COURSE CODE : BA 311

TITLE : International Business and Trade

TARGET POPULATION : All 3rd year BSBA Marketing Management Students
COURSE FACILATATOR : Ms. Joanne G. Saab

WEEK 15

Chapter 7
Lesson 1: Structured Trade Finance
1.1 Project Finance and joint venture
1.2 Multilateral development banks

LEARNING OBJECTIVES:
When you have completed this module, you should be able to:
1. Understand the importance of Project Finance and joint venture
2. To appreciate the purpose and nature of Multilateral development banks

Lesson 1: Project Finance

Project finance in its original meaning is normally related to larger individual private
or public sector projects, for example factories, power plants, larger construction or
infrastructure projects, sometimes even of national interest in the buyer’s country.
They are generally based to a high degree on the revenues of the project itself,
mostly secured on its assets and less on the creditworthiness of the buyer, as this
party is frequently only a single-purpose company or a partnership with limited
equity.

From experience, such projects can take years until a signed contract and an
effective loan agreement stage are reached, sometimes because of internal political
or local controversy as to its real or alleged social, economic or environmental
consequences. Such projects also incur more pre-contract costs than ordinary
export contracts, not only because of their length but also through feasibility studies
and appraisals, legal and technical costs and necessary approvals by a number of
local authorities

In many of these projects, finance is the key question, or rather how to arrange and
structure the necessary collateral for such finance. The World Bank, its subsidiary
the
International Finance Corporation (IFC) and some of the regional development
banks are often involved in larger projects of national interest, together with
international banks and the national ECAs from the supplier nations. But the final
solution for the project finance will inevitably be as complex and tailor-made as the
project itself.

Owing to the cost and work involved, such projects usually have a high minimum
support value, but the credit periods may be up to 15–20 years with flexible loan
structures and amortization periods reflecting the structure of the project. Other
requirements are mostly that support, at least from the commercial banks, should be
given as senior debt and risk sharing on an equal basis with other lenders.

Joint Ventures

In many developing countries and/or emerging market countries, the seller could be
asked to participate as co-owner of the project, or even be required to do so in order
to secure the contract. The buyer may have many reasons for such a request and

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local authorities may even have it as a requirement of the successful bidder before
giving import licenses or currency approvals. In other cases, it could even be
advantageous for the seller and their future business prospects with a particular
buyer or with the long-term goal of establishing a permanent base and a competitive
advantage in the country or region.

The local partner may hope that a joint venture will not only offer capital or equity
advantages, but also the benefits of technical knowledge and management along
with the international marketing expertise that an international partner can provide.
The authorities can also look for potential advantages in the form of a widened
infrastructure, additional exports and the creation of new jobs.

The establishment of a joint venture often requires significant management

resources from the seller and it may take years before the advantages can be seen;
before then, many legal, cultural and management differences may have to be
solved. On the other hand, many host nations clearly see the advantages of joint
ventures and can back them in many ways through local support or market benefits.
Today, most countries accept foreign majority ownership as well as foreign
management, which may increase the potential value for the international company
of such ventures but also mitigate any potential internal frictions.

Development finance institutions (DFIs)

In order to facilitate the creation of joint ventures in the developing countries, the
World Bank and, in particular, it’s International Finance Corporation (IFC), actively
participate in assisting such joint ventures or partnerships. Many industrialized but
also some emerging market countries have also established similar corporations on
a smaller scale, so called development finance institutions (DFIs), in order to
promote and/or support companies, mostly from their own country, in forming such
joint ventures in primarily the developing or emerging market countries.

The DFIs are private sector development finance vehicles, generally directly or
indirectly owned and funded by governments. Although their charters and their
project focus may differ, depending on the trade marketing or investment profile of
the home country, they also have many similarities.

The DFIs normally operate in developing or emerging market countries with a low or
middle per capita income eligible for such investments according to international
agreements (the OECD DAC list). Their objectives are to support economic
development in the country of investment, while at the same time supporting co
investors from their home country to the benefit of their own country.

The projects are mostly based on cooperation between reputable local partners and
the foreign co-investor in order to strengthen the viability of the joint venture,
particularly in smaller or medium-sized production, trade or marketing set-ups, when
this combination of local and foreign know-how may be a precondition for its
success.
Participation by the DFIs can take different forms.

The DFIs operate with a large spectrum of investment or financial tools to suit the
individual project, such as equity, loans or guarantees, but also quasi-equity or
mezzanine instruments such as preference shares, convertible or subordinated
loans and management buy-ins or buy-outs. The equity investments are generally
only minority stakes ranging from 10 per cent upwards, and with a clear strategy of
how to exit the project when viable, normally within a period of 3–7 years.

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Lesson 2: Multilateral development banks

Over many years, a number of multilateral and regional development banks have
been established, with the main purpose of supporting projects vital for economic
development within the region.

