Financial close (FC) is a lender’s and an infrastructure project’s moment of truth. In the nanosecond that it takes for millions of dollars to move from lender to borrower, the exercise takes on an entirely new feel. Here, the road to financial close and some of the challenges unique to development finance organisations are unpacked.
By Roland Janssens, Director at Ninety One, which manages the Emerging Africa Infrastructure Fund
In reaching financial close, what was once just a thought, then an idea, then a vision and finally a signed finance deal is now the economic means to become a tangible material thing of metal, glass, concrete, engineering, output and business.
Human beings of multiple skills will craft from often barren land a new power station, or port, digital hub or affordable homes complex. For the Private Infrastructure Development Group’s (PIDG) Emerging Africa Infrastructure Fund (EAIF), which is managed by Ninety One, financial close (FC) is the moment of empowerment that delivers the capital that can change lives.
Reaching FC (also known as ‘first disbursement’) can be a complex exercise. A large number of facts and documents, known as ‘conditions precedent’, to first disbursement or financial close, have to be ‘checked off’. This is a significant administrative, legal and contractual process. In addition, the elements that make up a project are rarely static.
Much can change between signing an agreement to lend to an infrastructure project and getting to FC. This is a challenge to all lenders of big ticket debt and a particular challenge to lenders like EAIF and PIDG, which have to factor in a range of social, economic and environmental and other considerations, in addition to those common to lending institutions everywhere.
Before money moves from lender to borrower an intricate process of validation is undertaken. Questions need to be asked and answered covering matters of fundamental trust between borrower and lender:
• Has the sponsor’s management team the right range and depth of experience?
• If there are new equity investors, who are they and are they fit and proper people?
• Is all the required insurance cover in place? [Ed: see pages 68 & 69 for more on Insurance]
• Is the technology proven and are appropriate O&M arrangements in place?
• Have there been material changes to the local energy market or to energy regulation?
• Are all issues of land ownership or population resettlement resolved?
• Are all the conditions of the concession and (in the case of a power project) the power purchase agreement met?
Literally hundreds of items will have been checked before the signing of loan documentation during the due diligence progress. Another re-check is normally needed and occurs at the time of financial close.
The health and safety of construction workers, permanent staff and nearby communities are in the premier league of matters that have to be satisfied. Environmental and Social Governance (ESG) is now as elemental to loan evaluations and approval as the quality and experience of the management teams applying for funds.
For instance, at the EAIF, projects are often in fragile states (some 65% of the fund’s commitments were in countries classified by the OECD as so-called DAC 1 and ll countries in 2019). Thus achieving financial close can mean being reassured that a terrorist attack is unlikely, or the risk from banditry when moving people and equipment, or local management of public health.
Indeed, a security plan may form part of the various studies that will have to be satisfactorily concluded and implemented as part of a project in such cases. Sometimes it can be as fundamentally simple as checking the ability of local public authorities to keep roads open. Health, safety and security are always given a high priority.
Due diligence begins when the borrower and lender reach agreement, which is effectively the start of a route map to final FC. In April, the fund began due diligence on the 15MW run of river Kaptis hydropower project in Western Kenya. The project sponsor, Tembo Power, appointed EAIF joint arranger with Finnfund. The objective is to raise $30 million of debt. Tembo Power, together with its partners Metier and WK Power, will inject some $14 million in equity. Tembo Power aims to have the new plant operational in late 2022. The pressure is on to complete FC by the end of 2020, if construction is to begin on time to meet the timetable.
Core objectives and culture
A long list of every requirement of FC would not be greatly informative. What would be helpful, in my opinion, is to look first at the rationale as an economic development entity. It is this that informs core objectives, legal behaviour and culture. For EAIF and PIDG, due diligence – the essential precursor to eventual financial close – starts at a very early stage.
The fund begins by assessing whether a project makes economic sense for the country in question and for the sector involved. The aim is to first be satisfied that projects will deliver a sustainable development impact.
As an example, our approach is informed and influenced by PIDG’s four key strategic themes:
• Developments that benefit a large number of people.
• Projects that are replicable, either in financial structure or technology and including seeking to reduce transaction costs.
• Impact and affordability – in other words, trying to get more bang for less buck.
• Transformative – building capacity, strengthening local capital markets, empowering women
Energy without borders
Last year, EAIF announced a $27 million loan to the Kikagati Power Company (KPC), which is building a 14MW run-of-river hydropower plant on the Kangera River in Uganda. The river marks the boundary between Uganda and Tanzania. It would be the tenth renewable energy project EAIF had supported in Uganda, but the first involving two DAC nations. Both are rated in the ‘least developed’ category by the OECD.
The Kikagati plant is being built almost entirely in Uganda, with a small portion of the civil engineering in Tanzania. Generation itself will take place in Uganda. 100% of its output will be bought by Uganda’s energy utility, which will sell on half of that to Tanzania. On approaching FC, this was an important aspect to be comfortable with and included checking the risk allocation in the concession agreement and whether it was in line with market practice.
Nachtigal in Cameroon
Some infrastructure construction projects pose greater potential risk to the welfare of those involved. Building hydropower plants is one of those.
Given that excavation and construction quickly follow from disbursement, we have to be wholly satisfied that ESG management is of the standard expected and that the required human expertise and financial resources have been allocated by the sponsoring company.
In December 2018, FC was achieved on the €1.26 billion, 420MW Nachtigal hydro project in Cameroon. EAIF loaned €50 million. Here, the lead arranger was the International Finance Corporation (IFC). The €916 million debt package involved 16 development finance institutions, development banks, and local and regional private sector banks.
Smarter processes and smarter documentation
Adopting a common lexicon and common phrasing and working to remove any possible ambiguities in terminology and legal meaning speeds up transactions and saves time and money. As such, to accelerate FC, the fund took an important step in March 2020 with the signing of a Master Cooperation Agreement (MCA) with the IFC.
The MCA will come into operation when the IFC is the mandated lead arranger of the debt package for an infrastructure project involving it and the EAIF. The MCA sets out a range of mutually agreed processes on reaching contractual agreement and allocation of responsibilities on each project.
Taking this step not only helps streamline cooperation with IFC but it also helps widen and deepen the new business pipeline. It will accelerate the time it takes to get good projects financed and deliver efficiencies in human resources and legal and administrative costs. EAIF is the first third party fund to sign such an MCA with the IFC. Other MCA counterparties to IFC are largely big development finance organisations.
Finance providers and legal and advisory businesses that are demonstrably smarter at managing processes while being palpably expert in their field will surely have a competitive advantage. If project sponsors inject similar levels of resources into funding applications, due diligence, negotiation and financial close, great strides can be made in bringing Africa the life-transforming infrastructure it will need for many decades to come. ESI