Infrastructure finance in Iraq: Mitigating risks and protecting investors

Anders JönssonGlobal Relations SecretariatOECDDubai, 27-28 January 2014

Breaking the vicious circle: excessive private sector profits risk entrenching excessive regulation.

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The Government of Iraq could gradually involve the private sector in infrastructure financing and implementation.

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Investors in Iraq face a number of risks; this assessment focuses on regulatory and, in part, political risks.

Cost of capital

Project risk

Infrastructure risk

Economic risk

Legal/Regulatory risk

Political riskReversal of government policies, non-renewal or revocation of licenses, risk of expropriation, risk of conflict, spillover effects from problems in the region, sovereign risk (a government does not meet its obligations).

Vague regulations and regulatory discretion – licensing, tax, expatriate labour, transfer risk (capital and profit repatriation), approvals for different activities, tariffs and trade barriers, incentive renewal, regulatory delays.

Potential for detrimental changes in the economic environment: credit, inflation, exchange rate fluctuations, financing, growth, FDI trends.

Transportation, communications networks, utilities, but also soft infrastructure: availability of skilled labour, suppliers, service providers.

Risks associated with the project: sector risk, market risk, demand risks, cost of market-discovery, finding suppliers, finding financing.

At the moment, the private sector still perceive inordinate risks in Iraq.

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Risk perceptions vary from sector to sector.

Companies involved in oil and gas extraction are used to high-risk environments

Some project companies are willing to engage in high-risk environments, but only with commensurate returns.

Sales and marketing activities do not require risking substantial amounts of capital.

Financial services and telecommunications tend to respond to high consumer demands, even in risky environments.

Employment intensive manufacturers tend to expect stability before engaging capital.

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Investment Protection

• International investment treaties do not apply in Iraq Protection of investments against direct or indirect expropriation Fair and equitable treatment to investors Possibility for the investor to bring international arbitration proceedings against

the host State

• There is no mechanism for dispute resolution in Iraq Local courts in Iraq have considerable discretion to revoke arbitral awards

• Foreign arbitral awards cannot be enforced in Iraq The Code of Civil Procedures does not contain provisions relating to foreign awards The New York Convention rules on enforcement of foreign arbitral awards do not

apply in Iraq Local courts in Iraq have considerable discretion in revoking arbitral awards

granted under the Riyadh Convention

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The GoI can take concrete steps to mitigate these risks.

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Sovereign guarantees is a useful tool to defray excessive risks temporarily.

• Variety of ways for a government to issue sovereign guarantees, But it comes down to the market’s acceptance that the guarantee carries the full faith and

credit of the country. Very often, even when administered by other ministries, there needs to be clear documentation of the MOF or central bank commitment of the full faith and credit of the government.

• In the context of some governments, especially in a post conflict situation, there is concern about that commitment, even if coming from the MOF. Options: pre-funded off shore escrow account structure is often proposed, because it

eliminates (or greatly reduces) the sovereign risk element by shifting the operational risk of the fund to a creditworthy jurisdiction. Of course the legal structure of the account is very important to maximise creditors’ comfort with who determines when payment will be made.

• Fundamental legal authority of government to issue them• With a government structured on the separation of powers model, the executive implements,

while the legislature authorizes (and may also appropriate) the funding. • Must have political will

In Iraq: role of the executive branch and the Council of Representatives

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Successfully involving the private sector in infrastructure means minimizing the risk:

• BiTs provide for investor protection provisions, including dispute settlement mechanism.

• ICSID assures investors that disputes would be resolved according to transparent and predictable rules.

• The New York Convention (144 members) ensures that arbitral awards are recognised and enforced.

• Many MENA countries are already signatories, such as:

ICSID: Algeria, Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Oman, Saudi-Arabia, Syria,Tunisia, UAE, Yemen

NYC: Algeria, Bahrain, Djibouti, Egypt, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi-Arabia, Syria, Tunisia

III Risk Reduction: BiTs, ICSID and the New York Convention

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• The Convention on the Recognition and Enforcement of Arbitral Awards is also known as the New York Convention.

