Finding the right credit enhancement’s package to support the obligations of a state-utility offtaker (the “Offtaker”) in state-utility Independent Power Projects (“IPPs”) in selected African markets is fundamental for the bankability of those IPPs.

In some markets, the credit rating is below the investment grade, foreign direct investment is hard to flow, and the credit worthiness of state utilities is poor.

Sovereign risks play an important role in predicting the number of IPPs for each country as well as the size of investment (debt and equity) commitments.

The risk of non-payment by the sovereign supporting the Offtaker’s obligations under the project documents in some IPPs is not insubstantial. A large percentage of the African countries are considered risky borrowers by international standards.

Multilateral Development Banks (“MDBs”) play an important role by offering risk mitigation tools to unlock financing in African countries such as credit support instruments.

Sovereign Guarantees (“SG”) and publicly structured guarantees

SG – the “easy fix” solution to attract capital for IPPs

Most of the IPPs in Africa over the past years benefited from SGs which were required by lenders (i.e. international financial institutions) and international developers in  project finance structures.

In the context of an IPP, a SG is a guarantee from the state that an obligation will be satisfied if the  Offtaker (as the primary obligor under the PPA) defaults.

Ideally, SGs from a guarantor with sound credit quality shall be obtained in IPPs. The SG shall rank senior or pari passu with the guarantor’s senior unsecured obligations.

SGs usually cover payment obligations of the offtaker. However, these can also cover all types of obligations and binding commitments.

In African IPPs, and under a fair allocation of risks between the independent power producer, the Offtaker and the state, SGs would typically cover the following risks:

States in emerging markets are reluctant to provide SGs due to insufficient fiscal revenues, increasing public indebtedness, macroeconomic deterioration and IMF restrictions. States tend to disfavor providing any guarantees on the top of a state supported PPA or a letter of comfort to support the offtaker’s obligations under the PPA.

Publicly structured guarantees

Absent any possibility to obtain a SG to guarantee the offtaker’s obligations, international developers and lenders may pursue the following alternatives to a SG:

Alternatives to SGs and publicly structured guarantees

If a SG or a guarantee by a state public entity is not an envisaged option, then the following other instruments developed by the market for  IPPs can be explored:

Partial Risk Guarantees (“PRG”)

The PRG guarantees lenders against debt service payment defaults resulting from the state’s failure to meet its payment obligations as stipulated under selected project documents (e.g. concession agreement or government guarantees).

The PRG would cover the risk of debt service arising from events and risks which include the following:

Political Risk Insurances (“PRI”)

Political risk insurances are solutions that covers (i) risks in connection with commitments on free convertibility of hard currencies and availability of hard currency reserves, (ii) risks in connection with change in law or invalidation of benefits that may adversely affect the project, (iii) risk of withdrawal of permits, licenses or concessions and (iv) risks of expropriation.

MIGA Political Risk Insurance

MIGA offers political risk insurance cover solutions as follows:

Partial Credit Guarantee (PCG)

PCG is a credit enhancement mechanism for debt instruments. It is an irrevocable promise by a third-party entity, usually an MDB (i.e. World Bank or AfDB) to pay principal and/or interests up to a pre-fixed amount.

PRGs cover part of the debt service default by the project company.

PRG is a useful tool to reduce the Offtaker’s risks through improving its creditworthiness and promote access to local debt funding.

PRGs address selected risks such as currency transfer and convertibility risks and commercial risks for developers finding it challenging to provide completion or performance guarantees under the project documents.

Revenues ring-fencing structures

Other structured tools were designed to ring-fence revenues accruing to off-takers and ensure that there is enough cash to meet the Offtaker’s payment obligations under the PPA as follows:

Guarantees provided by an Export Credit Agency (ECA)

ECAs are financial institutions that offers financing for domestic companies’ international export operation and other activities.

ECAs can underwrite the political risks and commercial risks of overseas investments, including in IPPs.

Other credit support instruments and liquidity guarantees

Other type of credit support instruments include the following: