A study report on Pooled Finance Development Fund, from the purview of public transport studies- towards the partial fulfillment of credits for the course Development Finance at the School of Planning and Architecture, New Delhi (November 2020)
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Pooled Finance Development Fund UPC3.2 Guide
1. Department of Urban Planning
UPC 3.2: Development Finance
Pooled Finance
Development Fund
Prasad Dipak Thanthratey
SPA/NS/UP/1409
Guided By:
Prof. M Palaniappan
School of Planning and Architecture, New Delhi
2. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
CONTENTS
POOLED FINANCE DEVELOPMENT FUND...............................................................................2
OBJECTIVES OF POOLED FINANCE DEVELOPMENT FUND.................................................2
BENEFITS OF POOLED FINANCE DEVELOPMENT FUND .......................................................2
WHAT IS STATE POOLED FINANCE ENTITY?.............................................................................3
OBJECTIVES OF STATE POOLED FINANCE ENTITY.................................................................3
GUIDELINES OF SPFEs ..................................................................................................................4
RESPONSIBILITIES OF SPFEs..........................................................................................................4
NATIONAL CASE STUDY ..............................................................................................................4
INTERNATIONAL CASE STUDY....................................................................................................7
FINANCE STRUCTURE...............................................................................................................8
LESSONS LEARNED FROM RUSTENBERG MODEL ..............................................................9
LIST OF FIGURES
Figure 1Pooled Finance Model, Karnataka Water and Sanitation Fund ....................5
Figure 2 Structured Payment Mechanism: Karnataka Water & Sanitation Pooled
Fund Structure ..............................................................................................................................6
Figure 3 Location of Rusteberg in South Africa...................................................................7
Figure 4 Financial Structure: Municipal Project Finance In Rustenburg, South Africa
..........................................................................................................................................................8
3. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
POOLED FINANCE DEVELOPMENT FUND
The Pooled Finance Development Fund Scheme (PFDF) has been set up by the
Central Government of India.
The main aim of the Government authorities is to provide credit
enhancement facilities to Urban Local Bodies (ULBs) based on their credit
worthiness through State-Level-Pooled Finance Mechanism.
This will enable them to access market borrowings through state-level pooled
mechanism. PFDF is to ensure availability of resources to Urban Local Bodies in
order to improve urban infrastructure and ultimately attain the goal of self-
sustainability.
OBJECTIVES OF POOLED FINANCE DEVELOPMENT FUND
• Facilitate development of bankable urban infrastructure projects through
appropriate capacity building measures and financial structuring of projects.
• Bankable projects within the context of PFDF are defined as those projects
structured with appropriate credit enhancement measures in such a way that
they demonstrate the capacity for servicing the market debt to the satisfaction
of the rating agencies and potential investors.
• Facilitate Urban Local Bodies to access capital and financial markets for
investment in critical municipal infrastructure by providing credit enhancement
grants to State Pooled Finance Entities (SPFEs) for accessing capital markets
through Pooled Financing Bonds on behalf of one or more identified ULBs for
investment in identified urban infrastructure projects.
• Reduce the cost of borrowing to local bodies with appropriate credit
enhancement measures and through restructuring of existing costly debts.
• Facilitate development of Municipal Bond Market.
BENEFITS OF POOLED FINANCE DEVELOPMENT FUND
• Urban local bodies proposed projects are progressive projects are able to
access market resources for generating funds.
• capitalizing on the projects which are running and also the projects which are
proposed can increase the ranking of financial credit enhancement reports by
facilitating the details of various revenue generating sources.
• market bonds can also available the scheme to provide financial support.
For implementing Pooled Finance Mechanism, a State Pooled Finance Entity (SPFE)
shall be required to be set up in each state.
4. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
WHAT IS STATE POOLED FINANCE ENTITY?
• To achieve proper implementation of the Pooled Finance Development
Scheme (PFDF), a State Pooled Finance Entity (SPFE) has to be established in all
states.
• The center extends support to SPFE via the Pooled Finance Development Fund.
Around 5% funds for PFDF will be used for project development while the
remaining 95% should be used for Credit Rating Enhancement Fund (CREF) to
boost the ratings of municipal bonds.
• The cost of development of a project for each ULB has to be analyzed (75% will
be reimbursed by the center and 25% by union territory/state governments).
• It is important to note that the central government will contribute 10% of the
proposed bond issue or 50% of CREF, whichever is less. The accounts of Credit
Rating Enhancement Fund are managed by the State Pooled Finance Entity.
• The CREF funds are invested in bonds of various financial institutions rated AAA
or Government of India bonds.
• It is important to note that the bonds issued as per the pooled finance
development scheme are tax-free.
• All the same, the dividend income and interest earned from CREF is not tax
exempt.