• Signed 10 June, 1958, in New York. • Currently 144 member countries.• The Convention authorizes the arbitration tribunal to decide the dispute

and issue a binding award. The Convention applies to:• The recognition and enforcement of arbitral awards made in the territory

of a state other than the state where the recognition and enforcement of such awards are sought.

• Arbitral awards not considered as domestic awards in the state where their recognition is sought.

• Arbitration agreements, i.e., agreements between parties to submit their dispute to arbitration.

The New York Convention guarantees that arbitral awards are enforced.

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Investor-State Dispute Settlement

PPPs could be used to transfer risk gradually to the private sector.

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Difficult in Iraq due to prohibition of foreign land ownership (Art 23 in the Constitution)

For governments:• PPP failure early-on – generates fiscal and other costs, including a

demonstration effect deterring other investors• Budget risks – requires very careful coordination • Select the right partner (right expertise, capacity, commitment and

access to finance etc)• Selecting the appropriate form of PPP (BOOT, lease, management

contract etc)• Managing public expectations before, during and after!For the private sector:• Determining risks and identifying the optimal risk allocation• Long term commitment and dealing with uncertainty

PPPs are not a panacea – they carry substantial risks.

Investment

Government Intervention

Fee For Service

Build OperateTransfer

Long Term Lease Performance

Based Maintenance Contract

PMC

DesignBuild

BuildOwnOperate

DesignBidBuild

DesignBuild FinanceOperateMaintain

Privatisation

DesignBuild OperateMaintain

Outsourcing

*This is not an exhaustive list of Delivery Models but rather is a sample for illustration purposes only.

BuildTransferOperate

There is a plethora of different delivery models available.

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PPPS are typically structurally complex.

•Typical PPP Structure

Project CompanyLenders Shareholders

Operator Contractor

Contractor’s Parent Company Bond Issuer

AuthorityStep-in Agreement

Concession Agreement

Concession Agreement

OperatingAgreement

Performance Bond

Parent Company Guarantee

Warranty/Step-in Agreement

The institutional capacities needed to implement PPPs successfully are manifold.

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The OECD Principles on private sector participation in infrastructure provides guidance.

Rationale:

• A number of PPP projects in the past have failed Often the main cause was not project specific, but short-comings in

investment environments, capacities and attitudes The time is ripe for a fresh push to mobilise private investment

• The 2007 OECD Principles for Private Sector Participation in Infrastructure give advice on how to avoid the mistakes of the past Synthesising a large body of analysis and case examples Offering recommendations of best practices, agreed among a variety of

experts and policy communities

Overview:

Annotated recommendations to host country authorities focusing on five topic areas:

• Deciding on public or private provision of infrastructure services

• Enhancing the enabling institutional environment

• Goals, strategies and capacities at all levels

• Making the public-private co-operation work

• Encouraging responsible business conduct

II 2007 OECD Principles for Private Sector Participation in Infrastructure

• Principle 3: The balance of responsibilities between the private and public side should be

considered in light of the public interest and reflect the amount of the project risk that the

public authorities expect their private partners to assume in light of the model chosen for

international investors’ involvement in the project.

• Principle 11: Strategies for private investor participation in infrastructure need to be

understood, and objectives shared, throughout all levels of government and in all relevant

parts of the public administration.

• Principle 13: Public authorities should communicate clearly the objectives of their

infrastructure policies.

• Principle 14: There should be full disclosure of all project-relevant information between

public authorities and the private investors, including the state of pre-existing infrastructure,

performance standards and penalties in the case of non-compliance.

• Principle 15: The awarding of infrastructure contracts or concessions should be designed

to guarantee procedural fairness, non-discrimination and transparency.

• Principle 19: Dispute resolution mechanisms should be in place through which disputes

arising at any point in the lifetime of an infrastructure project can be handled in a timely and

impartial manner.

II 2007 OECD Principles for Private Sector Participation in Infrastructure

Several distinct, independent institutions needed

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Summary

• Break the vicious circle: involve the private sector gradually, defraying risks where it makes sense.

• Understand risk perception and mitigate risk in various ways.• Get public procurement right: ensure transparency. • Pilot PPP‘s, but use it with caution and build capacity slowly. • Use OECD Principles to ensure value for money. • Create the correct institutional framework.

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