consistent with its ' .rik- prnfile an.- etratprny amd (b) apr,oveI use by banks of more advanced capital models. * Pillar 3 (market discipline): Expanded public I %clr)toLrrot blty Nnatit to facilitate mIarklt discipline. l Box 15.1 Three Pillars "buckets" for which there are specific capital rpniiirpments For inztance, under the 1988 Accord a loan to a private corporation has a minimum 8 percent capital requirement, regardliess of the riskiness of rhe corporation. By contrast, the proposed standardized approach differentiates between lower-risk and higher-risk corporations, and introduces four different risk buckets. If a bank lends to a AAA-rated corporation the capital require- ment against that loan will be equivalent to a 2 percent capital charge compared with 8 percent fur a loan to an unrated corporation. Ai efiort has also been made in the proposed revisions to take into account tech- niques to reduce or mitigate the credit risk of loans with guarantees and high-quality liquid collateral. Under the proposed Accord a loan to an unrated corporation that is fully guaranteed by a strong company will h1ave a capital charge equ:'ivalent to a I--a to t1he strong ---1mpa The IRB approach, which is for more sophisticated banks, relies on the internal credit-rating systems of the individual banks for determining the capital charge against an asset. If the bank can convince its supervisors that it has internal credit systems in place that accurately assess how much risk an idividual borrow,er poses, based on an analysis of the probability of default (PD) and the expected loss given default (LGD) and exposure at default (EAD), then the bank may use its own internal risk assessment to set its capital requirement. The IRB has two approaches-the 90 Section IV Thte New Basel Capital Accord: I))Zplicat0ons fo)- Bank Lending vto Ernergir,gMarnkets qnSovereign Risk Ratings 1 * Key change is the move away from OECD_I membership as the key risk weight determinant to one based on external ratings Examples of Changes in Risk Weights on Sovereign Debt: Country Current Weight S&P Ratlng* Proposed Weight Ecuador 100% CCC+ 150% Hong Kong 100% A+ 20% ft 11I ( I U/Y . W4. O 1. l lU/, Singapore 100% AAA 0% Standard and Poor's sovseign iting fbrlong4enmf reegn cr c posoes as offay 18, 2001 Box 15.2 Sovereign Risk Ratings Foundation approach for banks that can determine the probability of default of the borrower but will need to rely on sunervisors for estimate of the likely loss in the event of default, and the Advanced approach for uanks that can estimate rPs, LG DS, aInud LADLs for Uteir borrwers. The proposed Acc6rd has three primary implications for emerging markets. These pertain to the sovereign-risk ratings (see box 15.2), corpo- rate-risk ratings (see box 15.3), and credit-risk mitigation. In the case of the sovereign-risk ratings, under the 1988 Accord the Basel Committee's approach to A ,so igna 'i s vvaqit UslzirlI. AJcountry that is a inembier of the Organisation ;for Economic Co-operation and Development (OECD) was presumed to have a sensible and credible financial infra- structure, good corporate governance, and a stable government, and so received a zero risk rating-the government, by definition, was viewed as a strona rrpeit As a rpcilt hbnLks thit lend to OCDT- govIPrn.epntc dn not have to hold capital against such loans. Countries that earn high externai-credit ratings, but are not members of the OECD, are understandably upset with this "club" rule. At the same time, not all OECD countries are in fact low credit risks. The Basel Committee is syvmntlietic to the criticirn1 ond ha,- therefore. nronosed relying on external-credit ratings of individual countries as the basis for 91 IFC and Its Role in Globalization Corporate Kisk Ratings 1 * Standardized approach: iisk weights are tiered based on external ratings. Internal ratings-based approach (IRB): Based on: - probability of default (PD); exposure at default (hAD); and - loss given default (LGD) for each exposure. Box 15.3 Corporate Risk Ratings assigning capitai requirements. it has aiso taken into account the fact that not all countries will have external-credit ratings from one of the major credit-rating services, and so has proposed that the published ratings from export credit agencies may also be used to set capital risk weights. Under the standardized approach the external-credit rating is the pri- ~~--~~~~ - U ~~~~~ - J- TIC - U _1_ 1- - - mary factor tilat determinieis ihow IIL(uCh LapiLtdl is requiIeu. II a UbiIK hias graduated from the standardized approach and is following the more advanced IRB approach it can utilize its own internal credit-risk rating of the country. In such cases the amount of capital required against a sover- eign loan will be a function of the bank's internal assessment. Banks can refe:-rence external ratings, b-ut the ulti.mat capita IIrg wil --en --An the bank's own determination of the credit risk posed by the individual facility. In such cases the capital charge could fall below that suggested by an external rating. The proposed Accord takes a similar approach toward loans to corpo- r-tins. TTndAr tle stanardizd annrnorah a, Innk los-c at tie- ext-rna- credit rating of a corporation and uses this rating to determine its capital requirement against loans to that corporation. If the bank has qualified to use an IRB capital approach, the bank must assess the probability that the borrower will default, the recovery rate if there is a default, and the out- St2nninq Pynn-ciirp nt thp time nf dePfalIt Tn rereive 1nnrnv:l tn use the IRB, banks must demonstrate to their supervisors, on the basis of several 92 Section IV The New Basel Capital Accord: Implicationisfor Bank Lending to DMergiMg Aarkets years' data, that their systems accurately predict their actual loss experi- ence nn n ncrtfnlin o,f In1nn As mentioned earlier the Basel Committee has attempted to incorpo- rate into its capitai proposai risk mitigation from collaterai and guarantees. It has established rules governing hedges when the maturity of the hedge is different from the underlying exposure or is in a different currency. The Committee has been very cautious in its treatment of nhvsical col- lateral and assets such as trade receivables. It is extremely difficult to esti- m--ate the value of such collateral over a full credit c-ycle; there is recogni- tion that the proposed Accord is already quite complicated. Banks have argued that such collateral does, in fact, reduce credit risk, and that the Committee should give some capital recognition. The Committee has been more open to incorporating the benefits of guarantees into r1sk VVeigt. If a A AA-rated enVtA ag,1to provide a guarantee against a loan to a lower-rated borrower, the lending bank can rely on the credit rating of the guarantor. For capital purposes the loan is assessed as though the bank lent to a AAA-rated borrower, and the credit rating of the guarantor is substituted for that of the borrower. Whether or not such a guarantee is treated as a full subsitutiion wTil! depend on the identity of the AAA-rated guarantor. Guarantees from government enti- ties and banks are givein more weight than guarantees from other entities, such as insurance companies. The proposed Accord does not make any allowance at this stage for the fact that, for the lending bank to lose money. both the guarantor and the borrowing entity would have to default. For example, a bank that lends to a AA-ra,ULte borrowC1, WIiiIc is also guaranteed by an AAA-rated insuranlce company, receives no capital relief from the addition of the guarantee. Preliminary reactions to the January 2001 proposal have been mixed. Early indications are that, in general, banks support the overall framework and direction and like the idea of regulatory capital requirements being more. ini w.itIh b1anks'.own internal c.alcuatiLonL1 of reqIUid captal. A the same time, banks have raised a number of issues. One concern is that the IRB approach is quite complex, and will be very expensive to implement, yet the potential capital relief under the IRB approach (compared with the present capital Accord) is modest at best. Tho f(mrmnttop 1-Ar ;,,tpmApr th',t thr hPi q raio inpt;r rlh things being equal, for banks to move from the simpler standardized 93 IFC and Its Role in Globalization approach to the more complex IRB approach. Banks, however, have reported, thant the nroposal doesc not nrovidel schr an incentive. Rather banks have found that they need less capital under the simple standard- ized approach than under the more advanced IKB approach. This is a flaw in the proposal. The Committee is reviewing the calibration of the capital charges under the proposed Accord to correct this irregularity. Another concern is the treatment of onerational risk in the hank. In establishing the capital requirement under pillar I the Committee has inciuueu credlL, marKet, and operational risk. vvnile some banks may nave very high-quality assets in terms of credit risk, there are risks arising from inadequate or failed internal processes, people, and systems that need to be taken into account in setting overall bank capital requirements. As a result the Committee included a crude operational risk component that covers fr-aud4 and4 losses 4rol- --ak -_era cotrl as par of -t oveal .)LL iauu aiu Il 'lull' vvL-ar, 1L~Ad LvLU"1hUd pai F aL JlILZ UJVcIdII capital requirement. This component has generated significant comment from the industry. Banks argue that the operational risk weight generates a significantly higher capital charge than what banks internally allocate; that the proposed methodology for determining operational risk (which uses gross profit as a proxy for the level of operational risk) is unrelated to the actual risk in the bank; that for low-frequency, high-loss events, capi- tal is not the answer; and that there is no capital incentive for a bank to reduce its operational risk. A more general concern of banks is that the January 2001 proposal was incomnlete Notwithstmnding it. length, nuimher of tlet2ibz on item snrch as the treatment of retail credit, asset securitization, project finance, and the treatment of equities are stli being worked out. As a resuit banks have been unable to calculate the effect of the proposed rule on their regulato- ry capital requirements. Banks have urged the Committee to reissue the full draft Accord for comment, taking into account industry comments received on the January 2001 proposal, including a recalibration of the capiLdl w1eigIts o a-voiu ld1ap spikes in LCquineU capilal. iiiis request is sensible. In closing, I would like to emphasize that the Committee is eager to work with interested parties on the many issues raised by the draft Accord. We need to understand the consequences of the proposal for the banking 1industry. wVL,l though1 Lill VozI iai -Jllll- Forurmen peiod .; ended ay 31,201 suggestions and information on the practical application and implica- 94 Section IV The New Basel Capital Accord: Implicatiois for tions of the proposal are welcome. It is only through open and candid industry dialogue that the Cormtittee will be able to develop a se-sible and practical rule. ' The Basel Committee on Banking Supervision is a commllittee of banking supervisory authlorities. wihtich was CestaUbIiLAU UY 111 -c------ UdIL- g;UVeIuIsI Ut the G- UI CIcUIII les 111 1753. 95 C H A P T E R 1 6 Country Risk in Basel 2 Frans Cornelissen Senior Vice President, Head of Country Risk Management, ABN AMRO Bank As most would agree, the 1988 Capital Accord had some shortcomings. For one t iig, it was tCrU crAu iAn th way it a1_nlye corporate credit rLisk. For another, it was not too fair in treating AAA-rated companies; it did not treat them the same way that it treated emerging-market companies. All it did about country risk was to make a distinction between Organisation for Economic Co-operation and Development (OECD) countries and nonOECD count whch, of course, was too S, 1+ t failed to take into account collateral and credit derivatives in the right way, and operational risk was not in there at all. Even capital arbitrage was going on. The purpose of the proposed Accord is to address these problems. Hence hbnks were asked tn make cnmments on draftc of thef newAT Arcord. The first round of comments ended in mid-2000, and the second round ended on May 31, 2001. As jonathan Fiechter pointed out in chapter 15, however, banks still have an opportunity to submit their suggestions. In the first round of comments a special group-the Working Group on Country Risk-was organized by the Institute of International Finance (IIF). One of the Working Group's major concerns was that the Accord had cappedu thle rating f01 LtC privaLe sector entities by tne rating or tne sovereign. The Group's paper argued that capital controls are becoming more rare, and 96 Section IV The New Basel Capital Accord: Implicatiois for Ban,k Leuldin,g to ;,rig^.a4rkGts~ that even in cases of capital controls or sovereign default certain companies perfnrmedA Tn tp csc-ndA A-rft ofl-th Capit Al -A 4-io the ca-as rem.ovedA The IIF Working Group on Country Risk also stated that a distinction should be made between sovereign risk and country risk. Furthermore, it looked at how different banks were actually treating country risk. This is where the risk issue becomes more complex, because the banks seem to have different methodologies. Some banks took country risk implicitly into account since the rating of obligors included factors such as inflation and the legal environment. Others have a special country risk-rating sys- tem that affects the obligor rating, sometimes as an explicit add-on to the credit risk. The second draft of the Capital Accord has been trying to address country risk in such a way that it leaves ample room for the banks to determine exactly how country risk should be incorporated, especially iII theV internall ICLIratng-basd3 (DIRB) approachi. In my view, the Capital Accord should not explicitly require an add-on for country risk, in addition to the credit risk. This would not take into account those banks having credit risk models that take country-risk fac- tors more implicitly into account. In the second round of consultations a new issue came up: how to deal with foreign currency as opposed to local currency. The Capital Accord states that, in the case 'ot toreign currency-lending, the risk that the for- eign currency might not come back because of capital controls (transfer risk) should be included in the obligor rating. The banks discussed this subject at length. In the case of a sovereign, the statistics provide clear evidence that there is quite a dirrerence Detween tne locai currency ciaims on tne sover- eign and the foreign currency claims. A sovereign can print local curren- cy and cannot print foreign currency, so clearly the distinction must be made. The Capital Accord, although not too explicitly, is allowing room to do just that. In the standardized approach, one can even put a zero-risk w ei g h t IUfor lUc al1 c u11y r fre i1nC nancing tos igns. In the case of corporates, however, the issue is a little more difficult to address. Of course, intuitively it is very clear that foreign-currency lend- ing is more risky. The question is, why? Is it more risky because, if a com- pany is borrowing in foreign currency while it has a local currency income, there is a curNrec-y IniSni-atch? But that tvyp,e of risk is not uncom- mon in the developed world as well as in the developing countries. For 97 IFC and Its Role in Globalization example, if a U.S. company is going to borrow in euros and does not have rev.eInueIS in euros, it will also havLe risks. Thi type ofL risk, t1h. cuLrrIen%cy mismatch, has to be kept separate from the transfer risk. If the transfer risk, the risk on the foreign currency flows from emerging markets, is rel- evant and we want to make the distinction between foreign currency flows and local currency flows, the banks are not against that. However, one has to be able to prove it for five years. In other words, one has to show that the companies have been defaulting on foreign currency loans and not on local currency loans, which might not be that easy. It wiii be interesting to see how this issue will be treated in the final Capital Accord. As for the Accord's qualitative impact on banks, it is dearly promoting better risk managzement. Much effort will have to be DUt into building new risk systems, especially for emerging-market banks. At the same time, one caInot ue too aL Lbitious here orI 0o1 e 1 iigIIt end up with a risk s yse nL that incurs too many costs. It is also clear that the quantitative impact will be that higher risk credits will need more capital. That is rather bad news for emerg- ing markets because more capital is needed for lending to these markets. One feature of the new Capital Accord that will benefit some non- OECD sovereigns is the removal of the distinction betmeen OECD and non-OECD countries. Some OECD sovereigns will lose from that. The same is true for some banks in OECD countries. Especially in relation to lending to emerging markets the Accord is not very transparent. This is because banks are expected to use different annroachesz fnr c1alcilating thp carpitl fnr lending toe Pmerging.a rkets Emerging-market banks will go for the standardized approach, but inter- national banks are likely to go for the IRB approach, which will give differ- ent results on the same risk. With regard to the financing of sovereigns and banks for periods of less than three months, there is also the possibility that the emerging-market sunervisors. since they have some authority there, can set the risk rate for the local currency financing. This again could lead to different capital requirements on tnis risk ror difrrerent banks. Another major concern is that volatility on lending to emerging mar- kets could increase at times, especially in an emerging market crisis. If the ratings are lowered, then you need more capital, of course-so things could work out to be procyclical. 111 Lying LU tpCUIdt UiC ULeo UIIIC 1u1 tile sLdarUdlUleCU appruacil as opposed to the IRB approach, it looks as though the latter will require 98 Section IV The New Basel Capital Accord: Implicatiois for Ba,,k Ln,din,g to Emr,ergil:g I1 alVrIf s more capital for lending to emerging markets. Banks will need higher m nruinc fn1r thl lPCATPr-r1tprI rr%mroniPc tr. ,--vL -, lr for tihP 1iahpr rpn,,riPA capital. In other words, margins for lending to emerging markets will need to go up. In the case of the B-loan, capital requirements and the value of the pre- ferred creditor status will depend on how the final Capital Accord handles the distinction between foreign-cLirrencv lending and local-currencv lending. 99 C H A P T E R 1 7 Base! 2 and Emerging Markets Ernest Napier Mvoianaging D irector, Financial SCeirvices Group, .2tanudardi & O( FUoor's As the preceding presentations have made clear, the proposed new Basel Accord is an ambitious blueprint aimed at strengthening the bank- ing system on a global scale. My remarks focus on three aspects of the Ar-crcr oif nartricular interest to Standrdnr &, Poor's (SP3): the setting of regulatory capital limits, the implications for emerging market financial institutions, and the possible treatment of the International Finance Corporation's (IFC's) B-Loan ("Participations") Program under the pro- posed changes. To ct:rt T shouldl sav that S&zP cnntiniupe to supnnort the RBasl Committee's efforts to strengthen banking regulation around the world. Wvve think that much progress has been made in the second consultative paper in terms of the three pillars: capital requirements, improved super- visory oversight, and the effective use of market discipline. At the same time, as one of my colleagues has pointed out to me, this Accord is a jour- ney and not a destination. Perhaps some day we will arrive. I lie cornerstone of' thle new proposal 1 is its two suggeeLdU optiLo1s Lor improving the risk adjustment process for calculating minimum levels of regulatory capital: the standardized approach and the internal ratings-based (IRB) approach. S&P finds pros and cons associated with each of these options. In its view, the major drawback of the standardized approachi is not enough iffrnito all.n -the var -- type of1isk Whether a bank is AAA-rated, BBB-rated, or so on, the amount of capital 100 Section IV The New Basel Capital Accord: Implicationsfor Bank Le,,diiia tn Fnlerraia AMnrkcts that it is required to put away does not vary as much as we would perhaps like. Looking at the two options under this apnnroach-to tie the rating of banks and other entities to the sovereign, or to assess banks individually- S&P considers the first option to be tne weaker of the two. By lumping tne good players with the bad players it does not give enough credit for the better-quality banks out there. S&P would see that as a limitation, and therefore finds the second option a much fairer approach. If we had to tip the scales one way or the other, S&P would probably favvr LlIC IRB approvdcii, Iiiaiiily bLecaeU it IldlWs UIIn LLo FUL IIIUcp LdPILI away, depending on the risks involved. In other words, the IRB approach does not try to use a one-size-fits-all treatment. It allows greater credit dif- ferentiation, which we feel is a good thing. Where the IRB approach falls short, however, is that it might not go far enough in suggesting how much capital banks need. Its probabilitiesof default scenario could lead to some questionable conclusions. For exam- ple, just using a three-year average would not necessarily pick up what would happen to a bank in a worst-case recession environment. One has only to look at what has been going on in most mature markets over the past five vears. which hive beeni a relatively benign environment If banks were required only to put away capital based on default statistics for the past tnree years, tnat would greatly underestimate tne amount or capital that banks would need if things were to take a turn for the worse. Thus one of our major complaints with the IRB approach is that it does not allocate capital based on an economic cycle. Table 17.1 shows ho w things can change depending on the time peri- od. Inl thIIIs eAall4I, avM6iag pirUabilitieL I UdIauilt Ifo a thre-yerdI pC11- od rose dramatically, from about 1.6 tol5 times the average level, depend- ing on the rating during this broad period. As the statistics confirm, the longer the time period used, especially for the worst period within the cycle, the better the model in terms of assessing how much capital is need- Ped. Despnite i'ts mrniinuses, howeIAre-r, the~ TIRB approac is baic!y-upror to the standardized method. The second point I want to address arises from the oft-heard criticism that emerging markets may end up getting the worse of both worlds under the new Accord, and ultimately this may cause the initiative to fail entirelv Any regime that imposes higher capital allocations based nonr- rower quality, so the argument goes, definitely works against emerging- 101 IFC and Its Role in Globalization Default Rates For Static Pools1 19801 -2000I cc cc L B |BB I BEBB A |AAI | I YWd ^Vege te 4 L 4,7S o; ~1 7l 44 V VV} U | U 3 Year AverageRate 14 37 2100 4 62 0.74 0.17 0.00 0 03 Miimnum (3 yr) 6.67 8 24 1.22 0.00 |0 00 | 0 0.00 vrun(35n-) 51.5 ?33 243.3 1 14 12 . 