OBJECTIVES OF STATE POOLED FINANCE ENTITY
The State Pooled Finance entities have the following objectives:
• Buy bonds of Urban Local bodies
• Responsible for the management of Credit Rating Enhancement Fund (CREF)
• Decrease the borrowing costs to local bodies courtesy various credit
enhancement measures and debt restructuring
• Boost the growth and development of various projects on bankable urban
infrastructure
• Pave way for greater access of Urban Local Bodies to financial and capital
markets aimed at improving critical municipal infrastructure
• Collaborate with Urban Local bodies for successful implementation of urban
infrastructure projects
• Pick the desired projects on the basis of viability analysis
• Plan and mobilize the required resources by issuing bonds for investment in
various projects
• Work towards getting appraisal for projects from credit rating agencies for
planning large investment
5. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
• Draw up various projects which are technically sound apart from being in line
with relevant environmental regulations
• Sign agreements with Urban Local Bodies and the central government
GUIDELINES OF SPFEs
• Facilitate Urban Local Bodies to access capital and financial market for
investment in essential municipal infrastructure.
• Reduce the cost of borrowing to local bodies with appropriate credit
enhancement measures and through restructuring of existing costly debts.
• Facilitate development of Municipal Bond market.
• Facilitate the development of bankable urban infrastructural projects.
RESPONSIBILITIES OF SPFEs
• Work in close collaboration and co-operation with the Municipalities/Urban
Local bodies in urban infrastructural development projects.
• Select projects based on viability and priority.
• Get appraisal for the projects by recognized credit rating agencies in order to
attract larger investment.
• Mobilize resources by means of issuing bonds and redirecting funds for
investment in projects.
• Purchase bonds of ULBs or provide sub-loans to them.
• Set up and manage Credit Rating Enhancement Fund (CREF).
• Sign appropriate agreements with the Central Government and
ULBs/Municipality.
• Prepare projects that are technically and financially stable and in tune with
environmental norms.
NATIONAL CASE STUDY
KARNATAKA WATER AND SANITATION POOLED FUND
In 2005, the Government of Karnataka (GoK) accessed market borrowings through
the pooled finance mechanism to finance the Greater Bangalore Water and
Sewerage Project (GBWASP) proposed to be implemented across (erstwhile) seven
CMCs and one TMC adjoining the Bangalore Municipal limits.
These CMCs and TMC have since been merged with the Bangalore Mahanagar
Palika in 2006-07.
6. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
The overall cost of the project was approximately Rs 340 crore, which was
proposed to be funded by a variety of sources including a pooled bond issue of
Rs 100 crore.
In order to access the municipal bond market, the GoK constituted the Karnataka
Water and Sanitation Pooled Fund (KWSPF) as a SPV, specifically created to tap
the market borrowings.
Karnataka Urban Infrastructure Development and Finance Corporation (KUIDFC),
which is the nodal agency in Karnataka for implementation of externally aided
projects, acted as the asset management company for the trust.
KWSPF (the issuer) issued Rs. 100 crore of fixed coupon tax-free pooled finance
bonds in July 2005.
The bond issue was rated LAA (SO) by ICRA, indicating high credit quality, and was
fully subscribed.
The issue had a tenor of 15 years with a 3-year moratorium and did not carry any
put/call option. Therefore, repayment would start from the fourth year with the
principal redeemed in twelve equal instalments.
The bonds carried a coupon rate of 5.95%
Figure 1Pooled Finance Model, Karnataka Water and Sanitation Fund
7. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
Timely repayment is being ensured through a structured payment mechanism
monitored by Canara Bank, which was appointed as an independent trustee to
the bond holders.
The KWSPF Trust issued loans out of the pooled bond proceeds. Each of these
underlying loans was backed by a structured payment mechanism whereby the
erstwhile city municipal corporations (CMCs) concerned will fund 1/10th of their
annual repayment instalment by depositing equivalent funds in a designated bank
account.
These balances will then be pooled together to fund an escrow account opened
in the name of the KWSPF Trust. The bond holders will be serviced from the funds
lying in this escrow account. Further, well before the bond holders due date, the
Figure 2 Structured Payment Mechanism: Karnataka Water & Sanitation Pooled
Fund Structure
8. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
independent trustee will check the adequacy of funds in the escrow account and
issue notice to the GoK to top up the deficit, if any.
GoK will be obliged to top it up to the extent of deficit. If there is a deficit even
after this top up, the KWSPF trustee will utilize the Bond Service Funds (sized at Rs
25.5 crore). The BSF will be topped up within 60 days of the utilization by a
combination of a USAID guarantee (50% of bond principal) and the GoK.
The BSF was sized by the rating agency (ICRA) at Rs 25.5 crore in order for the bonds
to achieve the target LAA (SO) rating. This BSF was funded upfront and hence
acted as a source of credit enhancement. Also acting as credit enhancement was
a guarantee from USAID to the extent of 50% of the bond principal.
