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The World Bank Group’s Approach to the Mobilization of Private Capital for Development

Chapter 3 | Constraints on PCM and Opportunities to Scale Up

This chapter identifies constraints on PCM, opportunities for scale-up, and areas for further research. The external constraints are (i) regulatory framework, (ii) client capacity, and (iii) capacity to work with MDBs and meet government-to-government (G2G) competition. Internal constraints are (i) Bank Group target setting and implementation, and (ii) instruments and platform approaches. The chapter also includes an efficient frontier analysis that identifies opportunities for PCM scale-up. Finally, it identifies areas for further research.

External Constraints

External constraints are those that governments or all MDBs jointly are best placed to address. They include regulatory and client capacity constraints, lack of coordination among MDBs, and competition from government agencies. The Bank Group supports governments in tackling external constraints through catalyzation activities aimed at improving countries’ policies and regulations, including lending (mostly DPOs to support policy changes and investment project financing for clients’ capacity building) and technical assistance or upstream advisory. External constraints also exist based on the level of market openness, trade openness, political and economic stability, natural resource management, and human capital development. Addressing external constraints is important for PCM. However, these constraints are not at the core of this report’s analysis and are reviewed only briefly in this section.

Banking and Regulatory Frameworks

The banking and investment regulatory frameworks affect PCM at the country level. EMDEs rely much more on bank loans and cross-border loans for infrastructure finance than other economies do. Institutional investors in different constituencies are subject to legal regimes of varying rigidity, especially regulations on Organisation for Economic Co-operation and Development (OECD) country capital stocks to limit funding to EMDEs. Three sets of regulations can be relevant for investment (particularly for infrastructure investment): accounting, solvency, and investment rules. Fair value International Financial Reporting Standards accounting rules for financial institutions can lead to de-risking and shorter-term investing. Risk-based solvency rules for insurance companies and pension funds potentially also lead to procyclical investment behavior.1 Pension funds in most countries, for example, face some quantitative or qualitative investment restrictions.2 Regulation of asset owners and asset managers also has side effects in this context.3 More research is needed on the impact of financial regulations on PCM, including on possible trade-offs between financial stability and creation of an environment that is conducive to private investment opportunities.

Mobilizing domestic institutional investors can be a major constraint to PCM. Domestic institutional investors, a key source of PCM, tend to be highly risk averse and tightly regulated. Nevertheless, mobilizing domestic institutional investors like pension and insurance funds has extraordinary potential for financing key priority areas for Bank Group client countries. It is estimated that $1 trillion of resources in developing countries are parked in safe assets originating in OECD countries rather than being invested to develop infrastructure and financial sectors domestically. Some creative approaches to expand the appetite of local institutional investors have been successful (box 3.1).

Box 3.1. InfraCredit Nigeria: Mobilizing Domestic Institutional Investors

GuarantCo—a small, multilateral development finance institution that provides guarantees and technical assistance in support of local currency capital market development—has sought creative ways to expand the appetite of local institutional investors and has had some success in countries like Nigeria. One of GuarantCo’s innovations was to support the creation of InfraCredit Nigeria, a local institution with equity stakes by the Nigerian government and development finance institutions like Germany’s KfW. InfraCredit helps credit-enhance local bond issuances related to infrastructure to a level that allows local pension funds to invest in them. GuarantCo itself contributed only $50 million in contingent capital but was intensively involved in providing technical assistance to set up the new institution and engaging in dialogue with Nigerian capital market participants and regulators. Thus far, InfraCredit has successfully enhanced two major bond issues: a Nigerian naira (N)10 billion, 10-year bond in January 2018, and an N8.5 billion, 15-year bond in February 2019. The latter, for a hydroelectric facility, was the first certified corporate green bond issued in Nigeria. Thus, using only a relatively small, unfunded contingent contribution, coupled with intensive technical assistance, GuarantCo gave a major boost to the engagement of local institutional investors in Nigeria’s capital market. Based on this successful example, GuarantCo is launching a similar project in Pakistan.

Source: Independent Evaluation Group industry interviews.

Client Capacity

Client capacity and knowledge of PCM instruments and platforms can be a constraint on expanding PCM. With increasing debt, clients are willing to explore alternatives through private financing, but their understanding of PCM instruments and platforms is often limited. Government counterparts are critical to developing PCM, including by proposing relevant deals. Despite their overall interest in PCM approaches, however, clients often perceive the involvement of private actors and Bank Group PCM instruments as riskier than traditional World Bank instruments such as investment project financing and DPOs. In many cases, government clients that are used to concessional loans do not understand the opportunities and consequences of PCM instruments. Bank Group staff play a key role in engaging with government counterparts to identify relevant deals and in building their capacity to pursue them. Helping clients identify a pipeline of bankable projects and valuate them correctly is particularly critical (figure 3.1), as is helping clients understand the costs and benefits of various Bank Group PCM products. A prerequisite for technical staff to engage with clients on PCM approaches is getting expression of interest on PCM from clients and having PCM approaches in the Bank Group country strategies, which technical staff say is often difficult. Clients also have a limited understanding of alternatives to World Bank guarantees. For example, some clients (such as Bangladesh) do not take into account the contingent liability, counterparty risk, or implications of the counterguarantee mechanism in other forms. Other clients (for example, Ghana and Mongolia) pursue G2G guarantee mechanisms without indemnity agreements. Still others (for example, Zambia) issue sovereign debt on international capital markets as alternatives to PCM solutions and take on market risks directly.