2.99) I...... I 1 f, d 6 0. 45, Table 17.1 Default Rates for Static Pools 1981-2000 market banks, owing to both the composition of their loan portfolios and the environments in which they work. In addition; most emerging-mar- … -- - . ~ _ _ / 0 0-- --C ket banks lack the empirical data on default incidents, default correla- tions, rating transiilons, and recovery rates in order to legitimately quali- fy for the IRB approach. Furthermore, the IRB approach is very expensive, even prohibitive for some of the emerging-market banks. Hence the IRB approach may not be to their advantage. The question is, what can these banks do about this situation? Since A S _ _A _ 1.. L_I,A ~...:11 L_ _.A 1_A -------l L 111UbL ~11Cll,lll-l11dlKUt Ud1HkN Will UC UbIIll t11 6tdIlUdlUlLVU dpplUdCil, there are actually a few ways to "level the playing field." For one thing, they can go shopping for external credit assessments that will give them the most favorable capital charge. Under the standardized approach, claims are broken down into three categories: claims on sovereigns, claims on b fanks, and claims on corporates (see table 17.2). If a soeeg is rated below B-, or if a bank is rated below BBB-, or a corporate is rated below BB-, it may be in the best overall interest of the bank to request that this customer not get a rating, because reverting to the unrated status would invite a more favorable treatment. Any system that promotes this type of dAitortinn n,nd therefore ic not nromnting marlpt transnprPn,rv iC f.awed and could eventually backfire. S&P also believes there would be political pressure on regulators to allow banks in their country to use rating agencies that might give them 102 Section IV The New Basel Capital Accord: Imlplications for Bank Leniding to Enmerginvg Markets Standardized Approach Clairn on Sovereigns Iedii Amemnent A.AA to BBA S + BB+ to Behw UoIPd A- A- Bto B 13Bv B _ ;XWeqht 1 20-4A b °°lO 50941 1(004% Claim on Banks Credit Aese AAA I A+ to BBB+ BB- l Belo, Unroted1 OfBaaIm AA- A- to BB- B- B- |Riskwe,ghtler 20A 5 5I% 1I 0 Opti.n2 jjI I ||Rskwvejtfh hr 0A 94 |21 |- | | 1A0% | 2 Cla nn on Corn orates l Credit A-e ALA to A+ i BB. Belo U AA- A- ED BB E- BB Table 17.2 Claim on Sovereigns, Banks, and Corporates the most favorable results. That would also be a distortion. In S&P's view this Accord could have an adverse impact on emerging market banks and this could ultimately unravel the whole scheme. The treatment of B-loans raises further concerns. S&P has felt there is so.me value to preferred creditor status. Indeed, there ic nrobably enough evidence now to suggest that lenders such as IFC do get preferential treat- ment, and therefore are only subject to the underlying credit risk of the borrowers to which they lend. As a result, banks participating in the B- loans get the same sort of currency protection that IFC does, and they, too; only have to worry ahoit the underlving credit risk. Therefore a strong argunment can be made that the capital charge should be less, given tne tact that tnis eliminates mhe transfer risk. Despite some limitations, which we hope will be worked out before 2004, the Basel Capital 'Accord is definitely a step in the right direction for global banking. According to S&P's estimates, about 40 percent of the largest international banks in Australia, Europe, and North America will probaUly e elUgibule to use tLe 1RB approach rornm tIe very outset. 'v'v'c feel confident that this proposal will not cause an overall decline in capital. 103 IFC and Its Role in Globalization ' Wl3hiuch Diyrection zv ill' We ,E 1 1) StrengthRcgulatory minimum capital levels... 2) leprovc dic Rcgulatory processes. 3) Promote market discipline and rans-arncy. - The Basel Capital Accord 1) Weaken Global Canita:le vels 2) Discourage Financial Market Transparency. 3) Impact Fund Flow (in National 21d Cross Table 17.3 Which Direction Will We Go? What the internal economic models of most banks today suggest is that banks feel as if they are overcapitalized. I am sure that the bulk of the stud- ies on the IRB approach will confirm this. If that is the case it could lead to a reductUion -in capital. XrP udoes not bueieve that rulost banks around the world are overcapitalized. Rather, S&P believes that they are adequately capitalized for the risks they are taking. If capital goes down but the risk profiles of those institutions stay the same, it could result in rating down- grades (see table 17.3). g global ratllng AistribUtion of b4ankNs for the las' decade alrea`d shows quite a dramatic change. When I first started working in this industry, banking was a AA-rated industry. Right now, it is probably a single-A industry at best. Any system that would create ways for banks to weaken their capital without mitigating their risk profiles would be very negative. Perhans in the enrd there is nothing for any of usto worry about, but then again that is what a rating agency is paid to do: to worry even when there is nothing to worry about. 104 C H A P T E R 1 8 Base! .2: Possible :impac:61 on t hBl International Finance Corporation's B-Loan Program Dirk Muller Partner, Financial Services Consulting, Risk Management, KPMG The central question I wish to explore is how Basel 2 will affect the International Finance Corporation's (IFC's) B-loan program. In the con- text of emerging markets, one leading concern will be country risk. As mentioned by other speakers, the Basel Accord gives little guidance on how to treat country risk Thprpfore therp has hppn considerahle dcuiis- sion in the banking industry about how to deal with this risk under the proposed new ruling. A second important issue for the B-loan program is project finance. Here, too, the Basel Accord is not very specific, although alternative approaches are now being discussed, and further details may be forth- coming in the weeks to come. A ~L. ~ L.n 1.. ~ tA third LonUcll IfiItIIC DB-ldoa pJr[gradr is W11ether pIrICi IIUcreditLI status (PCS) will be available under the new Accord and thus whether B- loan participants can have access to PCS benefits. Fourth, which approach-the standardized or internal ratings-based (IRB) approach-will most of IFC's B-loan participants go for? That will make- a signiflicant difference to the -isk -ate Tnd.r the standardize Ian. 0 t,1ttaL L Ltlll.1t11 L LU I lt. I L) at,... til .L tlt. aLa-J IU~I~UlL approach the risk rate would be a maximum of 150 percent, whereas under the IRB approach it could reach 625 percent for loan business with a higher probability of default. 105 IFC and Its Role in Globalization From an emerging-market business point of view, then, there is no incentive at all to go for the sonhisticated IRB approach. In fact, there may be no choice in the matter at all. In Germany, at any rate, it looks as though our regulators will ask all the internationally active banks to go directly for the IRB approach by 2004, so there is no other choice there. Banks using internal creditor models to allocate economic capital might already be allo- cating similar amounts of economic capital, so there would not be a sig- nificant change if one compared economic and regulatory capital. ,he question b-ank-s sh-ould4 threor --- asking ],- How1 - a those -- that-+ Li I. L iU31.1 ua, I I 3 I'JJ tLHIC.IUIC. U'.. UaMlrui 1a. 110 JAV all LILJ3'. LliaL decide to go for the IRB approach benefit from the B-loan program? As I just mentioned, the PCS has not yet been made part of the risk mitigation under Basel 2. One could argue that PCS, because of its political over- tones, helps reduce country risk, by which I mean transfer and convert- ibility risk bit not thp bnrrnwpr's risk As Perpryonp L-nows, ratina agencies such as Standard & Poor's acknowledge PCS in some cases through an improved foreign currency rating. Thus it might make sense to pursue the IRB approach simply to implement PCS as part of the rating process of the IRB. This could be a possible solution even if Basel 2 does not men- tion PCS explicitlV. for it would then be Dossible to benefit from this model. To ilustraLe, Ilt us lOoK aL the IRB approach a iItIC ilnre closely, as regards the key factor of probability of default. I believe that PCS can have an impact on the probability of default when it comes to distinguishing between the foreign-currency rating and the local-currency rating. This status could be built into the rating analysis and thus would be similar to what t-Ile external rat-in agencies a-- uoing now. Of course, one cannot simply assume that PCS always reduces the probability of default and therefore the risk. As with all other risk factors under the IRB approach, one has to prove that the historical default data comply with the ratings, for example by means of statistical tests such as back-testing. Basel 2 has imposed a number of conditions that have to be met before internal rating systems for the IRB approach can be approved by the reg- ulators. For instance, there has to be a five-year history of the probability of default. The history must be available by 2004. Also by 2004, the rating svystpm m.ust lrepadv hnve hben in use, for at least threpp vpers. AlthAiioh thp accord permits banks to have a transition period up to 2007, these 106 Section IV: The New Basel Capital Accord: Inmplicatiois Jor BanRk 1Lendinv to Fnmervini Markets requirements will probably delay everything, not only in making PCS part of the rating system but also in winning general approval for the rating system. There are other requirements, of course, but they are more qualitative in that the rating process must be transparent and independent. But there is some incentive to follow through with this. By way of example, suppose that a company has a local currency rating of BBB and a solvent foreign- currency rating of BB. Suppose, too, that PCS improves the company's foreign-currency rating and brings it to the same level as a local-currency rating. This would mean that the foreign-currency rating for the compa- ny would be BB without PCS, and BBB with PCS. We can now look at the probability of defaults, based on statistical data from Moody's. The likelihood of default would be 1.79 percent for BB and 0. 16 percent for BBB+. That tis tosay, if onp taksc this Pvxmnlp nc -as iven, then under the standardized approach PCS would make no difference, because having a BBB or BB rating would both lead to a risk rate of 100 percent for the corporate model. However, under the IRB approach there would be a significant difference. Without PCS the company with the BB foreign-currency rating would have a risk rate of about 180 nercent. With PCS, it would have a risk rate of 40 percent. This is a very simple example, of course, but it shows what can be done under the IRB approach. To sum up, there seems to be little doubt that the new Basel Accord will lead to a significant increase in regulatory capital for lending to emerging markets, especially under the IRB approach. When one compares eco- nomic and regulatory capital, it looks as though banks with sophisticated internal creditor models that airaauy allocating economic capital wil! not necessarily face a significant change in capital. Furthermore, the B- loan program, with its proven PCS, should reduce controversy signifi- cantly under this new Capital Accord. A way to have the benefits here would be to implement PCS as part of the internal rating process. To achieve this, though, banks would have to meet certain requirements. 107 hBrne oroect if The Business of Project Financing 011 C H A P T E R 1 9 Dealing with Portfolio Problems: Two Cases Part (a): A. 0. Volga, Russian Federation Jyrki 1. Koskelo Director, Special Operations, international Finance Corporation Charlles 'v'an dlerRMndl Chief Special Operations Officer, International Finance Corporation Anke Avderung Di rctIor, Globa' De OriUgination, Dresdner v,lienw^ot I a erstein Francis Hamilton Senior Adviser, Syndications, International Finance Corporation Jyrki L Koskelo-Director, Special Operations, International Finance Corporation Many important lessons can be gleaned from problem projects. This presentation deals with one such project, undertaken for a paper manu- facturer in Nizhry Ndvgorod, in the Russian Federation. Tet me first explain the International Finance Corporation's (IFC's) general approach to such problems. Problem projects such as A. 0. Volga are handled by our Special Operations Unit (SOU). SOU is a relatively small unit staffed by about 20 highlv fpeciali7Pfd highlvynexprienceP individiualk It has three field offices: one in Jakarta, one in Bangkok, and one in Prague. Essentially, it operates 111 IFC and Its Role in Globalization in areas where IFC has significant problems. The way it gets involved in a nrnorct is a tra-nc-rent proces relatingy to internal creit r-tings. Once an IFC project deteriorates beyond a certain rating threshold the relevant investment department turns to SOU for advice. In the past year the unit has made considerable progress in learning to tackle problems in their early stages, which is a cost-effective approach. In addition, IFC has been trying to become more proactive and has initiated a "SWAT"-team review process to improve our position in areas (countries or industrial sectors) wnere crises are expectea to aeveiop soon. Suu is now less iso- lated from the rest of IFC, and much more team-oriented, than it used to be. There is excellent teamwork between the unit and IFC's Syndications and Legal departments. Our most pronounced successes to date have occurred where a small group of highly experienced people from different parts of IFC has focused on a problem project. Our perception is that the only area where SOU's recovery strategy tends to differ from that of our participant banks is in trying to maximize ultimate return. SOU's time horizon tends to be longer than that of a commercial bank, which means that we are seldom anxious to sell and get out quickly. 0.A.here a co.m.n,prci lnI bank migt try to sell a proble1m. loa,n at 50 to 80 cents on the dollar and close the file, SOU will keep working and waiting for the chance to get 90 or 100 cents back. As the A. 0. Voiga case illustrates, to achieve this goal the unit will go from good times to bad times, and back to good times again, in a single project-a process where patience. persistence. and continued truist in one's own assess.ment of the value of the asset or loan are needed. Charles Van der Mandele-Chief Special Operations Officer, 7r- tort, n nt,rt Al l T,;"S1,l 0 C'nrnnrn t;nt, aLSL,tLf I&sv" . I fl4IttU v_vU v jJtS ILL To explain the A. 0. Volga project, I am going to call it "High Noon in the Wild East," and treat it as a dramatic play in six acts. It starts with a prologue, which provides the setting: democracy in the former Soviet Union, and the creation of the Russian Federation. In Act 1 thp RPiazinn PPrntn Pnaitc connnrn;ic rofnrmc UTI,1rh are well received, and introduces privatization. A particularly important development at this point is the increased domestic demand for all con- sumer goods, particularly for information, and therefore for news from the mass media. 112 Section V The Buisiniess of Project Financing A special feature of this drama is the dynamic local government in the nrovi,nce nf MN71in NovgMnord,r w1hich was xryr- anvxious toi CIAhoT ;tC reformist credentials. Boris Nemtsov, the reform-minded governor at the time, and other prominent people from that region promoted a very aggressive privatization of assets in the province. The A. 0. Volga project was sponsored by a well-known German paper trading connanv. which had built un a significant eniiitv nosition in A 0_ Volga, largely to reinforce its trading relationship with it. This prominent German company helped bring several large German banks into ine proj- ect, and they subsequently joined IFC as participants in the B-loan. The project's objectives were to upgrade A. 0. Volga's existing papermaking facilities, improve the quality of its products, increase production, improve environmental controls (which were, at that time, dismal), and provide highl - ede working4 capital 131 U V I jU 11i1iiY I1VCUVLU VVUI 1.tLi, La13 ILch. In further support of the loan, IFC made an equity investment of US$11 million, initially for 25 percent of the company. Hence all the ele- ments were in place for a US$75 million loan for a US$150 million proj- ect that was expected to be profitable and have a major demonstration Act 2, therefore, opens with total euphoria. The loan was approved in February 1995 and committed by May 1995. The loan was well secured against the fixed assets of the company. There was a very complex escrow account that made everybody happy. The shares of the company were Dledged to IFC. Most imnortant. the foreign snonsors' shares in the hold- ing company were also pledged to IFC, because there was, for tax and otner reasons, a iiolding co-npany above it. It looKed as though notning could go wrong in the first year. We had record net selling prices, low pro- duction costs, and record production and sales volumes, primarily for export, which was of'course a good thing. We also had highly favorable exchange rates between the U.S. dollar, the Deutsche mark, and the D- ssian rubleI. TheC Adebt serice coseunt - was 1 higlyeguar. TheC 1kU~1I I UUl. I IL L UUL OLI V I%-'- LhJ1IOCLLUCJILLY, WdCt iii61iiy 1lq_u1a1 I II German sponsor company was able to pay itself high management and marketing fees. By the end of 1995 everybody was happy. However, Act 3 then brings despair. In 1996 and 1997 the company was adversely affected by a sharp price decline in world paper markets, a result of reduced and overseas. The scenario changed. The Internet WaS beginning to make inroads into Russian society. Domestically, people 113 IFC and Its Role in Globalization were reading newspapers less and less, and therefore local demand for newsprint was falling. Meanwhile, large paper companies were adding capacity. As a result of all this, A. 0. Volga's ex-works price declined by 33 percent. That was a big drop that was never recovered. The dramatic downward trend in newsprint prices caused volumes to decline, because nonprofitable production capacity had to be curtailed. With prices down by 33 percent, production volume went down. and sales volume dropped by 50 percent. To make matters even worse, there was also a project cost £ T ICd1 11'~ Mi r_ oVerrUn I U1 U/_U 11lof1U11, U1 aIuoLI 15 percent. The German sponsor then had to look with some desperation for addi- tional capital, which it finally found in the form of an equity investment of US$40 million by a private U.S. investment company. Six weeks later the new investor had to be told that its money was gone! Fortunately, the com- pany was able to keep IFIC and the B-la parici-pants reasonably 1-ppy, because it had built up an escrow account providing a source for some pay- ments and, at least during 1996, a loan default was not yet contemplated. The local tax authority then suddenly decided to freeze local bank accounts, claiming that the company was in default. At that point things really started going bad. The German sponsor all but backed out, leaving some production going, and appointed a local successor management. By the end of 1997 the company was in formal default. Local management, using paper clips, Scotch tape, and a few other things, tried to keep things together, but the biggest problem was the lack of working capital, which forced the company to reduce canacitv further- They begged us to release some of the escrow account. Given the tremendous uncertainties, though, tile D-loan participanits andu IFC reinained firmi on not releaslig those funds, and thus indirectly contributed to the general despair. During this period the company and its main sponsor continued their efforts to identify a new foreign strategic investor. By then, IFC's SOU had become involved. We had to travel to several places in Scandinavia and eIsewhIere lo see if we could Aiind a com, parIiy that coulu proviue new .man- agement, marketing support, and, above all, working capital. The problem at that stage was that the market continued to be very weak and people were very concerned about Russia and where the coun- try itself was going. Now that the foreign sponsor had deserted it, the gations. It was, itself, a publicly traded company. Then management tried 114 Section V The Business of Pr-oject Fianacinig to cobble together a transaction with the local provincial governor, who was very anxious to prevent a total collapse of the company and project, especially since A. 0. Volga was a major local employer. The governor promised to make some funds available, with which the company would then M-rake us a -repayment. lWAme were even tal king it some discount at that stage. It is a measure of the despair that even the governor backed out of that deal at the 111 hour, and we had to start from scratch again, which meant [FC had to foreclose on its escrow account. We lost a little leverage, then, because, with the company already down, we had no more favors to grant, and therefore the shareholders and management no longer considered us an interesting party to talk to. T his marks the beginning of Act 4, titied "Restructure." irC continued to try to recover the money bit by bit, through a continuing dialogue, indi- cating that it was in the company's interest to keep us as a good friend. We were, after all, trvingz to helD it. Little bv little, the comDanv began paving us, and sharing part of its excess cash flow with us. In retrospect, the most 1111iUpi-Lnt CW111IC1L l11 nUI oCLUlLYy paLKage prUVeU Lut Lbe 1th pleCdg Uo the shares to us. That allowed us to tell the shareholders, and the manage- ment, that if they did not cooperate with us we might in the end have to take over the company, and that we would not hesitate to do so if we found that it was not acting in good faith. Paper mlarkets rerr.ain-eA -ea, 1_-ee,-n -andrie never -illy r e One positive development was that A. 0. Volga's new management, which at that time consisted of a mixture of Russians and some foreign people, suc- ceeded against all the odds and without working funds to lower their pro- duction prices and also to lower their selling prices for volume orders. RpBciiue they succeeded in sel!ing larapr vnlhmPes rephiildin producitinn vol- ume, and lowering cost, they started operating at about cash flow breakeven. This was,very important when, in 1998, the ruble collapsed, changing the economics of the company totally. The bulk of its costs were in rubles, but revenues were largely in Deutsche marks and U.S. dollars, which obvi- ously became worth much more with the collapse of the ruble. Suddenly, the company was making serious cash. This opened the way for discus- sions on thl restrucuLLUing of the debt. An i1p1aILdlL uevelUprnent iII Lil meantime was that the shareholders were taking a greater interest in the company, and were becoming involved in corporate governance. In other words, we were no longer relying on discussions with management alone. 