Perspectives 2019 2020 Public Sector

30 Sustainable Sovereign Financing: Optimizing Resource and Risk Allocation Illustration of Blended Finance Application Current WACC = 11% Equity (25%) Debt (75%) r E = 20% r D = 8% PV (Cashflow) at 11% < 0 PV (Cashflow) at 8.35% > 0 Commercial Debt 60% DFI-enhanced Debt 20% PE 10% GE 5% SE 5% Example “Blended” WACC = 8.35% Blended r E = 13.75% Blended r D = 7% • Social Equity (“SE”) (e.g. at 5% return) • Government Equity (“GE”) (e.g. at 10% return) • Private Equity (“PE”) (e.g. at 20% return) Equity • Concessional Debt (e.g. at 2% return) • DFI credit-enhanced Debt (e.g. guaranteed debt at 4% return) • Commercial Debt at 8% return Debt Blended Finance Transition from “Debt” to “Equity” Traditionally, governments have sought to finance infrastructure and associated projects through monetizing future cash flows or, in other words, borrowing today and paying back tomorrow from either direct or indirect revenues generated by the project. Sovereigns cannot afford to continue to finance its investments in the country through debt given the size of funding required and the government’s relative debt capacity and sustainability. Governments need to transition from providers of debt to suppliers of equity. As an equity provider, governments will continue to have a degree of ownership and control in projects and be guided by the societal impact of such projects. They may need to forego a degree of financial returns in order to leverage the necessary capital to fully fund the asset. Lastly, government must be willing to absorb the first loss attributed to the project and work with its developmental partners, including official donors and multilateral development financial institutions, to share in the equity risk of the project. The transition does require certain trade-offs but it also represents the potential to achieve leverage in the range of 1 to 8 as demonstrated by recent blended finance structures. Blended Finance Structure High potential opportunities for Blended Finance exist where the composition of the structuring components make economic sense but certain investment barriers prevent investors from achieving necessary commercial returns. By introducing new components or enhancing existing ones, a bankable deal can be created by reconfiguring the risk-adjusted returns at each tranche of the capital structure. Blended Finance can take many forms where public and private sector capital are co-invested in a structure with differentiated risk absorption and return dynamics. The most basic form and the best illustration of a Blended Finance solution is to reflect the risk absorption and return tranches within the capital structure of an asset ( see diagram below ). Within the capital structure, the equity providers absorb the first losses of the asset up to their respective level of capital contribution. Once the equity capital is depleted in terms of loss absorption, the debt providers begin to incur losses subject to their seniority within the capital structure. The returns dynamic is reverse whereby the most senior debt providers are paid out first with the most junior equity contributors receiving the remainder of the free cash flow waterfall. Debt providers will be repaid from the revenues generated by the asset in the medium to long-term and relinquish any further claims on the revenue generated by the asset once the debt has been repaid. Subsequently, the equity holders will then realize the long term returns (if not having already received dividends following the debt pay-outs).