Figure 3.1. Key Issues for Infrastructure Investors

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Source: Independent Evaluation Group Global Investor Survey; Preqin 2018.

Figure 3.1. Key Issues for Infrastructure Investors

Source: Independent Evaluation Group Global Investor Survey; Preqin 2018.

Working across MDBs and G2G Competition

DFIs and MDBs need skills to engage with private sector actors, both project sponsors and investors, including on financial structuring. Apart from IFC and the European Bank for Reconstruction and Development, most MDBs have long histories of public sector lending, and their staff and processes are geared toward that end. Reorienting to the kind of staff capacity and processes needed to mobilize private investment will require the DFIs to make concerted efforts to build the skills to structure more complex financial arrangements.

Several factors constrain MDB collaboration on PCM (for example, exposure exchanges). Most private sector mobilization—especially syndication—takes place with financing provided to private sector, nonsovereign clients. Indeed, all framework arrangements for collaboration thus far have included only nonsovereign projects.4 Both the quantity and the quality of the project pipeline are critical for MDBs in pursuing collaboration to increase PCM. Exposure exchanges have the potential to increase the PCM capacity of the development partners.5 However, they are limited by several constraints: the project pipeline, the legal and statutory constraints of each development partner, and the tendency of MDBs not to consider exposure exchanges as a potential avenue to increase PCM. Despite these constraints, some institutions have found innovative ways to optimize their balance sheets and pursue exposure exchanges, increasing both PCM and their headroom for future lending, including for sectors that do not easily attract private capital (box 3.2).

Box 3.2. African Development Bank Portfolio Risk Transfer: An Example of Exposure Exchange

In September and October 2018, the African Development Bank (AfDB) undertook two groundbreaking operations that involved transferring a portion of the risk in its portfolio of development loans to private sector investors. The transfers freed up resources for additional lending, including lending for development of social sectors for which it is difficult to mobilize private capital. In the first operation, AfDB undertook a synthetic securitization, wherein it sold off a portion of the risk embedded in a set of 40 private sector loans worth about $1 billion on its books to a group of investors led by Mariner, a United States–based impact investment fund, with support from the European Commission. Investors receive annual payments of 10.65 percent for the duration of the arrangement in exchange for assuming one of the junior (riskier) tranches of the loans. In return, AfDB received total capital headroom relief of $650 million for future lending. Unlike true securitization, where loans are removed from the books of the originating institution, these loans stayed legally on AfDB’s books, and AfDB will continue to administer them for their life. These techniques could be scaled up to involve investors in development finance at the same time as addressing the headroom constraints of development finance institutions to channel greater financial resources to clients and sectors that do not typically attract private capital.

Source: Independent Evaluation Group industry interviews.

G2G sovereign lending can limit the Bank Group’s potential to scale up PCM. G2G direct lending undercuts MDBs in terms of financing structure, loan pricing, loan tenor, and processing time. It can also distort private actors’ expectations of the addressable project pipeline in a country and reduce the addressable market for MDBs in general, especially on infrastructure financing.

  • OECD countries typically pursue G2G lending in EMDEs directly through special investment vehicles to boost returns on their national savings and as an alternative to traditional, fixed income investments. The sovereign investor base that pursues G2G has expanded from OECD countries to South investors, increasing competition among sovereigns. This is particularly evident in the Sub-Saharan Africa, South Asia, and East Asia and Pacific Regions.6
  • Middle East sovereigns (for example, Qatar, Saudi Arabia, and the United Arab Emirates) were once active only in the Middle East and North Africa Region but have increased commitments to large infrastructure projects across East Asia and Pacific and Southeast Asia (for example, in Indonesia and the Philippines) and in the road and air transport sectors. In Bangladesh, Middle East and North Africa sovereigns fund social sectors with potential for private sector participation through bilateral agreements.

Internal Constraints

The Bank Group can scale up PCM and improve country outcomes by addressing internal constraints on mobilization in two areas: (i) definition and enforcement of Bank Group targets, incentives, and skills; and (ii) design of instruments and platforms.

Target Setting and Implementation

Unclear PCM targets at the operational level and inconsistent measurement methods are a constraint. Although progress has been made to systematize reporting across MDBs, PCM is understood, defined, and discussed differently across the Bank Group institutions. The IFC PCM definitions and targets are clear. However, IFC’s notion of core mobilization includes both private capital sources and public capital sources (such as DFIs and sovereign wealth funds) that take on commercial risk from IFC projects. This allows IFC to tap diverse sources of capital for commercial transactions compared with other MDBs and DFIs. The World Bank’s accounting of PCM projects at the project approval stage is not aligned with practices at IFC and MIGA, where PCM projects are accounted at the commitment stage. The World Bank may be overestimating PCM because of measuring it at the approval stage rather than at the commitment stage. However, the World Bank may be underestimating PCM because it does not account for certain Treasury advisory activities that mobilize private capital and are aligned with the PCM definitions. Definition shortcomings make measuring PCM results difficult and reduce the meaningfulness of aggregate results in the Bank Group Corporate Scorecard.