115 IFC and Its Role in Globalization Serious negotiations began in mid- 1999. It took awhile to finally arrive at a rpetrucitirinu agrppmpnt aftpr nnp of the sharPhlde1prc nffered a small amount of desperately needed cash for a significant shareholding. That opened the door to a restructuring agreement, which was signed on September 1, 2000. As far as we were concerned, we had a decent restruc- turing agreement in place. The company was delivering good cash flows again, and by the fourth month into the restructuring we were again being serviced properly and adequately. A _. .1. _ L _._A1_. *3¢. lL -v(t 5 tclen UIougIIt upporLunity. lumost immeduiately atLer tne restruc- turing agreement was signed IFC was approached by a not unknown Russian conglomerate. IFC got in touch with A. 0. Volga's management, which began talking about a leveraged buyout. The conglomerate offered to purchase IFC's loan at a discount, which was very tempting at that time. A.Ae haA just COJII out of a long st-gle -ut ehn we Adi,scussed it .with1 VIII t )UOL IWAIV.. UJLL I,i a iv ii6 aLur, LUL VVI1 VY l U L U~~ It VVilI the B-loan participants we all agreed that we were quite comfortable with the new situation, and there was no need for us to take any discount what- ever. We would be quite happy to tie our fate to that of the company for the next four to five years, as had been foreseen. The first conglomerate accepted that and said it might come back, but in the meantine it wanted to become a majority shareholder, by buying out the other shareholders. The conglomerate approached the U.S. private investor that had lost all of its equity during the period of despair (Act 3), and made a bid for those shares. Then a bidding war suddenly erupted, when a second Russian con- glomerate entered the Dicture and started bidding; first for the UTS investor's shares and then for the other shares, including those owned by IFC. At tfat stage, IFC maae it clear tnat we would not deal in our shares until our loan, and our responsibilities to the B-loan participants, had been addressed. From its first discussions, IFC concluded that the other stakeholders, including the shareholders, were not very happy with the second con- glom1eratLe, wilose offer couldU bUecome hostile andU tiherefUore Udetrimentail to IFC's position as a lender, so it started preparing defensive action with the pledge of shares as its principal weapon. By that time IFC had also made it clear to the first conglomerate that, if necessary, it would foreclose on the shares pledged to it. If IFC subsequently also exercised its preemptive rights, iVtwould ha g-- -a-.A. -- o- -ntrol and would efIfAct1-iy have become the owner of the company. 116 Sectioni V The Busisess of Pr-oject Financing Act 6 (High Noon) occurred when, in a dramatic week in February 2001 people began arriving from all parts of the world to talk to us. IFC succeeded in attracting offers for its loan, which had previously been quotedU at perLaps 4, JO, anu 60 percent, thien gra1dually went up to 80 percent and 90 percent. At one stage, we even got an offer for 120 percent of our loan-the face value plus interest. This came from the second con- glomerate, which had finally been persuaded that IFC was holding the trump card in the form of the pledge of shares. Notwithstanding the high- er foffr TlFC cusupprort edb the, B-lnon partrritc rr..... 1. , clA 4-y,1 *s vLI% 1, II oFF .tyyuJ IA.A v17 i'.I ncsa. yai tlIIIlUIlJFt3, QlA..y.A. Li'. 11511 A7 lower offer from the first conglomerate. First, the offer was better substantiated. It was friendly-in other words, it enjoyed the support of all the stakeholders. There was a strong likeli- hood, of which we were aware, that the first conglomerate would align with the sponsor and simply prepay the FC. loan. Even after we accepted the offer, however, the second conglomerate cried foul and demanded an auc- tion. Given the risk of negative pUDiiCity, irC reluctantly agreed, which caused a minor delay in concluding the transaction. Then came the happy ending, though, as had already been anticipated by IFC. The first con- glomerate bought out the foreign sponsor and then used the latter's right to prepay the IFC loan in full, including all interest, penalties, and costs. 11116 CAperICIet.C yieIUs a nuLIMULC 01 1i11FU1 Lt 11CeUs1on. 1F11r, we maed sure that the workout was co-owned by the B-loan participants through the dissemination of regular and detailed information. Second, we had a good idea of the value 'of the loan and could resist efforts to sell it below intrinsic value. Third, IFC had a strategy. It knew what it wanted, but it was file,Able. XAJe ,,rere able to lkeep an eye open for opportun,ities as te flp_;Wp IAT. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~111. t- II--- - - -- 4:- ---- - 0-1~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~L 1C10 ti arose. Fourth, togetherj with our lawyers, we knew the agreements inside out, and through intimate contacts with all parties had a solid grasp of what made the company and the stakeholders tick. That made negotia- tions a lot easier. And fifth, throughout the process, IFC was transparent, was seen to h onest ahout its nnsition and its objectives; and was there- fore credible when it counted. Anke Avderung-Director, Global Debt Origination, Dresdr.er 1'ienwvort A ...... prtei, The largest lender in the A. 0. Volga transaction was Dresdner Bank. It was also the agent for the security accounts, and therefore had to struggle 117 IFC and Its Role in Globalization with all the minor administrative details; it was closely involved in all aspects of the transaction- Many have asked what it wa- like to work with IFC. I think the main point to mention is that in difficult situations such as this, or in any workout situation, it is essential to agree on a common set of goals. This rule holds true for any banking consortium, but even more in a consortium where IFC is in the lead. As mentioned at the begin- ning of this presentation, IFC may have a slightly different attitude toward timing, toward staying in the deals, and taking a more long-term view on acton - A...-Jre1 wi t c..A a.o.mmer.. ....eial banks. In the A . O . vUilga transactio n it was essential to put the project quickly back on a solid basis and to try to get the money back, too. It was equally important to see what we could do over the long run. The second important point, especially in relation to B-loan struc- tiures icslg thedpsibility of a conf.icrt of interest. Th-at meanns that TIFC-in its double position as lender and shareholder-might have different atti- tudes from its two positions. In this particular project, and I think in all workout situations, IFC decided to act first and foremost as a lender, which makes it important to have a common understanding with the hanks and a ioint annroach in this regard. In fact. IFC's shareholding in the project was a key factor to its eventual success, but during the work- out period it was important to iocus on IFC in its iending position. Coordination and consultation were equally important, especially in a banking consortium such as ours, with five commercial banks plus IFC. Coordination could be a problem. Consultation processes can be lengthy and very difficult. This was a problem we had to overcome, and in the end I thi1nk1 we succeeded in Uoing so. We also IhladU to LU recni L z 1 tatIL Ui-IU- stances can change very quickly, especially in the Russian environment. The consortium had to react to several proposals quickly, something that was a very demanding task for us as participants and was true for all the banks in the consortium with us. But I think we managed to respond quickl,y and to ghre FIFC thle supprt it nd to continue negotiations with the client in this particularly difficult situation. Cash-flow modeling was another of Dresdner's central competencies and certainly one of the things we always focus on. In this particular case, of course, it was very difficult to keep track of the cash-flow model with rhnaoincr ir,rrimctnnrcpn npw nffpre nnAl PYtrpmplV uAlntilp nrnPr mnArIPt --b-Zov^^t _-^_-^^w^-___' *-_- ^_-_' *--- _--_---_- v--*--- -r*- ..------ This was a challenge to IFC and to us, but in the end we managed to do so. 118 Section V The Business of Project Financinig The most important point in this transaction was to get the basics done and leave the cash flow modeling as a comnlementarv aspect of the deal. Communication received special attention because this is the most important aspect of a b anking consortiulm: as banks, we are always in negotiations. vve had a very good experience with the IFC team in this regard. Communication among the banks and with IFC was always clear and ongoing, so I think this is one of the main success factors and a problem at the same time. Last, but not least, I should mention the IFC umbrella, given the -Russian crisis anU tLill- IiovLaLs ji ir. o In9. I IFC uImu.,U a vrearding transfer and convertibility risk has remained effective, since IFC's loans were explicitly exempted from the moratorium. To comment briefly on our solutions to the problems: first, we had a dedicated team of workout experts at IFC, and negotiations with the client and all the parties involved wrere held on a regular basic in Rsi. Tbic was very important, and as banks we tried to support this. Most of us have been involved in this deal since the beginning. We did not come from the workout side, but from the structuring side. I think this was also impor- tant as a means of supporting the transaction. I have already mentioned the regular flow of information and consultation. There was a neriod when the project was not formally in default, but was struggling. No one coulu be sure of where it was going, what it would be worth in a few months, or whether it would improve. This period was especially chal- lenging for informatidn and consultation because everybody was waiting to see what was going to happen. After the formal default was declared regular information was the key to continuing the deal. This period after the formal default lasted for three years, so there was quite a pile of flies and many telephone conversations, but we managed to get through it. The pooling of expertise was another essential ingredient of working together in the banking consortium and with IFC. At Dresdner Bank, as at the other banks, we tried to make available our expertise on documen- tatinn and onA rpctriictiirina wh1irch waIsC cPrtainlyr wArPe1 receivepA bNy TIC OfF course, we had the workout expert in the first row and so constituted a very good team working on this transaction. In the end, as I already men- tioned, the advantages of the IFC loan structure-making the loan in the first place plus taking a shareholding in the company-turned out to be the key siiccess factor in this deal. Again, ornmmunication proved essential to keeping well informed and keeping track of developments. 119 IFC and Its Role in Globalization Would I personally do any IFC B-loans again? The answer is a clear, yes. Francis Hamilton-Senior Adviser, Syndications, International Finance Corporation Several lessons can be learned from the way this syndicate was formred and worked. Although it can be risky to draw general conclusions from one case, it would be nice to see some aspects or A. 0. voiga repeated in all future problem loans. The first point to mention is that we had only five B-lenders. It was a homogeneous group: four major German banks and one Austrian bank. The four German banks, as mentioned earlier in this chapter, were all ,Pm;1;nP -.;+, +1, tr- - +Ic A..4- bIZ was> there la lilal VVILII Lll. \J'iiiaii ayuIivul, allU LIC iUvLIlIan uallr. Wa LliIt1 because the major equipment supplier for the A. 0. Volga expansion proj- ect was an Austrian company. So they all had good reasons for being lenders, and shared with IFC some sense of responsibility for the project because of the commercial bascis for their lnonc Whpn thcinac IAPnt IArrna Pcn rinllw XA7ith rpnrst t, the performance of the major German sponsor, the banks did feel, if not directly responsible, at least involved in and familiar with the problems. In other words, while disappointed by the performance of the sponsor, the banks were not about to go to IFC and ask why it had landed them in this transaction with a dubious comnanv All the lenders had gone in with open eyes, believing that the sponsors were going to perform very well. Second, regarding communications, IFC is confident that the degree, frequency, and level of our communications with the B-loan participants were satisfactory. Communication was, of course, much easier because of this homogeneous group of just five B-lenders, all of them in Europe. We issued detailed monthly progress reports, and with innumerable tele- I-_ _ _ _ --- ~ - - J - I~L _ - - AJ n __ - ph iosII LU1IVC1bdLI1l d rlU 1CrUldl ItICL1Is, tLIICI w-as a good fioW 01 ilfor- mation from IFC. Third, at no stage did any of our B-lenders feel tempted to dump the loan (on the secondary market), or to jeopardize IFC's restructuring efforts through independent moves. They all understood our approach, even if th,ey did no- necessarily agre -ith our --er actio.--TA_ I -Ae, tog od - ...L HI.C1% AOLY ab,ICC. WILV Outl 'JU l '. yt. a ~LXUII. .II' a., U 11r,tII U%J11U3 developed between us, based on personal as well as institutional familiarity. Fourth, of the five B-loan participants, two (Dresdner and WestLB) had significantly larger participations than the others. I would like to pay 120 Section V The Buisiness of Project Finanicing a special tribute to the support and cooperation we received from these two; particularly Dresdner- which acted as agent for the escrow account as well as being the largest individual participant. As in any complex restructuring, there were a iew small areas of the documentation to which some of the lenders paid more attention than others. Dresdner had an excellent eye for all the details, and indeed point- ed out, for example, some minor miscalculations in the cash-flow projec- tions. It was gratifying for IFC to be dealing with co-lenders who shared UUI UU)Ct-ALVCZ allU WIIU U11UVL)LUUU N'tCly adyCAL Ul L'l Li a113at.L1U11. As lenders, we were also lucky. You have to be lucky-and you have to be able to take advantage of it. All in all, the A. 0. Volga restructuring experience was not one we would we would choose to relive, but it had many good features. 121 IFC and Its Role in Globalization C% u A P T ' R 1 a (continued) Part (b): Tuntex Petrochemical Thailand Eric Jourdanet Senior investment Officer, Oil, Gas, and Chemicals Department, International Finance Corporation Alma Ourazalinova Participations Officer, Syndications and international Securities, International Finance Corporation Vera Reusens Senior Manager, Uouuai ExporL and Project rinanceII o rUItis Dankrl Eric Jourdanet-Senior Invlestment Officer, Oil, Gas, and Chemicals Department, International Finance Corporation The Tuntex Petrochemical Thailand (TPT) transaction provides a numibuer of importantL 'lessons fromll the commjiierciial Dal` FerpLctiVe. Thll initial project was to construct and operate Thailand's first purified terephthalic acid (PTA) plant, with a capacity of 350,000 tons per year and a cost of about US$355 million. The plant was completed within budget and began commercial operations in October 1995, four months ahead of schedule. Designcapacity i now 42nn0nn tone npr irenr of PTA inrcluAdna investments implemented in 1996. The plant was built at a competitive capital cost and is today an effi- cient PTA producer, most of its sales being in the Thai domestic market. The company is part of the Tuntex Group of Taiwan, China, which was 122 Sectioni V The Buisiniess oJfProject Finanicinig founded and is controlled by Mr. Y. H. Chen. Tuntex Group activities include textiles, real estate. and netrochemicals. and the Group has vari- ous investments in Thailand. As it later turned out, sponsorship was one or the main problems encounteredi in this project. In 1994 the International Finance Corporation (IFC) provided the company with financing, including an A-loan of US$17 million, and a B- loan of US$137.5 million. Sixteen participant banks were involved. As part of the financing plan Thai banks provided long-term loans of US$17.5 lJliiJuon and a ro vi w c'apita1lfalit-y foIr 750 ;nillion baht, which at the time was equivalent to about US$30 million. The lenders shared security consisting of a mortgage on the assets, contract assign- ments, and a pledge of the shares of the company. Repayments of the B-loan and Thai bank loan started in March 1997, and repayment of the A-loan in Mnarch 1998. The repayment schedule was fairly skewed until 2001, with the bulk of the debt to be repaid in 1999, 2000, and 2001. However, the Asian economic crisis and the baht devalu- ation in late 1997 adversely affected both the company and the sponsors, and caused cash generation, profit generation, and the overall financial structure to deteriorate sharnlv. Polyester and PTA markets in the region became very depressed. The conversion ratio between Piii and plaraxyiene (PA), wilch is an imnpor- tant barometer for cash generation, fell from about US$300 per ton in 1995 to US$270 per ton in 1996 and 1997. It then fell further, to US$192 per ton in 1998 and about US$130 per ton in the first quarter of 1999-a huge drop in margin. Since then, fortunately, the margin has stabilized at ab-out TTS$200r per ton. The working capital situation also contributed to the liquidity short- fall. It so happened that; the PX price had gone up significantly just before the crisis, putting a strain on the company's liquidity. Then, because of the baht devaluation in 1997, the working capital facility was effectively deval- ued from US$30 million to US$20 tillionn so the two effects accumulat- ed and pushed Tuntex into a liquidity crisis. The company coulid not pay principai in March 1999, and the sponsors were not able to provide the required extra cash that was still available under the project support agreement. IFC was then mandated to work on a debt restructuring based nil the concept of fair burden sharing amon-g the company, its sponsors, and the creditors. The debt restructuring doc- 123 IFC and Its Role in Globalization umentation was finally signed in August 2000, and it became effective in M~arch 2001. WAve receive -Ahe, frst+ interes pa-__n -nder the -ew -ched "VIII . U. 1 Vv~ I .l IVL-.U LIP.. IlIaL 111IL~I--L JF0yIIIk..L U11UL..I LIill, IllVV UIEU0 ule at that time, so the loan is now fully current. With that background, I would like to elaborate on a few interesting terms and conditions of this transaction. Of the US$117 million of out- standing debt, US$86 million of the A-loan, B-loan, and Thai bank loan have beepn recheduled. The company now has the capacity to repay its total debt over five years, commencing in March 2001. The working capi- tal facility provided by the Thai banks as part of the restructuring remains in place, and indeed has been increased to US$30 million equivalent, as was intended when we originally financed the project in 1994. The first interesting feature of this transaction is the increasing spreads. The nonrescheduled part of the loan maintains the same spread, m neaniinig IO2.5 uasis points (bp) for the A-loan, anu 175 bp ior the D-loan. As far as the rescheduled maturities are concerned, that is, for the bulk of the loan, the new spread will be the London interbank offered rate (LIBOR) plus 375 bp, which represents a significant increase of 200 bp. The spread on these rescheduled maturities can decrease in future, how- ever, in linMe witLhn a sequence ofk events hinkked t thle provision of sponsor support and an excess cash flow sweep. As part of the transaction, a flat front-end fee of 50 bp was paid by the company on the total rescheduled amount of the A-loan, B-loan, and Thai bank loan. As mentioned above, the newr higher interest spread can be reduced again, depending on sponsor support and payments from excess cash flow. One reason for this is that the sponsors were unable to provide immediately the US$29 million of sponsor support requested. They were granted time to do so, but nonpayment according to the new schedule will he an event of default Sponsor snpport iniections, once made; will be used to repay the loan in inverse order of maturities, and the spread will decrease by 50 bp on tne rnrst such injection and by 25 bp on the second. The second interesting feature of this transaction, with regard to spon- sor support, is that it was secured as far as possible by an asset owned directly by Mr. Y. H. Chen. His intention was to dispose of a valuable piece of real estate in California, of which he was the indirect partial owner. iwJnIesIpllu, huwt:VCI, Wds uy lllCdllb 0I d aOiIIpilLaiU LaSLauC ul nuiuIlg companies, belonging to different jurisdictions and with Mr. Chen a 124 Section V The Business of Pr-oject Firnancing minority shareholder at each level. In effect, his holding was about 10 per- cent of th. yi..ytF Ly, aiiu hIau a Ltoal vaIue oL abut U S$20 iiLil. To ensure that if and when the land was sold the proceeds would be used as sponsor support for Tuntex, we therefore set up a legal structure involving a flow-of-funds agreement, together with a personal guarantee from Mr. Chen for up to the US$29 million of sponsor support, and trig- gered hib the salp nf the lInd in quietion. This restructuring also has an interesting cash-sweep mechanism. While normal loan repayments will be made out of sponsor support and cash flow, the cash-sweep mechanism will prepay the rescheduled installments on a pro rata basis, and will also trigger spread reductions of 50 bp and 25 bp. So in nractice we start from a snread of 375 hnb reduced by 50 hn when we receive the first US$12 million of sponsor support. It is then further reduced by 50 bp on receipt of US$22 million of cash-flow sweep. Another reduction of 25 bp comes with the next US$12 million of sponsor sup- port, and yet another of 25 bp with the next US$22 million of excess cash flow. The sequence is designed as an incentive for the company and the sponsor to provide the' promised support, to repay the lenders, and indeed to UbefLiLL LLUIIL ally FpeFayOle1L1iL. These cumulative spread reductions can lead to a minimum spread of 225 bp-which is still', however, 50 bp above the initial nonrestructured spread. Moreover, on the basis of conservative PTA margins, the company should now be able to! repay the loans in full on a stand-alone basis. This is mportan, since in the end it r~r,cinc q tionable wtherthespon- sors will be able to come up with substantial amounts of support money. The final payment date for the B-loan was extended from September 2001 to September 2004, which is compensated for by a significant increase in the spread plus the 50 bp front-end fee. The B-loan spread was increased from 175 to!375 bn and annlied retroactively from March 1999 meaning that while the restructuring became effective in March 2001 the I >1J3 _ I . 1 1 r- I- spread increase was backdated to tne rirst defauit in March 1999. The restructuring also, of course, allows us to share in the upside of good market conditions through the cash-sweep mechanism. Finally, it is also pari passu, in that it applies equally to a Thai bank loan with the same conditions as ours, and that we share security pari passu with the Thai bank for thle new workin capitdal it provides as part of fh tranIsaction. The restructuring took about two years to complete, and encountered 125 IFC and Its Role in Globalization two main problems. One had to do with fair burden sharing, which in this case meant bringing the sponsors to the negotiating table and getting them to agree to reasonable terms. The second problem had to do with keeping to a reasonable time horizon for closure. The first problem reflected the fact that the sponsors were themselves in serious financial difficulties, given their involvement in crisis-hit sec- tors such as real estate in Taiwan. China. and textiles in Soitheast Asia After detailed due diligence on the sponsors, we found that they were unable In the sllort term to provide any sponsor support and were actual- ly in a worse condition than Tuntex Petrochemicals itself. Even so, we had to find a way to get them to the negotiating table and make them share part of the restructuring burden. Timing also became an issue, because of the slow process of understand- implemented. In addition, there was no real incentive for the company to reach agreements quickly. While in default it was paying interest only, and no principal, and was subject only to a 1 percent late payment penalty. Of course, going for liquidation was always an option, but the company as we did, that this would not have been in the interest of the lenders. Liquidation was particularly disadvantageous in that we also knew that the company had the ability to pay its debts over time on a stand-alone basis. I believe that this transaction was good for the lenders, who now have a performing loan on a commercial basis. It was also good for the compa- nv and the snonsors. who have emerged from default and have recoverpd the flexibility needed to manage their own business. The burdens have been fairly shared. It was certainly key to establish the principles and goals of the negoti- ation very early in the process, but once we had done that it took time to reach closure. IFC had to push to maintain the momentum of the negoti- ations, but at the same time to avoid lowering our demands or weakening our position, andU to steer awday fLron cunnerproductive conilicL. Fortunately, we were able to keep an active dialogue going with all the par- ties, and in the end this delivered results. Alma Ourazalinova-Participations Officer, Syndications and International Securities, International Finance Corporation I would like to outline briefly how IFC worked with its loan participants on the Tuntex transaction. As Eric Joiirdanet has mentioned, the financing 126 Section V Tule Business of Project Fin(aincing for this project was provided by a diverse group of participants: 24 percent bv Thai binnLs annd 76 percpnt kb tlp TPFC A- aind B-loansnc There wejprp 1 4 npar- ticipant banks under our umbrella: 11 from Taiwan, China, four Japanese or other Asian, and one European (Fortis Bank). As a result, we had to work with a group of participants in different time zones and with different inter- nal approval procedures. Moreover, in this case the B-loan was unusually imDortant-it accounted for 66 Dercent of the overall financing and about 80 percent of the long-term debt provided to the company. As usual, IFC took a leaudership role in the project, acting as ilenduc oI record for both A- and B-loans. While sometimes, particularly when there are other senior lenders involved, an informal lenders committee works on a restructuring, in this particular case IFC managed the process on behalf of the participants. WVe set up a team of specialists to conduct extensive andA rapid du iiec a h4ust,peae-nfrnto Tuntex specifically tailored for the B-loan banks, drafted a term sheet, and negotiated with the sponsors a restructuring package within a framework agreed on with the participants. We therefore needed to agree with the B- lenders on the restructuring package early in the process. The principle of panri passu treatment of all lenders was preserved. Since repayment of the B-loans originally began one year earlier than for the A- loan, the new repayment schedule provides a longer average life for the A- loan, and the spread increase for the B-loan, of 200 bp, is higher than for the A-loan (178 bp). Also, since the deferred principal amount on the A- loan is much less than:on the B-loan, the 50 bn front-end fee brought in only US$85,000 for IFC, in contrast with US$345,000 for the participants. As a restructuring progresses IRF norUmally is tLhe primary source 01 information for the B-loan participants. Therefore, it is important that we consult with, and where necessary get consent from, the participants, as early in the process as possible. A timely flow of information in both directions speeds up the approval process and improves the quality of the final resUtrucuring package.IF shVou ld Ie aware fro... a- tarly stage- of th participants' bottom line on the key issues. Vera Reusens-Senior Manager, Global Export and Project Finanice, rorris BanK Tuntex Petrochemical Thailand (TPT) has always been one of my favorite files. I am the head of the monitoring and intensive care division of the export project financing department of Fortis Bank, which is based 127 IFC and Its Role in Globalization in Brussels. We have about 50 project finance transactions in emerging markets in our portfolio, and the Tuntex file is one Ihave been giving to every trainee coming to my department as a showcase of how to analyze the original written Information Memorandum of 1993, and to compare it with reality. Perhaps the best place to begin is to explain the merits of the transaction and why Fortis entered into it. It had all the positive characteristics of a well-structured project finance. The market analysis showed an increasing trend in world PTA consumption, and demand in excess or rTA production capaciry. Tne government of Thailand was aiming to reduce petrochemical imports and integrate its domestic industry by setting up a new industrial zone in Map Ta Phut, Ravong Province. There was high PTA demand from the Thai textile industry, and local supply of all raw materials. The key- to undrsanding_ this busnes wa -nt too AifCCUl.Yuhv I1I1e&VY LuJ UIIUCLbLdlitLU1ll, L111~ UUM'11t:b WdLZ hUtLU UIILIUI i. "i-uIUU a-ve PX on the one hand, and the product PTA on the other, so the key to the business is the conversion rate or conversion margin between the PX and the PTA. Historically, from research carried out by a petrochemicals con- sultancy firm, the conversion margin has been around US$300, which indAicated veryr strotngC poftentia!, nrofit0hilit>, The project finance itself was well structured. We had an engineering, procurement, and construction (EPC) contract with a fixed-price lump sum, and normal technology. The sponsor provided both precompletion and postcompletion support. There was a very balanced debt-equity ratio, anti thp tpnnr was nlokv with a thrpp-vpnr cnns,tructinn chednle and thIpn five years for repayment. There was an off-take agreement, a raw material supply agreement, standard covenants, a pledge of shares, share retention obligation, and mortgage on all the assets. In a word, it was a textbook example of how project finance should be structured. In addition, IFC was Dresent. with its sector know-how and its B-loan umbrella, and the loan pricing was good. Nowadays one would probably consider 175 bp to be iairly low, but at that time (1993-94) it was decent remuneration. As Alma Ourazalinova indicated, the syndicate, too, was rather interest- ing, consisting entirely of Asian banks plus just one European bank. Fortis Bank was there because of our presence in Fortis Bank-Hong Kong, China, which had a good relationship with the sponsors, the Tuntex Group. T_ L: _ o1 A AsA_AA__AwrsAAAsA 1 nn (^ ----_AA--sA In hlinLuMhlilt, uolc noll seUeY tl-le wealrUnes o1) t11 177J LidlhLIdII. they were, principally, our over-reliance on Tuntex companies in the bor- 128 Sectioni V The Business of Project Financin1g rowing structure as well as the EPC contract and the off-take agreement. The Tiintex (Thailand) Public Conmpanyn T imited (TTC.) the main share- holder of our borrower, was also the off-taker, and that created a some- what dirflcult situation. Another issue was the transparency of the Tuntex Group. There were no consolidated figures, and we did not know that it had exposure to illiquid real estate business in Taiwan, China, besides being involved in an integrated business from PTA to Dolvester Droduc- tion, to yarn, and finally to textile products. As Llth istoLUry of LIIt Ldcse MhoW-, Lleif have I een rnlilaly UbeLaches of covenants. Tuntex was a Chinese-run family group, and I think its man- agement did not understand the requirements of a project finance struc- ture led by an institution such as IFC. In several instances we learned after the event of breaches of covenant that had to be retroactively waived. For the credit coMMittee of a cormmercial bank, it is not very pleasant to be asked for a retroactive waiver seven months after the breach of covenant actually occurred. Since then, more time has been spent monitoring the files, and IFC did a fine job of bringing things back on track when going through the restructure. When the Asia crisis hroke in mid-1997 I told mv credit department that it did not have to worry because Tuntex was a completely dollar- based company. Both PTA and PX were aiways quoted in dollar equiva- lents, so I was not too worried about Tuntex's performance. By the end of 1997, however, we could see a large exchange loss due to the devaluation of the Thai baht. Furthermore, we could see very low cash flow from oper- ations because of the accumulation of trade receivables, the reason being thalt TTC, one Uo the laii ll shard1C1ueho ldrsi in TPT and tU e of fL-taklLr o1 Ju percent of its production, was not actually paying for its purchases, and had stretched receivables over six months. In other words, our borrower TPT made the sales and had good revenues but it did not collect; so we were indirectly financing TTC, the main shareholder, which was not a very helalthy situatio.n. i By then TTC itself was having difficulties. In fact, the textile industry as a whole was suffering because of the Asian recession. There was less demand, and since TTC was vertically integrated, it was of course an important off-taker from our company. This had been an important xriv'ntane :t thp hi-ainninc of thp fininrinu hilt nftpr thp Ac5i n rriziz it -..-_Z..... t _-_, - -.- .-- ..~.- --- --- .-----1 became more of a problem. 129 IFC and Its Role in Globalization When in March 1999 the first payment default occurred, we began a restructuring, which we assu.med ,,,noudl take aroundA six months to nTeg- tiate. The business outlook was now poor, although, technically speaking, the company had always performed well. That is true, as far as we know, because as a B-lender we had no direct contact with the company. In any case, it appears to have been a victim of the whole recession, and I do not think we can syv there was noor managerment When the snonsors were called on to perform on their support commitments, they too defaulted. They were in tne same troubled situation as TPT. The textile business was poor, and, as mentioned earlier, the other sponsor in Taiwan, China, had illiquid real estate interests and was going through its own restructuring. After the initial default we received preliminary financial projections from IFC, which then reported to us every month about the progress of th-e negotiations and what the mlain pro-ler, s were. Thlat wvas good. COn Lbli I ~Ld1U1 dIU VV4 L11~ 1141 1UU111 YV2 111d VV1 ~uU %-1 the other hand, we were not very close to the details of the negotiation. In September 1999 the second principal installment defaulted, and in November the B-loan participants were confronted with the results of the negotiation, in the form of a first presentation of the rescheduling ter.m cs,ht alreAdy ngantiateA -ith tlep rnmn,ni Thesn nn Tnfrmn-tion Memorandum was circulated in March 2000. We approved the resched- uling plan; the signing took place in August 2000, and it took until 2001 to make the restructuring effective. As early as September 2000, however, the first sponsor support commitment in the restructuring had already fallen due and had to be waived; hecause the snnnsors were unnale to meet it. The restructuring needs to be looked at from two perspectives. First, I think the negotiation process was rather long: it took two years. Why was that? IFC spent considerable time finding out whether the sponsors were truly unable to support the company. There was a special audit, which took quite some time, especially to investigate the issue of the California landu assets that Mvir. Ch1jen offiered in support ol hi'lls obligations as a spon- sor. It took a long time to find out whether we could firm this into the deal. In the end we did not get proper security on this land, just a person- al guarantee from Mr. Chen and a flow-of-funds agreement whereby any proceeds from the land sale will flow back and be injected into the com- pan1j. But a4l tlat' took tim U e to work out, as did a problemII with the pledge of shares that had actually surfaced much earlier in the process. 130 Section V The Business of Project Finalncing Fortunately, communication between IFC and the B-loan participants was good4. A 1+tough- we weenot involved in the prprto f the- was goo ~ L.. .1 VV II 111VUJLVLU III ULl F' LFaI atn 11Ul L, rescheduling proposal and there was no consultation prior to the negoti- ation, I think that was the result of being efficient. It was a rather compli- cated participant group with the banks from Taiwan, China, and the Japanese banks and us, and I believe that for efficiency reasons it was niirh better fnr nnp nprtu tn tak1 the lead in tlhp restrucrtiurincy Honwiepxr,- that meant we were sheltered from the details of the negotiation with the borrower, the sponsors, and the TIhai banks. T his way of working has both advantages and disadvantages. At one point the company tried to com- municate directly with the B-loan participants and to elicit our sympathy because thev were unhappv with IFC. That Dut us in a bit of a difficult position because we did not want to cause friction between IFC and the B-loan participants. However, IFC and the participants did have different views about the duration of the A-loan' and the B-loan under the rescheduling. Under the original structure, when the B-loan was repaid, half of the A-loan would still be outstanding. In the first rescheduling plan, the A-loan was short- en.d, anA we h1ad an cxc.hange of viewvs with IFC1 on this. Tvnual FC L1U~ IL Y l. l LA.Ia15L 1 VLVV I I L S1 _JI L11I3. IL.YV.ltuaily LI ~'. agreed to revise its proposal and provide more of a balance between the durations of the A-loan and the B-loans before and after the restructur- ing. Effectiveness then took a long time to achieve, because IFC tried to get the best deal for the lenders on security. I think the revised new chpduile is fair and banancnpAAJ W. extenAeA thp maturity from September 2001 to 2004, gave two years grace, and the old 2001 repayment schedule was reduced by 50 percent, so aii in aii it was very reasonable. The excess cash capture, or the cash-sweep mechanism, is an excellent gimmick. The banks share the advantage of any business improvement if it comes faster than anticipated. There was a margin increase, which was good and reflected the Lincreased risk of a Thai comlLpany in financial diffi- culties. One could qulestion the retroactive application of the margin increase, but it is true that while in default the company was only paying a 1 percent interest penalty while the restructuring may cost it more. IFC focused much attention on the sponsors and on their support OUMMI11LL111CHIt, WILII d 111di re I CUULL1UII UCPVlUi1r Ull UULII -tylilClL Ul sponsor support and prepayment from available cash. However, this is a 131 IFC and Its Role in Globalization concept that I find a little bit unusual. If the company manages to prepay, why should it not get a mnargin reduction? WVhVy should ni first have to wait for the sponsors to meet their obligations before the margin decrease applies? It's a matter of how you look at things, of course. One can be in favor of both attitudes. In any case, we know that the sponsors are in dire straits, and one can even vvon. erw wthlle it vv-- ould 1 nt bebeter 1o a4 y avauaiableso sor support to just go to TTC, which is the main shareholder in our bor- rower and the main off-taker of the products. If TTC has financial prob- lems, it has an immediate effect on our borrower. Therefore while it seems logical and proper to insist on sponsor support for our company, in this case I might wonder whether it is going to help i.mprove TT('s situation. Hence the main issue now is still the conversion margin and TTC's sit- uation with regard to trade receivables. There is now a covenant that they cannot exceed 90 days, and that is a good measure, but I would like to see some reporting on the monitoring of this covenant, which we have not seen up to now. Nonetheless, I think IFC did a good job in restructuring this transac- Lion. vviLI this uiversified group of D-loan banks, iL was probably neces- sary to take something of an authoritarian position to avoid too many dis- cussions, and get straight to the point of the restructuring. 