The best known of these institutions is the World Bank, which is not a bank in the
common sense, but made up of two unique development institutions owned by 184
member countries – the International Bank for Reconstruction and Development
(IBRD) and the International Development Association (IDA). Each institution plays a
different but important role in the mission to reduce global poverty and improve living
standards. The IBRD is the main lending agency and raises most of its money in the
world’s financial markets by selling AAA-rated World Bank bonds, usually to financial
institutions, pension funds and other institutional money managers, as well as to
central banks. The IBRD focuses on middle-income and creditworthy poor countries,
while the IDA focuses on the poorest countries in the world. Together they provide
low-interest loans, interest-free credit and grants to developing countries for
education, health, infrastructure, communications and many other purposes.

When pursuing business opportunities in projects financed by the World Bank, it is

essential to understand that the governments, or their departments or agencies, in
the developing countries are the borrowers of money for specific projects and are
also responsible for procurement. All contracts are therefore between that borrower
and the supplier, contractor or consultant. The World Bank’s role is to ensure that the
borrower’s work is done properly, that the agreed procurement procedures are
observed, and that the entire process is conducted with efficiency, fairness,
transparency and impartiality.

The International Finance Corporation (IFC), which is also part of the World Bank
Group, operates on a commercial basis, providing a mix of finance (loans, equity
finance, risk management products and intermediary finance). It is active in
promoting projects for the development of private industry by participating as
shareholder or lender in joint ventures vital to the country and with reasonably good
prospects. The World Bank Group also includes the Multinational Investment
Guarantee Agency (MIGA), guaranteeing the political risks for investments and
projects in many developing countries.

A number of regional development banks have also been set up, based on the same
principles as the World Bank, but with a more regional purpose. These are the
African, Asian, Inter-American and Islamic Development Banks and their
development funds for lending on ‘soft terms’ to projects of special importance for
regional development.
These institutions also have finance agencies similar to the IFC model to promote
private industry within their regions.

The regional development banks not only participate in projects as a lender or a

guarantor but frequently also, and more directly, in feasibility studies and promotion
of the project itself, even as co-arranger. Their involvement often takes place
together with international banks and ECAs from supplier countries, but also in
cooperation with local governments, which are often the borrowers or the guarantors
of the loan. This will give these projects a high political and financial priority within
the country and an added reassurance to co-partners, suppliers and creditors that
they will be financially secured, not only during the construction phase but also

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during the entire repayment period.

The development banks have a high international rating due to their ownership,
capitalization and proven financial record and can therefore often offer their
borrowers better than market terms, for example through lower interest rates and
longer repayment periods. However, they can cater for only a small part of the
finance requirements. Therefore they also contribute to the development of different
forms of leveraged finance, such as co-joint or parallel financing techniques together
with other sources of finance, for example international major commercial banks,
special export banks and aid agencies from industrialized countries.

The projects supported by the development banks are often very attractive for
potential suppliers, not least because they receive cash payment through the finance
arranged by the banks. The rules for tender for projects financed by or through the
development banks may vary, but bidding is often restricted to companies from the
bank’s member countries. However, it should be mentioned that most industrialized
countries are also non-regional members of these banks and their national
businesses are thereby eligible to bid also for such restricted contracts.

European Bank for Reconstruction and Development (EBRD)

The EBRD (established in London in 1990) is a development bank with a somewhat

different profile from the other development banks and therefore probably more
relevant for overseas suppliers and investors from most countries. The bank is
owned by the member countries of the OECD but also by many emerging market
countries and has a capital base of not less than EUR 20 billion. Its main objective is
to support countries from central Europe to central Asia, including many former
Soviet republics.

The EBRD is the largest single investor in the markets in which it operates, and even
if its core business is the finance of larger projects – the bank has committed over
€20 billion to more than 800 single projects – it is involved in many other areas as
well. It participates in co-financing and in this way facilitates domestic funding for
other financial institutions or banks, and by supporting local commercial banks,
equity
funds and leasing consortiums, the bank has been involved in more than 200,000
smaller projects since it started some 25 years ago.

Apart from the role of supporting projects and individual local banks, the EBRD also
has an important role in supporting international trade in general, both imports and
exports, through its trade facilitation, the ‘TF Programme’. The programme can
guarantee any individual and genuine trade transaction associated with exports
from,
imports to, and between the EBRD’s countries of operations. Guarantees may be
used to secure payment of a number of finance instruments issued or guaranteed by
issuing or confirming banks for trade transactions. These guarantees cover a wide
range of goods and services, including consumer goods, commodities, equipment,
machinery and construction as well as technical and other services.

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Reference:
Grath,A (2008), Handbook of International Trade and Finance, Kogan Page Limited

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