World Bank staff do not have incentives to engage and mobilize private actors in World Bank projects and scale up PCM. Although IFC has PCM targets that cascade down to various units, World Bank memorandums of understanding between Regional vice presidencies and GPs—and related scorecards—do not include PCM targets. World Bank staff report that the motivation to structure PCM deals primarily comes from (i) client demand, (ii) a significant gap in financing, (iii) the limited World Bank lending envelope dedicated to a country, and (iv) rising levels of sovereign debt. These factors are often interrelated. This was especially relevant in discussions with the Transport and Digital Development GP, during which staff mentioned that in some cases, when there is no headroom constraint for the client country, the incentive for PCM is overridden by the incentive to pursue direct lending support from the GP teams. Staff indicated that PCM is used as a mechanism to sustain progress when country strategies and priority sectors shift, reducing the amount of World Bank funding allotted to practice areas that were funded in previous years. Interviewees representing World Bank management and task teams specifically highlighted the need to better align incentives to reward good performance (measured through achievement of PCM targets and pricing) instead of setting targets tied to IBRD or IDA lending operations only. Some task team leaders emphasized the need to put proper systems in place to track progress and efforts made toward structuring PCM deals, and others emphasized the need to track the existing PCM data against the committed targets accurately.

Financial structuring skills are scarce at the World Bank. Few World Bank staff have the technical skills to design PCM interventions. Staff across sectors and ranges of experience, both in the GPs and in Regional teams, repeatedly mentioned this as a constraint. To address this and scale up PCM, suggestions included ramping up relevant training and learning engagements for staff, with an initial focus on providing them with a better understanding of existing instruments. World Bank staff could also bring financial structuring knowledge to operational work by collaborating more systematically with Infrastructure, Public-Private Partnerships, and Guarantees and the Treasury. Involving Treasury and Infrastructure, Public-Private Partnerships, and Guarantees colleagues in operational work would help in scaling up PCM.

The need for supporting implementation of and sustaining regulatory reforms can constrain PCM. Addressing regulatory constraints requires sustained actions, including after private capital is mobilized. Investors seek repeat engagements in client countries and see the participation of the Bank Group as a risk mitigant. Specifically, investors receive comfort from the World Bank’s continuous sectorwide engagements. The Cameroon and Egypt cases illustrate the point that concomitant Bank Group support can lead to PCM and generate greater access to infrastructure service delivery. One interviewee highlighted that simple Bank Group technical assistance interventions can have a large multiplier effect, citing the example of Brazil’s reform of currency convertibility via its national treasury to achieve investment creditor status. The country cases also highlighted some of the challenges of sustaining reforms. For example, in Argentina, power network transmission capacity is a substantial constraint on the implementation of renewable energy generation and therefore on mobilizing private investment for this sector. In Mongolia, the World Bank undertook upstream work to enhance transparency related to revenues and rents from mining, but the limited success of governance reforms in the sector affected post-PCM activities. In Zambia, continued government capacity weaknesses and a slower pace of sectoral reform have limited the scale-up of initial successes with Bank Group–supported solar projects.

Mobilization Instruments and Platforms

The knowledge of World Bank clients and staff about guarantees is suboptimal. Clients and staff ask whether a guarantee can cover an exposure fully or only partially. Most major MDBs avoid providing full guarantees as a matter of policy for several reasons.7 Bilateral DFIs tend to have more flexibility and provide 100 percent guarantees. Staff have different opinions as to whether the World Bank policy of not providing 100 percent guarantees is a constraint on PCM.

Domestic lenders cannot benefit fully from IFC B loans. Local financing institutions cannot invest domestically under IFC’s umbrella (for example, syndications) per IFC’s current policies and as a result cannot impart local knowledge to PCM projects. To partly address this, IFC is trying to innovate by developing derivative products that would extend local currency financing. This, however, will not be a game changer for all countries because of limitations in finding local or overseas swaps with market counterparts.8 If IFC aims to expand its B loan program and scale up debt mobilization, it has to find new ways to crowd in domestic lenders (for example, local currency syndication products and hedged A-loan participation to free up PCM capacity).

It is not clear whether IFC is achieving adequate returns through debt mobilization platforms, and the return on MCPP needs to be assessed. It is not clear whether IFC is receiving an adequate return after providing first-loss credit enhancement to the initial three third-party fund managers through the MCPP platform. Ideally, an external auditor also needs to assess this platform through an independent risk return analysis. If the return is inadequate given the risk, a timeline should be established for modifying the platform design appropriately, allowing the desire to establish a demonstration effect on debt mobilization platforms.