132 C H A P T E R 2 0 lnvpstina in Environmental Projictn Louis Boorstin Manager, Environmental Markets Group, International Finance Corporation Brooks Browne President, Environmental Enterprises Assistance Fund James D. Westfield Managing Consultant, PA Consulting Group Louis Boorstin-Manager, Environmental Markets Group, Tnternational Finance Corporation In this presentatioA we look at two ways to support environmental projects. One is to finance projects tnat involve specific environmental benefits-such as renewable energy, organic agriculture, clean water, or waste management. The other is to look at any project being financed, and ask whether there are opportunities to improve its environmental aspects and, thereby, its profitability. The objective here is to make more money through cleaner produ1ction. A little over a year ago, according to a survey by the Economist, more than half of -the people in developing countries felt that their health was being harmed significantly by pollution and other environmental problems. This is an issue that goes to the heart of the people that the International Fnanrce Corporation (IFC) is in business to assist, people who liv in deve oping countries, particularly the poor people in those countries. These people face two types of environmental problems. One is what I would call local problems, which pose immediate and serious problems 133 IFC and Its Role in Globalization for the inhabitants of developing countries. Local problems, in turn, can be divided into two tvpes of prohlemns The first is Ioca! indoor and out- door pollution, whether it is contaminated drinking water, untreated wastewater, or air pollution (in many parts of tne worid peopie burn fueis in their homes that cause enormous health problems). The second is degradation of natural resources that people rely on for their livelihood, whether agricultural land, forests, or fisheries. Second, in the longer run the developing countries are clearly threat- enedu uby sUIll, giual isUes, suA as U11111Ct chadng1 ndIlU tLII los of UbIUIUg- ical diversity. Why is IFC, which is a development finance institution, particularly interested in these issues? I think the answer goes back to our mission statement, which says, "We are in business to improve people's lives and to reducer nnrPrtir" IFC has the ability, through its investments-just as all financial insti- tutions do-to "improve people's lives,' by addressing the local environ- mental problems by investing in projects that provide benefits (cleaner air, water, and land), and to invest in projects that help to protect natural resources. We also invest in proiects that didress global environnmental issues, whether it is global warming or the loss of biodiversity. Tne second goal mentioned Dy tne mission sratement is to reduce poverty." It is very important to understand that environmental projects have not only environmental benefits-they have very clear economic benefits. In the near term, these economic benefits typically are related to increased competitiveness and productivity in the companies, owing to mlore ellicient use oUt natural resourcesn. tInte longer termi luese benefits are related to more sustainable economic growth, because these benefits lead to making the basis of production more sustainable. These are the opportunities that IFC sees in the area of the environ- ment. That means preventing pollution instead of dealing with it at the end of the p.ipe. It ,xJxahs loing at a ---IIpan;, 4oing an audit of the- company, and saying, "How can we help this company become more effi- cient?" The projects undertaken here are not typical capital investment projects. They often require a combination of services, including consult- ing services, and smaller capital investments. I think there are also some intpresting opponrtuinities for crn.mmPrr;1 banks- in thep enr.vrnn-ent The second area of involvement is that we undertake environmental 134 Sectioni V The Btusiness of Project Financing projects, which could be everything from projects to improve drinking water; which we hqve carried out from Argentina to the Philippines, or renewable energy technologies, such as projects with geothermal, or bio- mass, or wind power. The third area of involvement is what I would call environmental ini- tiatives. To a large extent we are in an odd business, and this is the busi- ness of "pushing the market." This is again in keeDing with our develop- mental role, of trying to find opportunities where we think the market is gUIng to) UC 111 d cUUplC Ut yedla dllU 111'1e1p Ln dLtoacc dLe tIIUeoC UipU 1tU- nities, either by identifying technologies such as photovoltaics for solar power, or new business models that we think are going to become impor- tant in the future, and trying to make them happen a little sooner. One of the things that we have discovered about investing in environ- mental projects is that they have a number of barriers. It is important to understand these if we are to help banks or financial institutions address the problems that arise in projects. These often relate to the size of the project. For example, a renewable energy project will often be smaller than a mainstream power project. Often, they have longer lead times because it takes more time to understand the project and tn iinderstand the snnn- sors. Sometimes we deal with less experienced sponsors. There are technology issues-we often have a probiem of a nigh ratio or capital cost to operating cost. If one is interested in investing in a wind power project, say, virtually the whole cost of the project is up front, because it is in the equipment; the fuel to run that project is free. The fuel, of course, is the wind. There are some operating and maintenance costs, but those are actua-dlly lower thLan one wvould .-pic r_ fin for_ a foss:il-fuel-fired plant dLLUd1~ 1U~1 Lldil 11~ UUIUF Ld~LdUy iIIU 101 dt 1UN611-1UC1-111C:U pidllt. So these are some of the challenges that we need to surmount, and it is one of the reasons that the group I lead exists, which is to help address these challenges. A second set of challenges, which are a little harder to deal with and on which we sometimes collaborate with our colleagues at the WYA.'orld Bank, c*an beL call.ed distortion barriers. The diffi.culty here is that sometimes the projects we are looking at are not competing on a level playing field with conventional projects. A classic example ot that would be a wind project that is trying to compete with a coal-fired plant. But that coal-fired plant is selling power at a price that does not completely reflect the cost of producing that power, whether because the coal mrine does not have sufficient allowances for reclamation or whether there is not enough 135 IFC and Its Role in Globalization allowance for the particulate air pollution or the greenhouse gas emis- sions. These are real proble-ms. Wat w-e end up someti-mes doing viding cross-subsidies that serve to counteract these problems. More often than not, though, what we try to do is find countries and provinces of countries where the playing field is level. Sometimes we also run into an odd problem in this area, one that comes out of the hest of intentions hut often has a nerverse impact: name- ly, many bilateral and even some multilateral lenders may provide conces- sional runding. W'Ve cannot compete with that, because we provide com- mercial rate funding. We have often run into situations where we wonder why they are providing the concessional funding, because as far as we can figure out, it is not needed. In what sectors does IFC operate? * The environmental services sectors are, first, water supply and waste- water managrement; we hnve several hillion dolnlrs' worth of invest- ments in these areas. * Solid waste management is an area in which IFC has a keen interest. Having said that, I-will add that IFC has never invested in a solid waste management project. We have a few advisory assignments in this area, and some good projects in our pipeline, but for a variety of reasons we have not yet managed to invest. * Pollution abatement technologies and services is an area where we have not done that much, but would like to do more. * As for renewable energy, we have some biomass, geothermal, and a number of small-scale hydroelectric projects. We have just approved our first wind-power project, and we have done a number of ener- gy efficiency projects. Energy efficiency is an interesting area: in most of IFC's projects, where we go into existing companies and provide 1i0pivements for those companies, we are actually provid- ing several energy efficiency benefits. We do not measure those ben- efits, unfortunately. If we go into an old cement plant, though, or a chemical factory, or a factory performing another industrial process, and we upgrade and expand it, typically one of the things we do0 is to provide a vast il.roe.n in-- enrg us,bcus ti wUU I~ LU IJUV1U a VCUJL 1k11FLJVCIIICIIL III CIIVIrY LIA- UCt_,UZ IL 1 such an important part of the production. If that step is not taken, 136 Section V The Business of Pr-oject Finan1cinlg the firm is not competitive. We have also invested in upgrading transarnisSion and' distribution liines, in the mlanufaIctur1. of effi- cient light bulbs, and even in some investments in energy service companies, which provide demand-side benefits. * t.usauiriuuu ugrichulture aund fourt-Iy; vvr' Ihave Udiin a ifw projcts here. * Ecotourism: We are beginning to look at projects in areas such as fuel cells and fuei-efficient vehicies. O1ne exam,tple of our nn,Arnn,ntal projects is Aga-- A-rgnti nas which is actually two separate investments for IFC in a US$4 billion water and wastewater concession in Buenos Aires; and a project with an inter- mediary company, Energia Global, which invests in renewable energy ven- tures in Central America. A terrific nrnipret in our agrihusine-s dinArtm-ent is in Fcuiador This is the first banana grower in Latin America to be certified by a nongovern- mental organization (NGO) as ecofriendly. The same NGO that provided the certification recently gave an award to Chiquita Banana, which has also just achieved the same ecofriendly status. Another project, a cement project in Estonia, goes back almost 10 years. That was a case where we went into an existing plant, upgraded it substan- ~1 11 _ -- 1 o - - - - - : tiaiiy, and actually dcUinveU d a0 9CILCJe L ICUUen Llt U IIon in11i16MV11. Another area of involvement in the environment is in projects funded by the Global Environment Facility (GEF). This is a pool of funds that IFC can access, for projects that address climate change and loss of biodiversi- ty. GEF funds can be used both as investment capital and as grants, and as anything in be-+-een. a lly 4111 II L)tVtew I We are not particularly fond of using grants, but we have used the funds in a number of different areas to help support interesting projects through guarantees. One is the Hungary Energy Efficiency Project, which started out with a US$5 million GEF guarantee. Recently, in February 2001, IFC apprnoPv a ro-guarantpee facilitv of UIS$1 m ni!ion;n makingy it a US$17 million project. What is exciting about this project is that we are working with a variety of financial intermediaries in Hungary. we are pro- viding a partial risk guarantee to them when they make loans for energy efficiency improvements. Our expectation is that this US$17 million will cataV7P Iy US90 million worth of loans from these financial institutions in 137 IFC and Its Role in Globalization Hungary. In fact, most of that US$17 million will never be spent. We will get most o0 it bacl, uecaus I think thCy ar-e goi1ng to Mad godU inveLst- ments, and they are not going to call the guarantees. The Small- and Medium-Size Enterprise Program is another project funded by GEF that has done everything from sustainable forestry in Costa Rica to efficient lighting in the Arab Republic of Egypt, to a project that addresses solar energy in several countries. The last topic I would like to mention very briefly is one that has had front-page coverage recently: the Kyoto Protocol. The reason IFC is inter- ested in this is not that IFC, as a financial institution, has obligations under the Kyoto Protocol. We do not. Those obligations are for countries. We are interested in this hecause we see it a1s a new source of financing for projects, and a very interesting source of financing. What we like about it is tnat if we can rind companies that are interesteu in buying these green- house gas emission reduction credits our clients get funding. They are paid for these emission reduction credits, but they do not have to pay money back. All they have to do is provide these certificates that say, "We have reduced greenhouse gas emissions." From a company's point of view, that is a great deal. They get money in, and all they have to do is give out a piece of paper. So, to be very frank, that is why we are interested in it. From the perspective of our developmental role we are interested in it because we see this as a way to help the developing countries gain access to cleaner technologies and to have our developed-country members, the c.rmr,klers of theo Oranisatio nr f rnomrir I-------f;-f -rl 1s1w1.1f(1O 1 3 .J1 L lh all.l1(111(1t1411 IVJI L.,SJlftfhIVIII1 i - V Lt IVI UIVlh 1(11 Development, reduce the cost of complying with their obligations. Brooks Browne-President, Environmental Enterprises Assistance Fund I -would like to preserit a siligtly UJILLeLC-1-It pe1pectiLVC. VV1IItII LIIere aLr many good emotional, quality-of-life issues and other benefits to mention in the context of the environment, there is also money to be made in the environment. I want to talk about the profit-drivers to making money in environmental sectors, which is the focus of the organization I work for, i lULILILIlLa, L.lLL.1 Il ;11Lall'. * UIU%A. Environmental Enterprises is an NGO. We are staffed by a private equi- ty and venture capital people. Our program is designed to address capital markets-obstacles that prevent the private sector from getting more involved in environmentally beneficial activities. So we focus largely on t-he t-hreeo p,llarsc o~f 0irY9r1tl activirty:r cli,r;^.te' cAnang, hignC7ricn1 138 Section V The Buisiniess of Project Filnancinig diversity, and clean technology. The vehicle that we use to address capital markets-barriers is pri'vate equity gulds, so we deal in equity and quasi- equity types of investment instruments. Our first fund is a US$10 million private equity fund in Central America. We had some private capital investors, but most of the capital came from multilateral and bilateral investors. We have been investing in - Wvriety of sMn.m1 hY,dr0electric an-d bionmna nrojects Pnprgyr Apdea and some pollution abatement in Central America. There is a large amount of coffee, and a lesser amount of garment manufacturing in these countries, so we have also done wastewater treatment there. On the organic side, we have financed organic pepper, organic broccoli, and sustainable forestry. These are all nrivate sector businesses Some make money; some lose money. The premise is, at the end of the day you can show the investment world that environmentally beneficial businesses do not just make you feel good, but they can also make money. Terra Capital is one of our flagship products, and IFC has been very supportive of it. It funds only the biodiversity sectors. We are about one- third invested. We still have private capital in this fund available to invest ill gdUU cuIlIyaniIi, anId I amil ver y eAxLcLU about LL111, Ubeause I think thLer is real money to be made, for example in organic agriculture. The Renewable Energy and Energy Efficiency Fund (REEF) is also sup- ported by IFC as a lead' investor. We have substantial private capital in this fund from NUON, which is a major Dutch utility; Alliant, which is a U.S. util- itr ;nA Tnhn Hancnck Tncurance, a T TS incsurancP ,-rnrrnr W Xkr. w etill fuind- raising for the REEF, and we hope it will grow to US$80 million very shortly. Finally, we have raised US$29 million for another IFC-led fund, which will invest in off-grid rural electrification. Together with that fund we have created a foundation to provide business development services. This is a healthy element of nrivate capital in this fund from institutions such as Rabobank, Astro Power, and Calvert. Most oi us started tilinking about the environment in the miu- to late- 1980s, when we saw lawsuits against polluters, and even financial institu- tions started getting sued when the businesses they financed were poor performers in an environmental sense. Today we are seeing a great deal more environmental awareness, both in the developing and the developed countries. 'Interestingl-y, envilronmtenital ivsiVg1 yersdi ago was IIIstlIy on pollution-abatement technologies and abatement-service companies, and on things such as the privatization of water companies. We are now 139 IFC and Its Role in Globalization seeing declining rates of return in some of these sectors. Pollution-abate- meint tecnnlology deals are still out there, buL iII thie cLU[CHeL capital mar- kets they are often regarded in the same light as telecommunications or Internet investments. There is a great deal more caution now. At the same time, there are good business opportunities in some nontraditional sec- tors, such as organic food processing and environmentally friendly con- sumler products dlistribtion co.+paies A,s -- reul,- the -aitl -arket aULIL jJULUL~ LI3IIULIVII %AJIFaIll..3 tla a IL3UIL, Lill LaF'itai Mlaa~Lt3 are investing in businesses that are supplying these industries, and there are some incredible margin opportunities, depending on the industry. If you are a first mover in a new market or in a new supply arena, that enables you to stake out a strong position, and it locks up profit margin. Terhnologyv imnrnpempntc t+at arp now ocncurringa nrp also makina an impact. It does not make sense to do business the old-fashioned way any more, with only end-of-pipe solutions. You can save money and make money by integrating efficiency into your basic production process. We are also seeing changes in larger, well-managed companies. Some Fortune 100 comnanies are quietlv undertaking environmental investing through their divisions or subsidiaries. There are barriers to entry, how- ever, which in fact favor erivironm ally IoLUS compalnes, whCLIer iL Is organic certification; energy generation or distribution concessions; or proprietary technologies. As fund managers we can provide value added to our investees. In our organic agriculture investing, we know who the buyers are. We know who the certifirers are. IvA T recentl wn to -- fah -hc - s1 -h l.,aroran Lil1 L L Iil a . vvv Ll WC;11L LuJ ILkJIUIaLI, WVIIILII 10 tLUC 111a)V1 UlraIll ics trade show in Germany, and introduced one of our investee compa- nies, a producer of organic sesame seed oil, to potential new customers from Japan and Switzerland. So we can make important connections for our investee companies. rn our busCiness ,^Teo A~-Itak some, earlier-stage risks, bearuse, in the developing world people involved in these environmental sectors are often from smaller companies. Although the smaller companies have the high- er risk they also represent the greater value added opportunity, which means that an investor can make more money at this level. One does need to be aware of the riks, however, These usua.ly have to do with technolo- gy, with the classic small business problems, and with government policy shifts. if the investment is in the power sector in Brazil or in india, for instance, the regulatory process may still be evolving. 