IFC platforms are not fully aligned with the customs and practices of large institutional investors. Although IFC targets investments in private companies below a certain valuation (low-medium size by industry standards), most target investors for platforms like the MCPP and GCBF have investment portfolios that are vastly larger than IFC’s. They are also more sophisticated in their benchmarking approaches to understand their risk return profiles. IFC could either participate in or replicate existing market innovations such as a loan securitization product introduced in Southeast Asia covering a global portfolio of infrastructure projects (box 3.3). Such approaches are not without challenges and need to be carefully studied and potentially piloted (as IFC had attempted to do in Argentina in 1997) to mimic large institutional investors’ existing portfolio and risk appetite.

Box 3.3. Bayfront Capital Infrastructure Securitization

In July 2018, a Singapore-based financial institution successfully launched the first large-scale securitization of infrastructure assets in Asia to fill infrastructure financing gaps in the region and increase access to service delivery. Clifford Capital, owned by the Singapore government’s sovereign wealth fund, structured a portfolio of 37 project finance and infrastructure loans—totaling $458 million, from 16 countries in the Asia-Pacific and Middle East regions—that faced a financing gap in their construction or expansion stages. The issuance was structured into three notes listed on the Singapore Exchange. Clifford Capital retained an unrated subordinate tranche for 10 percent of the transaction to maturity. The notes were purchased by a mix of major institutional investors in Asia (65 percent), Europe (25 percent), and elsewhere, including insurance companies, asset managers, pension funds, and bank treasuries. The landmark transaction—projected by Clifford Capital to be the first in a series of infrastructure securitizations—demonstrates the viability of marketing long-dated infrastructure in developing countries to institutional investors. Development institutions like multilateral development banks (MDBs) can help accelerate this process. MDB involvement in helping design, fund, or provide risk mitigation products to the underlying infrastructure strengthens their quality and makes them better candidates for institutional investment via individual project bonds or through packaged instruments like the Bayfront deal. In addition, MDBs and other development finance institutions can lend their financial strength to issuing new securitization packages by helping structure the deals themselves from their own portfolios or in a mix with commercial banks. They can also purchase subordinated or senior tranches of the security, depending on the risk appetite of other investors. MDBs can contribute to building data on the performance of infrastructure debt, along the lines of recent evaluations by Moody’s, to help institutional investors adequately analyze track records and risk probabilities.

Source: Independent Evaluation Group industry interviews.

The common challenges to MIGA guarantees revolve around MIGA’s comparative position and considerations about external debt and fiscal sustainability. MIGA’s historical comparative advantage rests in crowding in FDI and underwriting private sector project risks. Its new product offerings, however, are in public finance, creating dependencies on country performance, fiscal capacity, and governance quality issues not under MIGA’s control. These considerations raise issues about the complementarity, overlap, and substitutability of MIGA’s new products in relation to the World Bank and IFC guarantee products and sovereign, subnational, and state-owned enterprise loans.

Constraints Affecting All Instruments: Resources and Design Complexity

Expansion of IFC’s PCM platforms (for example, AMC, MCPP, and GCBF) and World Bank Treasury advisory is limited by internal capacity. There is a cadre of investors with a long-term approach and a desire to reap yields not available in industrial countries. Among them, appetite for long-dated, developing market assets is very strong, as evidenced in IEG’s Global Investor Survey (Narayanan 2018). Regardless of the instrument or platform, scaling up PCM can have implications for the Bank Group institutions’ balance sheets and investors’ concerns in terms of resource intensity and complexity.

Scaling up PCM requires additional resources partly fulfilled by the recent approval of World Bank and IFC’s capital increase. Pursuing PCM opportunities requires technical knowledge. Staff must understand the underlying mobilization instruments and know the techniques required to prepare projects that align with both client and investor expectations. Projects using four mobilization approaches (namely, equity, debt, bonds, and guarantees) tend to be highly specific to client context and require significantly higher staffing levels, both in number and in technical skills, than projects without mobilization approaches.

Economic capital use by PCM instrument is a constraint from the corporate risk perspective. Economic capital usage is a good proxy for the financial resource intensity of PCM. The Bank Group sets aside economic capital for all PCM instruments and platforms.9 The higher the risk of the PCM approach, the greater the use of economic capital, with implications for the balance sheet. Investment or lending projects with direct mobilization require leverage of the institution’s balance sheet, per the skin-in-the-game principle. Although the mobilized amount does not use up any economic capital, the cofinanced amount or support directly provided to the same project requires economic capital allocation. In these terms, advisory mobilization is the least resource-intensive approach, followed by the debt mobilization approach (short-term financing aside). The equity mobilization approach uses the most economic capital.

Guarantee mobilization requires loan loss provisioning on IBRD, IDA, and MIGA balance sheets, which is a limiting factor in the use of guarantees. Every World Bank guarantee issued needs to have capital allocation provisioned either on the IBRD balance sheet or on the IDA balance sheet. Scaling up guarantees thus potentially affects the level of loan provisioning available for traditional loan products, like investment project financing, development policy financing, and Program-for-Results, and implies that World Bank management needs to make trade-off decisions in certain client countries between lending on its own account versus issuing guarantees. Reinsuring World Bank guarantee exposure through third-party reinsurers, similar to MIGA’s reinsurance approach, is one option to increase the capacity to scale up World Bank guarantees. Such trade-off decisions have implications for IBRD’s fee income and the World Bank’s risk management.10 Reinsurance of World Bank guarantees is a complex issue that requires other financial considerations that go beyond the need to increase capacity to issue more World Bank guarantees.