140 Sectioni V The Bulsiness of Project Finanicing We must remember, too, that access to capital faces an education chal- lpncrp Many hbnkprs think that hininscc nlcIApr isz actuia!!y a, frnitna uiisi- ness, for example in sugar or rice production. It is not-it is altogether different: it uses agricultural waste as a fuel source for power generation. The leaders in the banking world can help some of their colleagues better understand that difference. I hope that bankers will also recognize that the environment is a good business opportunity, and not just something that needs to be dealt with to reduce their risk. James D. Westfield-Managing Consultant, PA Consulting Group I want to talk about clean production and pollution prevention, pri- marily in the developing world. A lot has been done in this field in Europe and in the United States, but I think there is a substantial market and a real opportunity in the developing world. There are at least four basic requirements for clean production. To begin with. the industry needs to fully understand Dollution and how to prevent it. Normal industrial people do not look at pollution in this way. They look at more production-oriented processes, and obviously they look at efficiency. There has to be some knowledge about pollution pre- vention, though. A second requirement for clean production is technical capability. People need to know and be proficient in technologies and approaches that can help them.. ,anLk;ng, and even the governrr.ent, has few such lech- nical experts. So there has to be a cadre of people with those capabilities. There also have to be government incentives and regulations covering clean production. Countries should be able to say to an industry, or to an entity, "If you meet certain requirements, you do not have to have sec- nndarv treatment If VNyo rnn chanep vyior prnulrction nrocrPzs vyi rcn recycle and reclaim, we will accept that." That is already happening in a number of places. Many industries and entities in developing countries are small, and they do not have a history of borrowing. Or if they do, the borrowing is under different circumstances. So. financing has to be available and tailored to the local scene, and that is the fourth requirement for clean production. Furtllermore, the uoiiipaiiy itself, and individuais in the company, have to want to pursue clean production. They have to understand that clean production can be a viable alternative. 141 IFC and Its Role in Globalization Lack of financing is a barrier for a number of reasons, especially when potential borrowers hav.e a history of credit problems. Many potential borrowers in developing countries have not borrowed before, so they can- not go to the bank and exhibit. Aithough they may have some collateral, a bank or a financier is going to want something in case the loan does not work. Borrowers also lack experience in designing and in justifying these nroiects So there has to he sorne technical help available- The hank has to understand this, because many environmental projects do not generate a new revenue stream. This is not like going into an industry and putting in a new production line or adding products that yield a revenue stream to which a potential borrower can point. At the same time, clean production and pollution prevention initia- tives can save a great deal of money. They also have a great payback peri- od, UtL Ltiy UV JIo L no1 g 11Lerate v nwV l.venue. I otI en ViL,1 couice1ns bainke1r- and I have dealt with this in many countries-because they cannot see where the revenue is coming from, even though it can be shown that a project saves money. Because banks themselves lack experience in this area they tend to be technologies that banks deal with, nor do they entail traditional types of projects. i am talking primarily about industry, about new industry, not old industry. Even if production from new industrial plants in Southeast Asia over the next five years will only be one-time greater-a very conser- vntive eqtimrte-then what is on the ground now renresentc a tremen- dous opportunity. Helping new industry adopt cleaner production is not only beneficial, Dut also financially viable, especially among the new industries that are buying old technology. Many are going to Europe and buying old bottling plants, or old canning plants. There are opportunities to add clean production or pollution prevention initiatives to the new plants being built using that old technology. What makes this technically easier and oitien less costly Is that it is not IIcessariy to stop prouuciun, because everything is being designed and put in before the plant begins operating. Furthermore, it produces quicker paybacks. In the past, established industry received most of the attention, partly because many existing industries have been under government scrutiny or have been orAereA to cIcan up. vIu can rneet m.ost or all of the requie- ments for end-of-pipe by clean production. The benefit is that clean pro- 142 Sectioni V Thie Buisiness of Project Firniacinig duction provides savings. Waste treatment does not. Waste treatment is a cost, and it is a continuing cost. It does not produce any savings, just addi- tional cost. It frequently does not improve the quality of the product, or mi-aufalctur ig efficiency. A manufacturing industry can benefit from efficiency upgrades, cost control requirements, and clean technology, however. Many technologies, in fact, improve the product and minimize seconds and rejects. Where a company needs investment capital, a bank or financing institution has leverage if it uinerstanAs what the technol-ogie --- 'o. Another point about existing industries is that they usually have a credit history, collateral, and borrowing experience, so they are easier to work with than other industries that do not have this history and experi- ence, or that are smaller. Now I want to present some case study data that we have collected, pri- marily out of Latin America, from actual implementation of clean technol- ogy products. T ne tirst two cases were very large industries in Latin America. The first case involves an inorganic chemical industry in Mexico that decided to modify its combustion process, reduce natural gas consump- tion, and reduce volatile organic comnound emissions. Hence the case has both an environmental and economic dimension. The natural gas con- SUmIptLIoII Wab ieduced substdantially. VVC lhelped thIC pidltb IIImUiy thirII phosphoric acid processing operations. Again, the project led to savings in natural gas and volatile organic compound emissions, and it improved product quality. The nnodification in gas emission and handling had sev- eral important effects.'There were savings in energy and volatile organic com,pounA emissions.: Data collected over --1ra -ear a-ftert.rjet were implemented indicate that the investment was very small, less than US$50,000, yet in zthe first year savings amounted to almost US$450,000-that means it had a 750 percent payback. Although this is not typical, by any means, it has happened in many places, and this was a Vpryi gonod Pyn.mnlp Slme resumltsrz 1Q haip not hpen nquitp sn secntcuilar The important thing is they experienced reductions. The financing here was not great, but the retur'ns were significant. In a second case, in the organic pharmaceutical industry, there were three major applications of process modification for bromine addition, for toliiene The companv reduced toluene use and volatile organic car- bon emissions. The total expenditure was something like US$30,000 to 143 IFC and Its Role in Globalization US$40,000 for capital, which does not include the company's personnel cost This rapital cost was primarily for technolog,v This is the kind of money they could have borrowed or spent from capital-and the return on capital was, again, about 800 percent, so tne savings were substantial. In a third case, again in Latin America but this time in sugar process- ing, a company spent about US$1.6 million, and its subsequent annual savings were about a third of that amount. So this had a three-year pay- back period. Again, this project was financed by borrowing, and the com- pany Ila a history ot borrowing. The first case was not financed by borrowing, by the way, because the company had capital on hand, but the second was financed by borrowing from commercial banks, as was the third. In Ecuador we worked with the government to develop programs, and regula1 tions, to - help encou1rag Upclean-tecno nlogy nfl1,tinn..nrpgrpwnt, nf options. The government recognized clean production as an alternative to end-of-pipe treatment. A wide variety of industries were involved. We went into 16 kinds of plants, including car assembly plants; many of them were small, but some were larger. In these plants we identified anywhere fronm a few to more than 40 pollution-prevention r1ean-technologv options. In a tanning plant, for instance, we identified 42 options, for a total investment cost or about US$297,000. in aimost ani or tnese cases tne companies borrowed and invested the money, and then enjoyed the annu- al savings. In one case the average payback was 10 months-a full return on investment in justlO months. This is documented information, based on annual expenditures before and after investing. vve hIave ue-velopedu a rule-of-t11u.b -in work-ing with VVIUdI diU g,V- ernments on these projects: if you can get an annual return amounting to one-third of what you invest, that is reasonable in financing terms. Then you can go longer or you can go shorter. We also found, in Latin America, that if financial institutions can see a three-year return on their invest- ment-and they can understand the financial benefits, the processing- manufacturing benefits, and the environmental benefits-they are willing to consider funding these projects. The fact that not one loan failed in Ecuador indicates that these kinds of projects actually work, and they pro- duce reasonable savings. 144 SECwTION VI Innovations Lv nl A P T R 2 1 The B-Loan Website Andy McCartnev Managing Director, eHatchery, LLC James Smouse Project Manager., B-Loan Website, International Finance Corporation As part of our effort to continue improving the International Finance Corporation's (IFC's) collaboration with the financial community, the Syndications and International Securities Department is establishing a B- loan market website to add liquidity and efficiency to IFC's B-loans. We are creating an online mepting nplace to facrilitatp the intrcsiicrtin of will - ing sellers of B-loan participations to willing buyers who meet IFC's cri- teria for participation in the B-loan program. Actual trading of B-loans does not occur on the site. We expect the website to enable qualified B-loan participants to: * Anonymously list their B-loans as available for selling. * Anonymously bid on existing B-loans that are listed. m ArJonyI11uUly place requests to purchlase DB-loans not curreCnILy listed for sale on the website. * Access current B-loan holdings of their financial institutions. * Obtain information about IFC news, operations, and upcominR syndications. vAvT- expect to launch +the websit in - the third orfortqarerof201 VVL jiLL LU la ii~J L 1.. I YUIt i LII1'._U1t LIIILl ll U VIU-I Ut Lii 4uaI L-L1 VI LAVJI, withl an announcement to IFC's existing B-loan participants, as well as to 147 IFC and Its Role in Globalization other financial institutions prescreened by IFC and interested in develop- inc thpir B-loa,n nprtfnoisc A XAJ/ will rprpegcter Pvitcrng narticipantc and invite prospective participants to register on the website. Approved parties will then be given a username and a password to access the website. As is already the case, individual buyers and sellers will be responsible for com- pleting due diligence, negotiating terms and conditions, concluding the sale. and submitting the annronriate documentation to IFC off-line- A few sample pages from the website follow. Public Home Page The home page will be available to all authorized, unauthorized, and prospective users. The exact design of the home page will be determined at a later stage, but essentially the content and functionality will include an introduucti-on to IUK s-yniulcations and the De B-loan websiteiM liks to irF, the World Bank, and other relevant websites; new participant and user registration information; login fields; and start page. Successful logins will be presented with a website disclaimer and confidentiality agreement that must be accepted in order for the user to proceed. .3I1FC q wymPfrR-Tpnon, P-I "Ml LIMR q1TJ ,,*i|liZillX~ m117 M 1F & Der | 7' 1 U. e j lL Web Sih. Apgn of - ,IEn p a o a^n=Y dFC-s ,a bo-oBoo tb. dr oo. cfi o -=y. sBu ho 000000 i.00 d. SC db d l - SonrOol D^pp h. bo bhdo.d 81-o B OL ,,, 1.11U 1.I fl _. I. *SI CPI PpLS=2 C etc:lql P,v .1rs fB i==. w. pli ^t-- &b4 1 ,. LwOOJ I mooogpLoo co foncrh moodrrooo of sBg slo,, of B -Loo pnrro^p.Oooo a .olr, bynl d.n qrs iiC - nFr bf p-0,0 0.0 B h-Ler p A-pd -Od,4 ,CB.loon, dootootoc00o.odotoO IFC /tuFO Too Wob Sb oi.O, q-oloEd B.Io.. p.o S A-qr -1 hy. bA-fono ., .ovdbi to bo da A-oyo-ly y hod op -nac B--,os h. bs hid -Oyooy p-r0 ooqroto f= Bon- s o 0 -0 - . fd r0b0 = i onn B loon hohW od Foroooobo too d-oo,d B4-lor Oon .^0o . Obi=n frtoo o 1f- L- IFC o opn- sod rw 0y,ic p0r r ~ ~ ~ ~~~~ o, ,oooo ,o,; ,, _roo,,Coo,,,-r _ , B 148001 - .11 F.-. C00-rE3 148 Section VI Innovations B-Loan Listings Page IvAT- expect .vopi,,aypae to ,ersn ,eBla - 1arep : ".FCI YV cAj L LWU PI1111Id1 y ParC~l LUL IC I.ICSCI IL HL n-iu aIiii aiKtLp Ia Le: I r'. B-Loan Listings"and "My B-Loan Activity." From the IFC B-loan listings page a user can access a list of all B-loans outstanding and B-Loans that are for sale, plus any participant requests for assets to purchase.' n-i~~~~~~~~~~~~~~~~~~~~~i ~~~~~~~~~7 ,. . ,' . 'a...-- ~ U.. R7,- '7 JZ~- MR ., . -....E 'The assets listed in all screenshots are fictitiouis anid are shiown here for demonstrationi puirposes onily They do niot renresent offers to buy or sell IR7 R-lans- 149 IFC and Its Role in Globalization Viewing the Term Sheet and Making a Bid vv I en a user selecLs tule borrower name from nB-Loan Listings," a con- fidentiality agreement page will appear relating to the asset that has been selected. If that agreement is accepted, a term sheet page will be displaved, as shown here. Functions available from the term sheet page are expected to * The ability to make _i_FC a bid. * The ability to post a B Td' A-f . hk% public or private anonyMous e-m.il 2 , B I to the seller. * "Set an alert" USD2X eOd3 D[iD enables an alert to be sent to that bidder's e-mail address when the ask pnce cnangeS toL a predetermined 5 amount. 150 Section VI Innoivations When the "Make a Bid" link is selected, a bid page will appear that enables bid i1nform _.ion to) be et red. s in4forrr.atsion i s Aeterm.ILneA tAo be: * Bid price * Term * Bid amount M CnnAitinric M.k, . Bid - Tmmr S , 6.a F ,&,y M-g, M-,Siy A f-. BGId% SM k Ari ABC Mlcn-g USD 32M B lon LMOR + 3 875Y. 05I19 USD BM no kd 99% I0, 0 yYts 11-F r- L, ,d4 F r - SD,000, SD. --- ------,,,k.&8., 1A 3 EtIFC- i , A preview and password confirmation page will appear after the com- pletion of the bid page and an e-mail will be sent to the seller, the bidder, and IFC. We expect that it will also be possible to edit and delete bids from this page. If the bid Drice matches the offer nrice, then anonymity will be lifted with an e-mail notification to the buyer and seller, at which point they can begin negotiations and due diligence ofirine and seek IFC's consent for the assignment. The loan will be removed from the B-loan listings page. If the bid price is below the offer price, the loan will remain listed (while the sell- er determines whether to accept the bid by amending its ask price accord- ingly). 151 IFC and Its Role in Globalization My B-Loan Activity Page The se ond page that we expec t will Com-Mplete the B-loan marketplace is "My B-Loan Activity." This page is customized to list items specific to the logged-on user or institution. The "My B-Loan Activity" page will dis- play all B-loans held by the participant, plus any current bids, offers, requests, and searches for that participant. The following screenshot is a prototLyFe thlat showsVLi", F " losen ctevnt and functionayly VI ths page. . I I 1 s - *- I tIiI -. . MItt , o tIFa.mS Pp.1 inOff., Pas_IaP.,, C,. fi s,ch& A *L 152 Section VI Inn?iovation1s Posting an Offer An offer can be posted from the "My B-Loan Artiuity" page. The seller will select the B-loan it would like to sell from the list of the user's hold- ings. This will open a term sheet that wviii be automatically populated with important information about the loan, including borrower name, sector, margin, maturity schedule, covenants, and so forth. The seller must review the ternm sheet information and update any incorrect fields- After the user has accepted or updated the term sheet information a I1. - C.. fC- . second page will allow tne user to enter price ana terms oi its otter. A pre- view and password confirmation page will appear after the offer and set- tlement terms page, and an e-mail will be sent to both the seller and to IFC that an offer has been sent for posting to the website. IFC will have the opportunity to review the term sheet before it is posted live on the website. ~ilFC P.0 Off- l Offr -md S,td-nl T-m ¾ B-ar USD40MBl,o, LBOR+2575% O15105 USDISM .1 ~ r .^-;III - .^ ] _*g9 r ~F- I J tIFC O_E' -. r _ NOTE: IFC must grant its consenit prior to the offer if a seller is offer- ing a participation in a B-loan with the following characteristics: Before fuill disbursement of the B-loan * Projects in advanced stages of restructuring. 153 IFC and Its Role in Globalization IFC Information This lab vv' till cotnan ITFC news and content, and links to other onlin related content. IFC will continuously update both the content and struc- ture of this page. New Business This tab will coltain announcem,nts of new Ar,mnn whe they are launched, press releases on syndications that have closed, and the lat- est monthly syndications pipeline. Each announcement will have specific e-mail contact links. Prefera.,ene This page will allow users to update their personal settings in a num- ber of areas relating to website operations. Exact preferences requirements will be confirmed at a later design stage, but to date the following settings have been identified: M RPeistraftiorn infcormatinn from tihp R-!non wphzitp rpaeitration npag * Geographic region(s) that the user would like to specify as a filter for asset listings and alerts * Set alerts and contact e-mail addresses * Change of password * Creation of login identification for that institution. Contact information For further information on IFC's B-loan sales website, please feel free to contact Mr. James Smouse with your comments or questions. Mr. James Smouse Project X/anager, B-loan Sales Website International Finance Corporation Syndications - Tannt-rrna-ti-nla rities Deartment 2121 Pennsylvania Ave., N.W. Washington, D.C. Tael: ()A)) A4Q5A=41 - Fax: (2) 97A4A=3Q7 E-mail: jsmouse@ifc.org 154 C H A P T E R 2 2 Investing in Education: NiiT Student Loan Program Guy Ellena Ticechnical 1v0anlager, lulalthl andu *"uuation lepFartment, International Finance Corporation C. N. (Madhu) Madhusudan President, Strategic Alliances, National Institute of Information Technology (USA), Inc. Nicholas Vickery investment Officer Finanniai Markets, South Asia Department, International Finance Corporation Guy Ellena-Technical Manager, Health and Education Department, International Finance Corporation We would like to discuss the first large-scale student loan program in India, undertaken by the International Finance Corporation (IFC) in col- labuoratilon w-ith' Citib1ank~ and the Natona Intit~ute oC TnfraP-,ion _ Technology (NIIT), one of the leading education and training organiza- tions in India. Through this project IFC is playing a pioneering role in the launch of a new financial asset class in India-student loans. Let me first give the general background for IFC's interest in education financing. Education is a topic that bankers usually do not discuss nuch despite its enormous importance to human resources. A few years ago we began making a case for IFC and private involvement in this sector, as well as in health, both of which are traditionally public-dominated sectors. 155 IFC and Its Role in Globalization The global market for education-encompassing everything from pub- lic and. private +_drgre to --hreuato,seil-ze traiing and corporate training-is unbalanced. Overall, it amounts to about US$2.2 trillion, and about 5 percent of the labor force worldwide is involved in edu- cation. About one-third of this US$2.2 trillion is spent in the United States alone, however, and only 15 to 20 percent is spent in the developing world. Another important factor ffor bankers to consider i the demand for education. When one looks at the size of a population and its education needs from primary through tertiary levels, China, india, and Latin America clearly have very high needs. Unfortunately, public expenditures on education are very low compared with demand. That is why a case can be made for financing private education, although many people continue to view private education as something for rich people. That view is based on trutn to some extent, especiaiiy in the must developeu countries, whichi usually have a strong and well developed public education system, and in which one has to elect to go to private education. Levels of real private expenditures on education do not always coincide with the economic sta- tus of a country, however. Exact figures are difficult to pinpoint, of course, because mluc pr. ivate expeniture is not reoAreAd. In- a sey cas, thle result can be surprising, especially at the higher levels of education, which should, by the way, include vocational training. To take a few examples: private expenditures account for 57 percent of education resources in Uganda, while Chile has a well-regulated public- expansion of private education in a short period. China alone has estab- lished 500 new tertiary institutions over a period of only four years. Cameroon, which has moderate resources and a large population, has seven universities, and 25 colleges applying for accreditation. Even in countrier where one would have exnected the public sector to do more; many students are receiving private education. In the Philippines, for example, 86 percent of students in higner education are in private educa- tion, and in the Dominican Republic the figure is 71 percent. In C6te d'Ivoire, which has a public-oriented tradition, 100 percent of profession- al training today is de facto privately provided. In The Gambia 44 percent of the training market is private. in view of their uevelopinig aniu eiinerging econioiines rnriiIy 01 ouI client countries are in dire need of trained professionals: lawyers, account- 156 Sectioni VI Innot1ation1s ants, teachers, dentists, doctors, nurses, and the like. Although private educatlon in developing contie --e serv -hrc, it - is als -increas- .AJ.tLI.Jl il 41. LfsJIfl5 LAL4ILL LU"k, 3L1 VL. iL I U.