There are opportunities to scale up PCM, despite these constraints. The next section discusses them.

Opportunities to Scale Up PCM

Almost all Bank Group client countries have untapped potential to crowd in private capital. According to IEG modeled estimates, most Bank Group client countries are attracting only 50–80 percent as much private capital as they could in normal circumstances (including FDI, portfolio equity, and private sector borrowing). To test the effects of country capacity for PCM further, IEG performed a data envelopment analysis of the efficient frontier for 115 client countries (appendix J).11 The analysis generated an efficiency score for each country.12 On average, private capital flows are at 61 percent of the estimated potential among these countries for the period 2015–18. The analysis further suggests the following:

  • Most regions show positive trends in attracting private capital flows (relative to GDP) and in their domestic investment environment. For the countries analyzed, figure 3.2 provides an overview of the estimated efficient frontier based on current income levels and the quality of the domestic environment, in turn based on country indicators like market openness, institutional quality, and political stability. The Netherlands, the Republic of Yemen, and South Africa are at the frontier. All other countries can move toward the frontier by increasing their private capital flows.

Figure 3.2.

  • All regions and all income groups have countries with large untapped mobilization potential. Private capital flows tend to be positively correlated with income, but there are exceptions. For example, some of the LICs and lower-middle-income countries (LMICs; for example, Mozambique and Vietnam) are as efficient at attracting private capital as the average high-income country, and some high-income countries (for example, Uruguay) are only as efficient as the average LMIC.
  • Some countries (within income groups) have untapped potential to reach their peers at the efficient frontier. For example, within the LICs, Mozambique and Nepal have comparable domestic enabling environments (as measured by the data envelopment analysis efficiency score of 0.4). Yet Mozambique attracted more private capital than Nepal did during the evaluation period. The discrepancy suggests that there may be opportunities to attract private capital to Nepal (among other LICs).
  • There is a lot of variation in the roles that different types of private capital play in different income groups. Private sector borrowing plays an important role among high-income countries and some upper-middle-income countries but seems almost nonexistent in many LICs. Nevertheless, LICs and LMICs often attract portfolio equity flows (as a percentage of GDP) similar to those of countries in other income groups.

The World Bank and IFC do not target specific countries to mobilize private capital. The targeting of the World Bank and IFC PCM approaches was not driven by considerations about countries’ records in attracting private capital relative to their domestic environments (figure 3.3). The Bank Group’s PCM portfolio was concentrated on the mean efficiency scores, suggesting that the Bank Group PCM portfolio focused mainly on countries with well-developed investment climates, regulatory capacity, and capital markets. However, there is untapped potential to increase Bank Group PCM projects in countries that are below the median line. For example, in figure 3.3, Nepal (abbreviated NPL) and Uzbekistan (abbreviated UZB), together with Chad (abbreviated TCD) and the Democratic Republic of Congo (abbreviated COD), feature in the low-low quadrant (lower than median efficiency score and lower than median PCM ratio). This confirms that opportunities exist to target LICs and LMICs and prioritize PCM activities.

Figure 3.3.

Current PCM approaches can likely be scaled up until a client country reaches a tipping point. Investors’ perception of risks declines as a country improves its governance, investment climate, and capital markets. The tipping point can be expected to occur when a country achieves a certain level of performance in these areas. After the tipping point, the additionality of the Bank Group’s PCM approaches may decline. At that point, some PCM may continue with innovative instruments, but private capital is likely to directly flow to the country without Bank Group involvement (figure 3.4).

Figure 3.4. Bank Group Private Capital Mobilization Expected Growth versus Country Reform Progress

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Note: FDI = foreign direct investment; LIC = low-income country; LMIC = lower-middle-income country; MDB = multilateral development bank; MFD = Maximizing Finance for Development; PDM = private direct mobilization; UMIC = upper-middle-income country.

Figure 3.4. Bank Group Private Capital Mobilization Expected Growth versus Country Reform Progress

Note: FDI = foreign direct investment; LIC = low-income country; LMIC = lower-middle-income country; MDB = multilateral development bank; MFD = Maximizing Finance for Development; PDM = private direct mobilization; UMIC = upper-middle-income country.

Instruments That Can Help the Bank Group Scale Up PCM

Opportunities exist to increase coverage of project- and country-level risks by innovating and introducing new PCM instruments. Interviews with investors and clients indicate that Bank Group instruments have the potential to cover public policy changes, address lack of pipeline, and increase collaboration (for example, with the insurance industry). This requires a thorough analysis of any internal risks involved in adding to complexity and involves trade-offs. In IEG surveys, institutional investors highlighted several detailed requirements that need to be filled before such complex investment opportunities (for example, unfunded risk participation with the MCPP or scaling up GCBF with regulated entities) can be considered because of the investors’ own capacity, internal risk, and investment strategies, and to meet regulatory requirements. Regulatory requirements include investments in their own reporting currencies, publicly listed securities with a high degree of liquidity, fixed income interest with an investment grade rating and sufficient yield, and large transactions to allow for advanced commitments and placements of capital resources.

World Bank disaster risk products are in high demand and could be scaled up with support from World Bank Treasury and advisory teams. When Treasury receives a fee for crowding in investors in the context of disaster risk management solutions to clients, the initiative should be counted toward PCM. Investors consistently oversubscribe IBRD-intermediated catastrophe bonds at spreads that are often less than originally forecast and at or below prevailing market levels (appendix E), generating efficiency gains and access to long-term capital for client countries to address priorities after disaster. But long-term client demand for disaster risk preparation and resilience building has yet to crystallize. For this reason, the World Bank risk transfer program addressing disaster risk solutions in both preparation and post-disaster phases will need time to establish itself. Both World Bank Treasury and IFC Treasury can monitor developments in Part I countries to identify new risk transfer products that could be applicable to partner countries and are consistent with the SDGs. Blue bonds are one example of an innovation from the World Bank Treasury (box 3.4). They deserve further attention in the context of PCM because they contribute to SDG 14 (life below water). Furthermore, tweaking such World Bank Treasury and advisory initiatives and recasting them in the PCM context can be considered.

Box 3.4. Blue Bonds: A Treasury-Supported Instrument for Sustainable Investors

Sustainable and green bonds have grown tremendously in the past decade, fueled by an increasing desire among investors to see their investments not just earn a financial return but also make the world a better place. Blue bonds use investment proceeds to help protect the ocean environment, which covers more than 70 percent of the planet’s surface and is critical to the livelihoods of billions of people across the globe. Blue bonds were first used by a sovereign nation in October 2018, when the Seychelles issued a 10-year, $15 million bond partially guaranteed by the World Bank. The proceeds of the bond are to be used to help fund a variety of projects to protect and better use the Seychelles’ ocean environment, including expanding marine reserves, building a more sustainable fishing industry, and reducing water contamination. The bond was sold directly to three United States–based impact investment funds: Calvert Impact Capital, Nuveen, and Prudential. The Nordic Investment Bank, a multilateral bank owned by Scandinavian countries, issued a second landmark blue bond deal on January 24, 2019. In April 2019, the Nature Conservancy announced plans to scale up the use of blue bonds, targeting $1.6 billion in bond issues across 20 countries by 2025, following on from the Seychelles pilot. Also, in April 2019, the World Bank partnered with Morgan Stanley to issue and market a $10 million sustainable bond geared to addressing plastic waste pollution in the world’s oceans.

Source: Bank Group Treasury, Independent Evaluation Group interview notes.

Avenues for Future Research and Analysis

Several questions related to PCM go beyond the scope of this evaluation but deserve further research, analysis, and strategic consideration. Academics (for example, Banerjee and Duflo 2011) have argued that governments in developing countries can domestically raise most of the money spent on the world’s poor (that is, domestic resource mobilization) rather than through mobilization of international capital inflows. IEG’s empirical analysis on country potential included a domestic indicator of private sector borrowing as one of three types of private capital flows into client countries. However, a more detailed analysis on the (potentially distinct) patterns of domestic resource mobilization and underlying factors is left for future research.

There are more MFD and PCM opportunities. Some are known, and some are not known. Several have major implications for Bank Group approaches to PCM in the future. Chapter 2 discusses all empirical and normative evidence currently available on MFD and upstream reform engagements. A lot more reforms work that influences PCM is ongoing, but the links are not recorded well in the Bank Group systems. IEG stakeholder interviews revealed several new approaches for the Bank Group to innovate and collaborate with other MDBs and the broader development community. For example, stakeholders suggest that the Bank Group, other MDBs, and DFIs work closely with the Basel Committee on Banking Supervision and the three rating agencies on the following areas:

  • Debt and equity investments: Recognize treatment of syndicated loans provided to EMDEs to free up commercial bank capital exposure and risk exposure; develop third-party ratings of Bank Group–supported projects into EMDE environmental, social, and governance investments for market recognition; securitize the World Bank loan portfolio and pursue loan syndications; and explore debt-for-climate swaps, which entail concessional funders buying back outstanding debt, freeing up resources to address climate change, and helping clients mitigate disasters.
  • Guarantees: Recognize guarantee products in the Basel framework; recognize reinsurance and A-loan sales but mark to market on all guarantee exposure; and pursue comprehensive guarantees, portfolio guarantees, and expansion of MIGA’s support beyond OECD currencies and beyond green project bonds.

The potential of these techniques and approaches—and the implications for resources (human and capital)—could not be ascertained at this stage. Further analysis is required with reliable data sets from internal or external sources, and all MDBs and DFIs should be engaged, for example, in climate finance and attribution of climate cobenefits. Such approaches and techniques have major implications for the SDGs and for the Bank Group’s balance sheet, resourcing, risk management framework, and governance.