~.I, IL L3 QIa JIILI.0 ingly serving the middle- and lower-middle-classes; although it is certain- ly more of a challenge, in some areas it is also reaching the poorest popu- lations. Demand-side financing mechanisms, such as student loan schemes, can help the private sector expand its service to the poorest pop- ulations A cond,icivp rpucilntoru frmne-1AiTrV ic a prrconAition for nyv widespread private sector response, and we do find that in many of our client countries this framework is underdeveloped but changing rapidly. That makes our task more challenging. Because of these changes, especially the increased demand for educa- tion. large for-profit educational institutions are starting to look at devel- oping countries. They are expanding their markets by moving toward countries whiere the emianuu, thLe neeus, anu the financing mechdanHiSIIis are sufficiently established to convince their shareholders that there is business to do there. So far, in many countries good education is available to the wealthy classes and, to some extent, to the lowest classes; a growing middle-class that has high expectations of social mobility still has limitecd ac.ess to quality education toAay, however. That increased demand from the middle-classes is what we think is driving private investments. A number of developing-country public institutions have reacted to their bad financial situations by introducing tuition fees for students who can afford to pay, and in some cases this has translated into imnproved quality of education. To return to IFC, its first investment in this sector was only in 1995 in a chain of primary and secondary schools in Pakistan. Then in i999 IFC's corporate strategy group launched a global study that began with a brief paper entitled "Investing in Private Education in Developing Countries," which outlined the broad objectives and rationale for IFC to become involved in the social sectors. In ApiII 2000 IrFC estbUlished the l bIUal racLtce Group 101 Socil Sectors, which is the group within IFC charged with health and education. That group presented a revised IFC strategy to the board of directors, emphasizing the need to mobilize private resource flows in the develop- ment of particular businesses. IFC expects that, in getting involved with 2Auca t onal -+.+- 1+-E + - - <+A sw_w _ - -4S; LUU LlUIIa I EtLLUtIUII0, It 13 6,Ullb LU LUVaAlla I11adl1 iai LllILlCllC allU to help those institutions expand to serve larger markets. In addition, 157 IFC and Its Role in Globalization these investments will directly contribute to building much-needed ihur,^an capital, whlic is one o'f the n.ost important - dver for econor.i growth and poverty reduction. Clearly, IFC does not want to invest in social sectors based on the fact that they are subsidized by other moneymaking sectors. We want to prove that private investments in education can be financially viable, whether they are for-profit or not-for-profit, and we want to build them as a new line of business for IFC. To this end we have approved 29 education proj- ects so far throughout the world. The volume approved is particularly high in Latin America (which amounts to US$88 million of a total US$138 million for IFC's own account), although we have only undertak- en nine projects there. At this point, we expect to do 15 projects a year, for an average of US$10 million each. I should also mention that IFC and the VVUI0rd BankD Iha-ve colabUoratedU -in putt-Ing tog,ether1 pivaLt s I CUULda- tion initiatives, starting with a website service called EdInvest. Edlnvest is a website that provides a great deal of information. Initially subsidized, it now must be more self-sustaining by selling its services. It is going to be based with us in IFC to get it much closer to private business, although with a llp fro. our big sister, the Wrld Bank. Finally, if private sector education delivery is to grow in the emerging economies, one absolutely essential need is the provision of student loans. Without them, and especially without loans of the type issued under the NIIT Student Loan Program, it will take a long time for the private edu- cation csctnr to saddrecc thes nPsprk cf Iow- and m.AidlP-incn^mP fa.mlipc rather than just act as a service provider for the well off. C. N. (Madhu) Madhusudan-President, Strategic Alliances, National T_ AA4L J-6*I IfT4: A_.AA TTCA ) T_A_ 01 tttULC VJ lIfJUI 1116701 irUCrltZIutUxy k V I, fM. There continues to be a great deal of confusion about how education can be for-profit, or how a developing country can invest in educational infrastructure. To answer such questions one must remember that the key resource on this planet is the sheer number of inhabitants, and that edu- rotirnon pAl-,cs s-sC tn rrsmnlrt th^st rPCnhlrfP intno^n Aaccot When our firm, NIIT, started operations in 1982 the idea of combin- ing profit and education was not widely accepted. Education, most people said, belonged in the public sector. There may be a token fee for tuition but everything else is provided by the state. One could not think of profit 158 Sectioln VI Inn21ovatiolns in that context. 1 his view was a big obstacle for the growth of NIIT in its first few years. However, one thing going for us at that time was the demand that was building up with microcomputers entering the marketpiace. Traditionai educational institutions were not looking at microcomputers, or micro- processor-based computers, as anything of value to them. Most of the higher-end technology institutions were oblivious to what was happen- ing. Meanwhile, the industry was taking off with many computers being UeClIVCviCU LU Lu111pd1IICb, UUL WILLI 110 UIIC Lu CUULdLC PCUOpLe i11 Lll ll USC. That was the market opportunity we saw. We asked ourselves how we could address this opportunity. The first step, we realized, was to start bringing some people in and training them on how to use these new computers. That constituted a small market in itself. Then a host of n-t- -issue arose pertainingo who act1ully needed to use a computer. Did one have to be an engineer, a mathematician, or a scientist? This made the confusing situation worse. So we decided to resolve that question first. Once we identified our market we looked around for a potential audi- ence W,- dpcidhed that India was n ango candidaitp Th sncial structuirp in India was such that after students finish high school, unless they get into an engineering college or a medical school, they are considered a write-off. The size of this community of write-offs is massive, because most people do not get into medical school or engineering school. Yet they have some basic academic qualifications and nothing for which to aspire. This is a sure-fire recipe for a revolution. So we decided to address this audience and enable tLile. to LUecomLe comLputer-l-tC-rdate, dilU LIICII see iI LIIey WoU1U Ub employed by industry. That, in a nutshell, is how NIIT got started. Over the years our company expanded into two "business lines." One of these is Teknowlogy Solutions, which provides software solutions for applications and knowledge management. The second is Learning Solutions, which is the focus of the education loan program... Since 1982 NIIT has developed 18 subsidiaries, and now has offices in about 36 countries. We also have 2,800 education centers. One of the key reasons for NIIT's success is access. Traditionally, to attend a particular school one had to relocate to the city where the school operated. With NITT we T ,Ait flinnped that mnoPl arouind anci said thant it was not nPcessary, to relocate, because there will be an NIIT education center nearby. 159 IFC and Its Role in Globalization Scalability and access are indeed two keys to the success of such programs. Henre our miccion a to take a computer education center and deliver it to everybody's home, or at least into everybody's neighborhood. How was this done? Over the years we have hired about 2,000 software professionals and 700 instructors. First we had to decide what kind of instructors to put into our education system. The basic premise that drew us in one direction rather than another was the fact that we had to impart skills. This could be done by going either to a traditional proressor or academician and iis- tening to lectures on a subject, or by going to someone who had developed systems and could provide real-life hands-on experience. That made us recruit instructors who were practitioners, not professors. This gives us a way of bootstrapping experienced talent into the training system, which is uouaiiy a UVVtili.r IUJi LIdUIUlIdI U1_1111VCLy LyCl1l. When we started in 1982 we opened two education centers, one in Bombay and one in Delhi, and by the time we opened our third one, which was in Madras, we were fairly exhausted because it takes time to drum up business, and the cash-flow needs were high. At that rate, it was going to take usforever to build eten 20 education centers The first rad- ical shift in our thinking was to find a way to scale this up without being limited by our own speed and resources. We decided to look into how we could network and partner with like- minded people and get them to be our engines of growth and reach. That "licensing" or "hu.siness partnershin" annrnach has worked extremely well and in fact has helped us expand into a strong 2,800-center network. in the early days we began working in parallel with a group called the Performance Management Group at the University of Michigan, Ann Arbor. The driving factor for this group was the fact that during a recession the first expense that companies cut is training. When they asked themselves why this happened the only answer they could come up with was that a return on in-vestment -was not visible ini the case of training. They then cre- ated a whole set of instructional design models aimed at measuring impact, which we started using. Subsequently we created our own instructional research and development facility, which has now become a large business in its own right, with multimedia and "e-learning" programs. Inl ijU' iIt - 199th meianl C-Uun11 .il on L,UUL-CdLPI V1isLCe INII to lUook1-I at all our instructional development activity, that is, to look at how NIIT edu- 160 Sectioni VI Ininovatiolns cation was actually managed in education centers. Its representatives per- fnrrned an evaluation of our courses and operationn They were so impressed that they decided to establish credit recommendations that would ailow NiiT students to take NIIT courses and have the credits transferred when they joined the next-level programs at American uni- versities. That action strengthened our own conviction of the value of what we were doing. By 1992 we had moved on to converting all our courses, which are of many different kinds, into one structure, almost like a university stIUtLUIC. That w-as the start of the programn called GjINII. Subsequently, Microsoft approached us to seek our assistance with its computer education in India that takes place under the certified educa- tion center model. Under its model of certified education Microsoft certi- fies a provider to impart Microsoft education. This has been popular in ...ar.. contrie, ut/ i. India the.y - eYr just startin. So L1r, OM JULL aalll Lt us and asked if they could use our education network for training people on Microsoft products. Now, we are Microsoft's premier education train- ing provider. In 1996 we started using e-learning, or the Netvarsity here, and TPchFdea, which is hbaircAva wbP-dAPixPrPi lperning sprxricps Nxt lAwP launched the web-centric curriculum, the iGNIIT, which is actually the flagship of the loan program. Since then we have added newer topics. Our success can be attributed in part to the fact that we are based on the hos- pital and medical school model. One of the problems with traditional education is that its goal is mainly to grant a degree, and rarely is there any communication between industry and academics. By contrast, our system operates on the preimise tihat software CeveIUpI11nLt requireIIrenIts shioulU drive the training. It is oriented toward real life and current technology, and it has absolutely no traditional academic constraints. As a result, those who come out of the training system are actually practitioners. They do not need another finishing school to be able to find a job. I think that is th'e core strength ofl tisi. --'.] Over the years NIIT has established itself as a very large training com- pany. It is now among the top 50 such companies of the world, having trained 1.5 million students. At any point in time, on any given day, about 350,000 students will walk into NIIT education centers. Unlike a tradi- tional education cyctprn this one is managed like a production system. Under this concept, education is managed as a manufacturing process. 161 IFC and Its Role in Globalization The focus is on efficiency, and thus on issues such as learning effective- ness, cap,aci,t-y utilization, or inst-ructr -utiza-tion, ,^,7hithis wha 1tfln.C it possible to manage the system as a business. One of our key objectives is to provide retraining because technology changes so quickly. A second objective is to help meet the global shortage of information technology (IT) skills among working professionals. A third is just to make people computer literate Our goals and our methods are the force behind what is truly a success story in the field of education. Nicholas Vickery-Investment Officer, Financial Markets, South Asia Dnparten-, Intern.ation,al Finanncr Conrnrportion The impetus for the loan program that was developed with NIIT was IFC's desire to finance students with potential, but without the resources needed to gain access to higher education. The program we subsequently developed in India has two key features. It is the first private sector stu- dent loin program in India that works without subsidies and without any government intervention. The other key feature is its innovative financial structure, wnich has made it possible to share the risk among CitibanK, IFC, and NIIT using the techniques of securitization in order to lower the costs for the students. So where does one start in order to develop education finance? We identified a sector in a country where there was potential. This turned out toL be IT, whil tuday is one' of th leLost powerfu- instrumLLents of- UL-dnC in India. The software industry has grown from US$150 million eight years ago to US$4 billion last year. It is one of the fastest-growing foreign exchange earners in the country. As a result, IT education is one of the fastest-growing segments of education, with 700,000 students enrolled every year in IT progra inIndia Yet there is still a 1-b-1 shr-f-tg - ITr engineers. Last year, this global shortage was estimated at 1 million stu- dents. Even with the slowdown in the IT sector this year, there is still a shortage of between 500,000 and 750,000 students globally. Within the sector we identified NIIT as the best partner for providing IT education Amonn tlh, cru,rcps nffered ki NITT wp idPntifiPd iMNITIT as the flagship program. It is a three-year program that is completed in par- allel with a university degree. During the first three years, when the student is still studying in a university, he or she is concurrently taking computer courses. At the end of three years the student is awarded a university degree 162 Sectioni VI IIInIovationIs and a certificate in IT. This training is followed by practical experience con- sisting oflf~ one UI -jkpet I.srknnn nfora cm -Aay and earn1ng a sti. This is why the recruitment opportunities for graduates of iGNIIT are so high, and why we chose this program as the one we wanted to finance. Although there is a pressing need for IT education in India it is not covered by the traditional financial sector. When we looked at the avail- ability of student finance in India we saw that very few institutions offer student loans. Those that do often reserve it for the elitist programs, such as those at the indian institutes of Technology and indian institutes of Management, which basically do not target what we refer to as the lower- middle-class, which is the core market that we are targeting. In addition, these finance programs are mainly based on collateral lending, which means that the families have to show they already have the revenues or tley hadVet LU eethe aI un1UIIt that hIey are burrowing. Hence only the people who could have afforded the loans at the outset are able to gain access to these funds. The reason for this is that student financing is still considered a risky activity, in view of the high default rates in student loan programs around the world. IFC'-s approach t1o student finance was t-o find th esosileprte in unsecured consumer lending and apply the methodology of unsecured consumer lending to student financing. We identified Citibank, which has had a presence of nearly 100 years in India and has the best collection rates in consumer lending in India today. With these three partners- NTTT nroviding, the hest of IT Pdiucatinn, Citihank nrnviding its lendincg expertise for consumer finance, and IFC providing the ability to structure and share the risk-we were able to produce a student ioan program of nearly US$100 million. The first step was to develop a student loan that matched the needs of the students. We developed a seven-year loan that covers 90 percent of the program costs of iGNIIT. It has a fixed rate of 16 percent, which is approximately as low as you can get in consumer finance III InlUdi, WILLI 11101L66C6 dLt daUUIIU J percerit anud urisecured consuner loans at 21 percent. We based the repayment on the student's earning capacity, and took a new approach to student finance where we decided that we were going to use the techniques of project finance. T'hat meant treating education as an 111Vi.31....l 1L LilaL I.asU Lto LULUi f . eiarnings as a VVay tL IIISJUi.i oui aFFroachi to education finance. 163 IFC and Its Role in Globalization During the first three years, when the student is still in school and not generating1r 111corr.e, weZ keptL LIIe pylllentL as Iow as possiUIe. Ih ICpaymentII then is about 1,000 rupees (or US$25) per month, which means that fam- ilies who are earning US$100 a month can afford the student loan. In the last four years the student makes equal monthly installments of about 4,000 rupees per month, which will enable him to repay the overall cost. Thesse 4,000 rupees correspond to 25 to AO percent of "he expected ea ings of the student, so we have based the loan structure on his future repayment abilities and future earning capacity. Under the program's structure, Citibank will be underwriting and servicing the student loans. The first level of losses will be grouped into what is called a junior tranche- so Citibank and NIIT will take the first losses jointly. The second level of losses, called the mezzanine tranche, will be covered Dy IFC. Anda Citibank will take tne tnird ievei of iosses, called the senior tranche. Instead of taking a traditional approach and sharing risk proportionately (as we have done in loan syndications, for instance), we have taken a sequential approach to risk sharing. That means the loss- es come first to the junior tranche, then to the mezzanine tranche, and th11e LU Lthe s1Ieior LtrIILIc. To size these different tranches we had to make some assumptions about how much we expected to lose on student loans. This was difficult to do because of the lack of historical data on student loans in India. We decided to base it on Citibank's approach to consumer finance, using a methodology that was approximately the same. Tn es_ __ ti ated_la that the losses on student loans would be about 7 to 8 percent of dis- bursements. We validated this through our due diligence, but also through Standard & Poor's risk assessment. As a result we were able to size the junior tranche at 11 percent. This is 1.5 tim.es the expected loss and is tlh-e rcis equivalent to equity. The second level of losses, which is taken by IFC, is the mezzanine tranche, sized at 10 percent. Because the mezzanine tranche benefits from the risk coverage of the junior tranche, which basically means that the expected losses are cov- ered 1.5 times before they reach the mezzanine tranche, we were able to get a risk assessment of BBB- by Standard & Poor's on this me77anine charge. Because of the junior and the mezzanine tranches, which togeth- er cover 2.5 times tne expected loss, we were able to get a risk equivalent of AA- for the senior tranche. 