  1. For example, in the European Solvency II regime for insurers, capital charges are higher for less liquid assets and bonds with longer maturities and lower credit ratings. However, the European Union has introduced “discounts” on capital requirements for lower-risk infrastructure investments (project and corporate debt).
  2. The Organisation for Economic Co-operation and Development gives an annual overview of constraints on unlisted and private equity and debt, credit ratings, direct investments, infrastructure funds, foreign currency, and other instruments (OECD 2018). These constraints may affect different routes to infrastructure and financial sector investments. In practice, the constraints may be more binding in some countries (especially emerging markets) than in others.
  3. Examples are the European Union Markets in Financial Instruments II on the operation of asset managers and the European Union action plan for sustainable finance, including new disclosure rules and a green taxonomy. Such regulations affect the International Finance Corporation’s PCM platform approaches directly.
  4. Including only nonsovereign projects is because of pricing: nonsovereign financing by MDBs and most development finance institutions is close to market rates. Thus, it is easier to find private investors willing to join such a deal because they earn a market return commensurate with their risk. Sovereign financing by MDBs, however, is at rates well below the market. The low rates mean that investors would earn low returns relative to the risk they take compared with alternative investments in developing countries.
  5. The sovereign exposure exchange agreement is a risk management tool that the major MDBs developed collaboratively. This initiative was launched in October 2013 by the International Bank for Reconstruction and Development and endorsed by the MDB heads after a meeting of the Group of Eight ministers of finance. Unlike commercial financial institutions, which diversify their loan portfolios across thousands and sometimes millions of borrowers, the MDBs lend to their sovereign shareholders. The resulting asset concentration reflects the strength of the relationship between MDBs and their borrowers, but it also requires MDBs to hold additional capital.
  6. Asian sovereigns (for example, China and Japan) are the most active in infrastructure financing and crowd out opportunities for low- and lower-middle-income countries to pursue private capital in East Asia and Pacific and in South Asia. Several projects initiated by the World Bank or the International Finance Corporation in Bangladesh, India, and Mongolia in the energy or extractive sectors were financed by Asian sovereigns directly under their bilateral treaty agreements.
  7. These reasons include reducing moral hazard, exposing the borrower at least partially to the market to build toward future borrowings without MDB support, and not contaminating the market for MDB bonds, among others.
  8. A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
  9. Economic capital is the capital required for the Bank Group institutions to maintain their AAA rating.
  10. One way to look at the trade-off decision is to explore the causal relationship between a loss on a project and inability to pay by the sovereign—in other words, to assess whether the project risk can cause a sovereign loss or vice versa. Seen in this light, there are different potential lines of causality. The first line is from the project in difficulty to the sovereign in difficulty: Should a project not perform well, it may not be able to service its debt. But typically, it seems unlikely that a project default would lead to a sovereign default, except for an exceptionally large project in a significant sector, particularly for most middle-income countries. As such, project risk will necessarily be higher than sovereign payment risk because the latter is unaffected by a project default, thus justifying the need to hold more capital for project loans than for sovereign loans, which is reflected in differential spreads between project and sovereign lending. The second line is from the sovereign in difficulty to the project in difficulty: If a sovereign is facing difficulties with payments to its creditors, it is likely that it may not be in a position to meet its contractual obligations to projects. (It will also be likely that the economic situation in the country is deteriorating and projects are facing increased risk.) In such a situation, it is most likely (but not inevitable) that a project with, for example, a partial risk guarantee will face serious difficulties that could lead to a default on the commercial loans, which would trigger a call on the partial risk guarantee (assuming that it covers payment risk). Such a situation would indicate that the sovereign payment risk is highly correlated with project default risk, which means that a lender would need to hold the same or more capital for a project loan than for a sovereign loan. The third line, in the case of MIGA, is that the Council of Governors and Board of Directors set the maximum amount of contingent liability that may be assumed by MIGA as 350 percent of the sum of its unimpaired subscribed capital and reserves and retained earnings, 90 percent of reinsurance obtained by MIGA with private insurers, and 100 percent of reinsurance from public insurers. MIGA’s maximum net exposure is therefore determined by the amount of available capital after setting aside contingencies. The Council of Governors and Board of Directors approved an increase to 500 percent in 2016, in accordance with the procedures set forth in Article 22(a) of the MIGA Convention. In addition, the Board approved an increase in MIGA’s portfolio reinsurance limit from 50 percent to 70 percent of gross exposure.
  11. The obtained efficiency scores are normalized to range between 0 and 1, where units located on the frontier are assigned the maximum value of 1. In the presented study, the data envelopment analysis first calculates an empirical production possibility frontier for private capital flows, which is then used to rate the performance of each country relative to the frontier. This provides an estimate of the capital flows each country should be able to achieve based on what other countries with similar characteristics and domestic investment environments are achieving.
  12. The distance between an observed input-output combination and the estimated frontier is used to quantify each unit’s relative efficiency. The obtained efficiency scores are normalized to range between 0 and 1, where units located on the frontier are assigned the maximum value of 1.
  1. For example, in the European Solvency II regime for insurers, capital charges are higher for less liquid assets and bonds with longer maturities and lower credit ratings. However, the European Union has introduced “discounts” on capital requirements for lower-risk infrastructure investments (project and corporate debt).
  2. The Organisation for Economic Co-operation and Development gives an annual overview of constraints on unlisted and private equity and debt, credit ratings, direct investments, infrastructure funds, foreign currency, and other instruments (OECD 2018). These constraints may affect different routes to infrastructure and financial sector investments. In practice, the constraints may be more binding in some countries (especially emerging markets) than in others.
  3. Examples are the European Union Markets in Financial Instruments II on the operation of asset managers and the European Union action plan for sustainable finance, including new disclosure rules and a green taxonomy. Such regulations affect the International Finance Corporation’s PCM platform approaches directly.
  4. Including only nonsovereign projects is because of pricing: nonsovereign financing by MDBs and most development finance institutions is close to market rates. Thus, it is easier to find private investors willing to join such a deal because they earn a market return commensurate with their risk. Sovereign financing by MDBs, however, is at rates well below the market. The low rates mean that investors would earn low returns relative to the risk they take compared with alternative investments in developing countries.
  5. The sovereign exposure exchange agreement is a risk management tool that the major MDBs developed collaboratively. This initiative was launched in October 2013 by the International Bank for Reconstruction and Development and endorsed by the MDB heads after a meeting of the Group of Eight ministers of finance. Unlike commercial financial institutions, which diversify their loan portfolios across thousands and sometimes millions of borrowers, the MDBs lend to their sovereign shareholders. The resulting asset concentration reflects the strength of the relationship between MDBs and their borrowers, but it also requires MDBs to hold additional capital.
  6. Asian sovereigns (for example, China and Japan) are the most active in infrastructure financing and crowd out opportunities for low- and lower-middle-income countries to pursue private capital in East Asia and Pacific and in South Asia. Several projects initiated by the World Bank or the International Finance Corporation in Bangladesh, India, and Mongolia in the energy or extractive sectors were financed by Asian sovereigns directly under their bilateral treaty agreements.
  7. These reasons include reducing moral hazard, exposing the borrower at least partially to the market to build toward future borrowings without MDB support, and not contaminating the market for MDB bonds, among others.
  8. A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
  9. Economic capital is the capital required for the Bank Group institutions to maintain their AAA rating.
  10. One way to look at the trade-off decision is to explore the causal relationship between a loss on a project and inability to pay by the sovereign—in other words, to assess whether the project risk can cause a sovereign loss or vice versa. Seen in this light, there are different potential lines of causality. The first line is from the project in difficulty to the sovereign in difficulty: Should a project not perform well, it may not be able to service its debt. But typically, it seems unlikely that a project default would lead to a sovereign default, except for an exceptionally large project in a significant sector, particularly for most middle-income countries. As such, project risk will necessarily be higher than sovereign payment risk because the latter is unaffected by a project default, thus justifying the need to hold more capital for project loans than for sovereign loans, which is reflected in differential spreads between project and sovereign lending. The second line is from the sovereign in difficulty to the project in difficulty: If a sovereign is facing difficulties with payments to its creditors, it is likely that it may not be in a position to meet its contractual obligations to projects. (It will also be likely that the economic situation in the country is deteriorating and projects are facing increased risk.) In such a situation, it is most likely (but not inevitable) that a project with, for example, a partial risk guarantee will face serious difficulties that could lead to a default on the commercial loans, which would trigger a call on the partial risk guarantee (assuming that it covers payment risk). Such a situation would indicate that the sovereign payment risk is highly correlated with project default risk, which means that a lender would need to hold the same or more capital for a project loan than for a sovereign loan. The third line, in the case of MIGA, is that the Council of Governors and Board of Directors set the maximum amount of contingent liability that may be assumed by MIGA as 350 percent of the sum of its unimpaired subscribed capital and reserves and retained earnings, 90 percent of reinsurance obtained by MIGA with private insurers, and 100 percent of reinsurance from public insurers. MIGA’s maximum net exposure is therefore determined by the amount of available capital after setting aside contingencies. The Council of Governors and Board of Directors approved an increase to 500 percent in 2016, in accordance with the procedures set forth in Article 22(a) of the MIGA Convention. In addition, the Board approved an increase in MIGA’s portfolio reinsurance limit from 50 percent to 70 percent of gross exposure.
  11. The obtained efficiency scores are normalized to range between 0 and 1, where units located on the frontier are assigned the maximum value of 1. In the presented study, the data envelopment analysis first calculates an empirical production possibility frontier for private capital flows, which is then used to rate the performance of each country relative to the frontier. This provides an estimate of the capital flows each country should be able to achieve based on what other countries with similar characteristics and domestic investment environments are achieving.
  12. The distance between an observed input-output combination and the estimated frontier is used to quantify each unit’s relative efficiency. The obtained efficiency scores are normalized to range between 0 and 1, where units located on the frontier are assigned the maximum value of 1.