164 Sectionl VI Illnlovatio11s Through this structure we have transformed 80 percent of the pro- gram into a risk-free program. One direct benefit is that we were able to scale up the program firom one that was going to be US$4 million, accord- ing to Citibank's risk appetite initially, to a program tnat today is nearly US$100 million. The second direct benefit was that we were able to lower the cost to the student to 16 percent a year. This covers the cost of funds of 12 percent, administrative costs of 1.2 percent, annual losses of 1.3 per- cent, and an investor margin of 1.5 percent. If we had not been able to dif- LIIt1t tl1r 111 A3 uLFLWC11 t LIdL HUZ1 IU1 Li1lt )UIIIUI VI1V%LU, L1IC 111CL- zanine investor, and the senior investor we would not have been able to reach such a low level of pricing. We developed a pilot project that was launched in January 2000 by Citibank to see what sort of appetite there would be for this product, and the results today s.ow that it has been a huge success. in the areas where the student loan was provided 80 percent of the students took it up. Furthermore, from a social mobility standpoint we were able to achieve enormous success. Half of the students who took out the loans will be earning an income that is higher than that of their parents, while 30 per- cent of the students who took out this loan will be earning an income more than double what their parents are making today. Without the stu- dent loan program these students wouid not have had access to education finance and therefore would not have had access to the education provid- ed by NIIT. 165 PROGRAM OF MEETING I INTERNATIONAL FINANCE CORPORAT !ON PARTIC!PANIT MFFT!NG WASHINGTON, D.C. JUNE 6-7, 2001 International Finance Corporation (IFC) Headquarters 2121 Pennsylvania Avenue, N. W. Washington, D.C. 20433 Wednesday, June 6 9:00 a.m.-10:20 a.m. Opening Session: Welcome and Update on IFC Operations Mr. Peter L. Woicke, Executive Vice President. TFCG and Managing Director, Private Sector Development, World Bank Mr. Assaad JT Jabre, Vice President, Operations, IC Trends in IFC's Syndicated Loan Program Ms. Suellen Lambert Lazarus, Director, Syndications and International Securities- IFC 10:45 a..1:0p.. Basel Capital Accord 2: Implications for Lending to Emerging Markets Speakers: Mr. Jonathan L. Fiechter, Senior Deputy Comptroller for International and Economic Affairs, Office of the Comptroller of the Currency Mr. Frans Cornelissen, Senior Vice President, Head of Country Risk Management, ABN AMRO Bank Mr. Ernest Napier, Managing Director, Financial Services Group, Standard & Poor's Mr. Dirk Muller, Partner, Financial Services Consulting, Risk xManagernlent, nPM Moderator: Mr. J. Michael Swetve. Princinal Svndications Officer- Syndications and International Securities, IFC 166 Progr-a in of Meetin1g 12:00 p.m.-1:00 p.m. Investing inSustain2hilitv Speakers: Mr. Bart Jan Krouwel, Managing Director, Sustainability anA cocial Trmova-ion G-roup, RDab-obank NTeAerlanA Dr. Julie Fox Gorte, Senior Environment and Technology Analyst, The Caivert Group Mnodprator: AMr RBrnarid F 'Shoahan, Chipf Stratpgist O)nprationna Strategy Group, IFC 1:15 p.m.-2:45 p.m. Lunch Keynote Speaker: Mr. John T Olds, Special Advisor to the Chairman, DBS Bank, Singapore 3:00 p.m.-5:15 p.m. "Breakout Sessions" ,*Afn in mi A-nnlf n ni InfrastructureWorld, Inc. Bringing Efficiency, Speed, and Global Reachl to the project Ilevelopient anuu Findance rruoce SDeakers: Ms. Barbara Laflin Treat- Managing Director, InfrastructureWorld, Inc. Mr. Pedro Batalla, Managing Director, Darby Overseas Investments Ltd. Mr. Declan Duff, Director, Infrastructure Department, IFC Moderator: Mr. Matthew Bauer, Vice President, InfrastructureWorld, Inc. Proiects in Telecom: Where Will the Funding Come From? Speakers: Mr. Jan van Bilsen, Director, Syndicated Debt, Emerging Europe, Middle East and Africa, ABN AMRO Bank Mr. Scott Sutliff, Vice President of Telecom, Global Project and Structured Finance, Citigroup 167 IFC and Its Role in Globalization Dr. Robert Stuart, President and CEO, InDepth Financial Advisers, LLC Moderator: Mr. Mohsen Khalil, Director, Telecommunications & Internet Technologies Department, IFC investing in Education: NiiT Student Loan Program- A Case Study Speakers: Mr. C.N. Madhusudan, President-Strategic Alliances, 'KTTT'1t (T TO A \ T INIL 111lv U1), Inc6. Mr. Guy Ellena, Technical Manager, Health and Education Department, IFC Moderator: Mr. Nicholas Vickery, Investment Officer, Financial Markets, South Asia Department, IFC 4:15 npm.-5:15 p.m. Corporate Governance: Enhancing Enterprise Value Speakers: Mr. Peter C. Clapman, Senior Vice President and Chief Counsel, Investments, TIAA-CREF Mr. Peter H. Sullivan, Chairman and CEO, Lombard Investments, Inc. Mr. IVIIKe Luvrano, Senior Investment urficer, rinancial Iviarkets Advisory Department, IFC Moderator: Mr. Khaleel Ahmed, Principal Investment Officer, SJyndicationsand IIIIU tina Sckurities, IFC- The World Bank GrouD Risk Mitigation Instruments: PRG/MIGA/IFC Speakers: Mr. Peter Jones, Manager, Finance and Syndications, MIGA Mr. Dan Hoang, Financial Officer/Derivatives, Treasury Department, IFC Mr. Michel Wormser, Director, Project Finance and Guarantees Department, V'V'Uor'l U Bank Moderator: Ms. Suellen Lambert Lazarus, Director, Svndications and International Securities, IFC 168 Program of Meeting IFC's Focus on Electricity Distribution Speakers: Mr. Jesus Marcos, International Financing, Union Fenosa AMs. Sarah Shlusser, VriCe rDesidlent, AES n,arric Moderator: Mr. Francisco A. Tourreilles, Director, Power Department, IFC 6:15 p.m.-7:15 p.m. Decep-on for Particpants an,d TJ- Cmo ,, i~lk 1~9jJ& u i JUl 54 & 4a 5 " 1 7 Siul ITVI(41Ll~1 1iIu 5lt Host: Mr. Peter L. Woicke, Executive Vice President, IFC, and Managing Director, Private Sector Development, World Bank 7:15 p.m. zmzYiutc Spet Kci Mrvii. Juar,t, D,. vvurourtirLrL, PresiCdnt, The World Bank Group Followed by: Dinner,ror Parnrticipants and IFC Senior A'Managemen1t 169 IFC and Its Role in Globalization Thursday, June 7 9:00 a.m.- 9:45 a.m. X_O Iafitn t thl:oug Cr-- Speaker: Dr. Miguel A. Kiguel, President, Banco Hipotecario S.A.; former Chief Advisor to the Minister of tne Economy and Undersecretary of Finance, Argentina, and Deputy General Manager for Economics and Finance at the Central Bank of Argentina Moderator: Mr. Cesare Calari, Director, Global Financial Markets Department, iFC 9:45 a.m.-10:45 a.m. When Things Go Wrong: IFC's Multifaceted Role in Restructurings A. 0. Volga-A Case Study Speakers: Ms. Anke Avderung, Director, Global Debt Origination, Dresdnpr K!pinwort W. sPrstein Mr. G. K. van der Mandele, Chief Special Operations Officer, IFC lvAlr. IrI" is Hamltoi,t, Senior Adlvisor, Syndictations,' IFC% Mr. Andres Hernandorena, Chief Counsel, Legal Department, IFC Moderator: Mr. Jyrki I. Koskelo, Director, Special Operations, IFC 11:00 a.m.-11:30 a.m. Jlr% s JrUrL lUll1%CbLtN lIlU lICFIIUb Speaker: Ms. Farida Khambata, Vice President, Portfolio and Risk Management, IFC Moderaator:. Msli. VILvry lizabeth U ard, Man, B-Loan Management Division, IFC 11:30 a.m.-12:00 p.m. B-Loan Website: Proposal for a New Market Place for Secondary Sales Presenters: Mr. Andy McCartney, Managing Director, eHatchery LLC Mr. James Smouse, Project Manager, B-Loan Website, IFC Mod.4 at.or,: Ms. SuellerTa, La,bert Lazarus, DirectorSy, Syndicatio aid International Securities, IFC 170 Program of Meeting 12:00 p.m.-12:40 p.m. Pers~pective on (Z1,uliztinn Closing Speaker: Mr. Thomas L. Friedman, The New York Times foreign affidirs colurLii-istI ; andU authlo,- ofi Thie Lexus and the Olive Tree and From Beirut to Jerusalem 1:00 p.m.-2:30 p.m. Lunch Keynote Speaker: Mr. Horst KohIler, Managing Director, International Monetary Fund 2:45 p.m.-5:00 p.m. Se.. nor. I Upcoming Transactions, RceDrnt Ret?ciurutuurings and New Initiatives 2:45 p.m.-3:45 p.m. Tuntex Petrochemicals: Restructuring Case Study in Tlhailand Spea-l lers: , ra R, Wm uRse,,s, Senior M-anage, Global -o and Project Finance, Fortis Bank Mr. Eric Jourdanet, Senior Investment Officer, Oil, Gas, and C.hPmien1' Dpnnrtment TFC. Ms. Alma Ourazalinova, Participations Officer, Syndications and International Securities, IFC Moderator: Mr. Rashad-Rudolf Kaldany, Director, Oil, Gas, and Chemicals Department, IFC Investing in Power in Central America Speakers: Ms. Sarah Slusser, Vice-President, AES Americas Mr. Haran Sivam, Senior Investment Officer, Power Department, IFC Moderator: Ms. Stefania Berla, Principal Syndications Officer, Syndications and International Securities, IFC Banorte: Financing Long Term Leases in Mexico Speakers:r A,r' Antnion Pmilion rti7 Conhc Dirpctor GPnPra!, Corporate Bank, Banorte 171 IFC and Its Role in Globalization Ms. Debra Perry, Financial Specialist, Financial Markets-Latin America, IFC Moderator: Ms. Toyin Adeniji, Syndications Officer, Syndications and International Securities, IFC 4:00 p.m.-5:00 p.m. Speakers: MrBr GV- D. Brauo Sen., \Tic,- President, Glb-1-1 ebt, Dresdner Kleinwort Benson Mr. Dong Liu, Investment Officer, Infrastructure Department, IFC Mr. Fran,ois J. Grossas, Principal Syndications Officer, Syndications and International Securities, IFC Investing in Environmental Projects Speakers: Dr. James D. Westfield, Managing Consultant, PA Consulting Group Mr. Brooks Browne, President, Environmental Enterprises Assistance Fund Moderator: Mr. Louis Boorstin, Manager, Environmental Markets Group, IFC Kronospan: Romania and IFC's Regional Strategy Speakers: Mr. Christopher Goss, Principal Investment Officer, Mr. Georgi Petrov, Senior Investment Officer, and Mr. Zahid Yousaf, Investment Officer, Southern Europe and Central Asia Department, IFC Moderator: Mr. J. Michael Swetye, Principal Syndications Officer, Syndications and International Securities, IFC 172 List of Attendees 200 1 fRlTI:C:flAN l MILAIETI IIl June 6-7, 2001 Company Name Title ABB Structured Finance Mr Glen Matsumoto Executive Vice President ABN AMRO Bank Mr. David Cole Executive Vice Pres;dent ABN AMRO Bank Mr Frans Cornelissen Senior Vice President & Head of Country Risk Management ABN AMRO Bank Mr Jan van Bilsen Director, Syndicated Debt ABN AMRD Bank Mr. John Neblo SeniorVice President ABN AMRO Bank Mr. Maarten Klessens Managing Director ABN AMRD Bank Mr Ragheed Shanti Head of Fixed Income Origination ABN AMRD Bank Ms. Jill Chen Vice President ABN AMRO Bank Mr. Juan Martin Vice President and Director ABN AMRD Bank Mr. Rui Silva Group Vice President and Director Alliance Capital Management Corporation Mr. Joel Serebransky Senior Vice President Allstate Insurance Company Mr. Ronald Mendel Senior Portfolio Manager ANZ Investment Bank Mr. Chris J. Vermont Global Head Arab Banking Corporation Mr. Lamine Djilani Assistant General Manager Banca Nazionale del Lavoro Mr. Marino Cucca Deputy General IMIoanager, Head of Corporate & Structured Finance 173 IFC and Its Role in Globalization Banca Nazionale del Lavoro Mr. Robert Lisi Vice President Banco Atlantico, S A Mr. Jose Miguel Arinita Commarcial Officer Banco Espirito Santo Ms. Crnstina Ferreira V cr Prpqident Banco Santander Central Hispano Mr. Jose Yepez Vice President Banco Santander Central Hispano Mr. Manuel Bramao Senior Vice President and Head Banco Santander Central Hispano Ms. Gema Sacristan Assistant Vice President Banco Santander Central Hispano Mr. Mark Tristant Vice President (Investment Securities Inc.) BNESrTO Mr. Fernando Mal}jilos DirecorN BANESTO Mr. Javier Rodriguez Head BANESTO Mr. Luis Basagoiti Executive Vice President and Gener a! Manager Bank Auti AG.. ._._ ino Bleie I_ Dla na e.-..ea 1A./ Udl:ll MA UOII d MU IVII. IIIyU UIGIII iVOlOli/ I OWQ of the Syndications Team Bank of America Ms. Audrey Zuck Vice President Bank of America Securities LLC Ms. Anne Predieri Managing Director Bank of Tokyo-Mitsubishi, Ltd Mr Atsumasa Tochisako Chief Representative Bank of Tokyo-Mitsubishi, Ltd. Mr. Hiroshi Azuma Vice President Bank of Tokyo-Mitsubishi, Ltd Mr. Michihiro Enomoto Vice President Bank of Tokyo-Mitsubishi, Ltd Mr. Shinichi Hongo SVP & Manager Bankgesellschaft Berlin Mr Herc van Wyk Director Banque et Caisse d'Epargne do l'Etat Luxembourg Mr. Guy Seyler Senior Vice President & Head Banque Generale du Luxembourg Mr Anthony Smith-Meyer Head of Structured Finance Banque Generale du Luxembourg Mr Michele Liebermann Credit Manager Barclays Capital Mr Arturo Girona Director Barclays CapitalMr onathan.delaP _ A s i Director 174 List of Attenbdees Bayerische Landesbank Girozentrale Mr. Dietmar Rieg Vice President & Manager BBVA Mr. Erich Michel Vice President BBVA Mi Marco Ach6n Vice President BLB International Co. Mi. Brieuc Le Bigre President BNP Paribas Mr William El Karak Project Manager BNP Paribas Ms Agnes Michel Head of Multilaterals and Debt Conversion Caisse Nationale des Caisses d'EDarane Mr. Yves Kodderitzsche Director Caixa Geral de Depositos Mr Dale Prusinowski General Manager Cala Madrid Ms. Ana Rios Manager, International Financial Institutions Caja Madrid Ms Maria Arenal Bello Manager, International Friairicial Institutions Investment Banking Cala Madrid Ms. Soledad Romero Head CDC IXIS (Caisse des Depots et Consignations) Ms. Celine Scemama Vice President CIC Credit industriel et Commercial Mr Lionel Waiter Head of Group CIC Credit Industriel et Commercial Mr. Mark Palin Vice President Citibank Ms Selma Storm Manager Citibank and Salomon Smith Barney Mr. John Gilldand Mlnennn- Director C;it;b.nk and Salomon Smith Barney Mr. Tony Boon Managing Director Crutgroup lnvestments Inc Ms. Denise Duffee Vice President Citigroup Investments Inc. Ms Pamela Westmoreland Vice President Credit Agricole Indosuez Mr Henri de Courtivron Executive Director Credit Agricole lndosuez Mr. Jean-Francois Head of Project Grandchamp des Raux Finance Credit Agricole indosuez Mr. Patrick Blanchard Global Head Credrit Aricole lndosslez Mr Patrick de Chocoueuse Managing Director Supranational ,rrstitutioris 175 IFC and Its Role in Globalization Credit Lyonnais Mr. Laurent Garaffini Head of Multisourced Export Finance & Multilateral Cofinancing Credit Lyonnais Ms. Karine Legeret Head of Multilateral Cofinancing- DFS/FI Credit Suisse First Boston Corporation Mr Takashi Miyake Director Dai-lchi Kangyo Bank. Ltd. Mr. Christopher O'Gorman Assistant General Manager/Head of Project Finance Dai-ichi Kangyo Bank, Ltd Mr. Katsuya Noto Vice Presideni Dai-lchi Kangyo Bank, Ltd. Mr. Tohru Tonoike General Mianager Dai-lchi Kangyo Bank, Ltd. Mr. Tsunehisa Suita Deputy General Manager Darby Overseas Investments, Ltd. Mr. Robert Graffam Managing Director DEG - German Investment and Development Company Mr. Rolf Grunwald First Vice President Delphos International Mr William Delphos Managing Uirector Den Norske Bank Mr Erik Hammer Senior Vice President & Head Deutsche Bank Dr Dagmar Linder Relationship Manager Deutsche VerkehrsBank AG Dr Christoph Tomas Vice President DEXIA Mr Tm Ononiwu Vice President DEXIA Ms Charlotte Lavit d'Hautefort Vice President DEiANVorld Busmess Inc Mr Philippe Nouvel Senior Adviser Dresdner Bank Lateinamerika AG Mr Rolf Tessmer Manager Dresdner Bank Lateinamerika AG Ms Stefanie Kuehl Assistant Manager Dresdner Bank Luxembourg S.A Mr Peter Wanken Managing Director/Deputy Head Syndications Dresdner Kiemnwort Benson Dr. Luc Griliet Head Project Finance 176 List of Attenidees Dresdner Kleinwort Benson Mr Jon Boles Regional Head Embassy of Canada Mr Stephane Charbonneau Director Embassy of France Mr. Serge Couvreur Economic & Commercial Counsellor Erste Bank Mr Johann Breit Vice President European Bank for Reconstruction Mr. Lorenz Jorgensen Director, Head and DevelonmentIFRRDR of Syndications First Union Bank Ms. Nancy Tuomey Director Fitch Mr. Gregory Kabance Senior Director Fitch Ms. Sheila Robinson Senior Director FMD Mr. Klaas Bleeker Head of Syndications FMO Ms. Lidwien Schils Manager FMO Ms. Michele Kiaassens Attorney Fortis Bank Mr. Pierre Ceyssens Manager Fortis Bank Ms Vera Reusens Senior Manager, Global Exporn and Project Finance Fuji Bank, Ltd. Mr. Hitoshi Seiima Senior Vice President & DGM Ful.i Bank, LUd Mr. Tsulkasa Takasawa Vice President & Senior Team Leader Fuji Bank, Ltd. Mr Yasuji Ikawa General Manager Fuji Bank, Ltd. Ms Kanae lomori Vice President HELADOA - Lar,desbank Hessen-Thuringfn Mr. Ulrich Laehler Seior V;co President & Head HSBC Securities (USA) Inc. Mr. Jeffrey Diehl Managing Director HSBC Securities (USA) Inc. Ms. Christine Drury HVB Group Dr. Martin Wueruth DUirector IFPT Management Inc. Mr. David Creighton Managing Par.ner IFPT Management Inc. Mr. Oton Tony Iskarpatyoti Vice President IFU (The Industrialization Fund for Developing Countries) Mr. Jorgen Dan Jensen Deputy Managing Director 177 IFC and Its Role in Globalization IFU (The Industrialization Fund for Developing Countries) Mr. Jose Ruisanchez Senior Advisor IKB Deutsche Industriebank AG Dr. Frank Schaum Head of Structured Finance IKB Deutsche Industriebank AG Mr. Sy Roner IKB Washington Representative Industrial Bank of Japan, Ltd. Mr Koichi Hasegawa Senior Vice President Industrial Bank of Japan, Ltd. Mr. Eric Richstein Consultant Industrial Bank of Japan, Ltd. Mr Toshihiko Matsumoto Senior Vice President/ Division Head InfrastructureWorld com Mr Matthew Bauer Vice President iNG Rarinns Mr Rauil Vidal Vice President ING Bank Ms. Elizabeth Wen Assistant Dirpctor/Head, Transactions & Risk Mitigation ING Barings Ms. Michele Mangan Director Institute of lrtornnonni1 Finanrc In Ms.Joan KWrrigan Pol1cy Advisor Institute of International Finance, Inc. Ms. Sabine Miltner Deputy Director Inter-American Development Bank Mr. Kevin Corrigan Head, SyndJcations Japan Bank for International Cooperation Mr. Katsuhiko Okazaki Senior Representat,ve Japan Bank for Internatiorial Cooperation Mr. Takashi Nakamura Senior Representative Japan Bank for International Cooperation Mr. Yo Kikuchi Representative JP Morgan Chase Mr. Fred Schriever Ill Associate JP Morgan Chase Mr Sergio Saichin Vice President JP Morgan Chase Ms Leigh Paschall Vice President JP Morgan Chase Ms Marguerite Gill Vice President Kreditanstaltfur Wiederaufbau Mr. Holger Apel Vice President Landesbank Rheinland-Pfalz Dr. Herbert Geist Vice President Landesbank Schieswig-Hoistein Mr Kiaus-Voiker Lenk Senior vice President Lazard Freres and Co. LLC Mr ivan Nedds Vice President Lyonnaise de Banque Mr Spiros Petrou Head of Syndicatons Mediocredito Centrale Mr Alessandro Castellano Managing Director 178 List of Attedtiees MIGA (Multilateral Investment Guarantee Agency) Mr Peter Jones Manager MIGA (Multilateral Investment Guarantee Agency) Mr Roger Pruneau Vice President Mitsubishi International Corporation Mr Yasuyuhi Sugiura General Manager Mitsui & Co. (U S.A 1, Inc. Mr Bill Bell International Prolect Manager Moody's Investors Service Ms Maria Muller Assistant Vice President, Analyst Moody's Investors Service Ms. Susan Knapp Vice President, Senior Credit Officer Natexis Banques Populaires Mr. Franck Gault Vice President Natexis Banques Populaires Mr Marc Forissier Head of Multilateral in stituti,ons New York Life International Mr. Jaljit Kumar Associate Nord/LB Norddeutsche Landesbank Girozentrale Mr Bruno Mejean Senior Vice President Nordea Mr. Chip Carstensen Vice President, Structured Finance Nordea Mr. Henrik Brink Vice President Orrick, Herrington & Sutcliffe LLP Ms. Marie-Anne Birken Partner Project Finance internmational Ms Nicole Ge!inas Latin American Editor PROPARCO Mr. Laurent Demey Senior Investment Officer PROPARCO Ms. Nathalie Mignon-Leboucher Head PROP-ARCO Ms. Stephanie Leydier Investment Officer Provident Invrestment Man3rJemrent, LLC Ms. Rr gma Kano Senior Investment Officer Prudential Capital Group Mr David Nguyen Associate IFRabobank International IMI. inge Skjn,Iju, UeirjsenOIVU Rabobank International Mr. Mark Northway Executive Director Rabobank International Mr. Shafik Gabr Senior Vice President 179 IFC and Its Role in Globalization RZB Austria Mr. Heinz Hoedl Executive Vice President & Head RZB Finance LLC Mr. F Dieter Beintrexler President RZB Finance LLC Mr Josef Thullner Vice President RZB Finance iLC Ms. Astrid Wilke Vice Pres:dent Sampo Bank Mr Jukka Hakkila Senior Vice President Sanpaolo IMI Bank Mr. Alessandro Ermolli Head Sanpaolo IMI Bank Ms. Ilana Carnevali Account Officer Sanwa Bank Mr. Eiji Nakatani Vice President Sanwa International pic Mr Charles Gundy Senior Vice President Sanwa International plc Mr. Katsuya Tsuboi Senior Vice President Scotiabank Ms Teresa Lee Senior Manager Societe Generale Mr. Laurent Chabot Director Societe Generale Ms. Maria Rosa Garcia Otero Director Sovereign Risk Insurance Ltd Mr Price Lowenstein President & Chief Executive Officer Sovereign Risk Insurance Ltd Ms. Nila Davda Vice President and Senior Underwriting Off.cer Standard & Poor's Mr Larry Hays Director, Sovereign Ratings Standard & Poor's Ms Rosario Buendia Managing Director Standard Chartered Bank Mr. Gordon Hough Senior Vice President Standard Chart.ered Bank Mr. ManueA Arava10 Head Standard Chartered Bank Mr Raghunandan Menon Senior Vice President Head of Network Banking & Structured Trade Standard Chartered Bank Mr Vibhuti Sharma Vice President State Bank of India Mr Om Bhatt Representative Sumitomo Mitsui Banking Corporation (SMBC) Mr. William Ginn Joint General Manager 180 List of Attendees Sumitomo Mitsui Banking Corporation (SMBC) Mr. David Gardner Head Sumitomo Mitsui Banking Corporation ISMBC) Mr Yoshio Ogino Vice President Swedbank Mr Per-Olof Uppeke Vice President, Project Manager Taylor-DeJongh. Inc Mr. Frank Langhammer Executive Vice President Tavlor-Dedonnh. Inc. Mr. Richard Parry Executive Vice President TIAA - CREF Ms. Niamh Fitzgerald Managing Director Trannamerica L easina Inc. Mr. Michael Cunningham Vice President Transamerica Leasing Inc. Ms. Lori Kielty Director of Marketing Vereins- und Westbank AG Mr. Rudiger Jester Vice President, International Division WestLB Dr Manfred Knoll Managing Director, Head of Structured Flnance WestLB Mr. Foster Deibert Vice President WestLB Ms. Carla Jakoby Regional Head Zurich Emorging Markets olnuatinsc (ZEMS) Mr Daniel Rinrdan Executive Vice President and Managing Director 181 MJeannetteMarie Smith 0O803 ISN !!7-301 VVWASHINGTON nD INTERNATIOXAL FixnCE COoRATION| AXmber f,h, Mbt Rani GC.,, ymZ ~fl t f auaJ 0 K'