The rating agency initially made an assessment of the standalone credit quality of
the CMCs. Though not strictly a credit enhancement, the GoK promise to intercept
devolution funds (the devolution funds are an essential component of the financial
strength of the CMCs duly reflected in their standalone credit quality assessment)
provided comfort to the extent it imposed an element of discipline in debt
servicing. The prefunded BSF and the USAID guarantee are designed to provide
support in the event of default by the CMCs and the inability of the State
Government to provide the requisite top-ups from devolution funds.
INTERNATIONAL CASE STUDY
MUNICIPAL PROJECT
FINANCE IN RUSTENBURG
(SOUTH AFRICA)
Year: 2003
Approach to Pooled Finance:
To address vital wastewater
infrastructure needs, the
Municipality of Rustenburg created
the Rustenburg Water Services Trust
(RWST) to finance and upgrade
infrastructure.
The Trust secured revenues from
municipal bulk water sales and an
off-take agreement with two local
mines.
This revenue security, and the ring-
fencing of the RWST as a special
purpose vehicle (SPV), enabled commercial finance to be accessed in the form
of a bank loan.
Figure 3 Location of Rusteberg in South
Africa
9. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
The establishment of a Trust, with revenues ring-fenced from the municipality and
strong operating arrangements, provided comfort to the lenders and helped to
soften lending terms.
Revenues provided by the two mines for the purchase of effluent created a strong
revenue stream for the Trust, and helped secure a commercial loan from ABSA
bank.
The public sector (including the Department of Water Affairs and Rustenburg
Municipality) played a key role to help structure a transaction that addressed
critical water resource needs for the municipal area
FINANCE STRUCTURE
• In 2003, the RWST was established as a financially independent municipal entity
and the infrastructure project was effectively ring-fenced under the Trust to
protect assets. A Board of Trustees was setup for RWST, with four representatives
from the Municipality, and three from the consortium (Magalies Water, ABSA
bank and Bigen Africa).
• The Municipality is the majority stakeholder and sole beneficiary of the Trust.
The structuring of the project ensured that the municipality maintains full control
over the Trust, in accordance with South African legal requirements. However,
the Trust’s constitution regulates the transfer of funds between the Trust and the
Municipality, thereby reducing the risk of municipal interference.
Figure 4 Financial Structure: Municipal Project Finance In Rustenburg, South Africa
10. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
• The RWST obtained a limited recourse loan from ABSA to finance the water and
wastewater infrastructure upgrades and expansion. The loan was for R280
million (US$37 million), with a 20-year term.
• The key to securing commercial finance from ABSA bank was the long-term
off-take agreement between the RWST and the two local mines. The sale of
treated effluent to the mines constitutes 50 percent of the SPV’s revenue, and
created a reliable revenue stream, important for investor confidence.
• The remaining 50 percent of RWST revenues come from the Municipality, which
pays RWST for the supply of bulk water and provision of sewerage services from
the collection of water and sewerage tariffs at the household level.
• The pricing for bulk water was benchmarked against that of a large well-known
bulk water operator, Rand Water, to guarantee that the price of water being
produced in the project was not higher.
• Revenue from these income streams help service the debt, and pay for
maintenance and operations by the water service operator.
• A strong governance structure, ensured sustainable operations and
management.
• Institutional and technical capacity at the SPV level provided comfort to the
commercial lenders.
• The presence of engineering specialists as trustees, and the procurement of an
experienced Operator to manage the facility added to ABSA bank’s
confidence in the investment.
• A contractual provision for automatic review and re-bidding of the Operator
after a specified period of time was also included in the overall structure, to
ensure that strong performance would be maintained over time.
LESSONS LEARNED FROM RUSTENBERG MODEL
The Rustenburg case proves that relatively small and financially weak
municipalities can raise significant funding through well-structured projects
with strong revenue streams from private sources. The revenues received from
the mines as part of the off-take agreement helped with the establishment of
a creditworthy body (the RWST), and involved mixing revenues from two private
sources—the mines and households (through tariff collection)—to secure
commercial finance. Public funds were used mainly to help structure the
transaction. The Trust was allowed to ring-fence the project, provide O&M
capacity, and ensure continued legal compliance. The public sector, through
the Municipality of Rustenburg and the Department of Water Affairs, played an
essential role in initiating and driving this transaction forward through close.
11. Pooled Finance Development Fund UPC3.2: Development Finance
Prasad Thanthratey SPA/NS/UP/1409
Granting SPV authority to a public sector entity helped mitigate concerns
related to the handing over of public resources to the private sector.
Rustenburg Municipality was named the beneficiary of the RWST (this followed
a requirement in the South African Municipal Systems Act), thereby avoiding
political issues typically encountered over public-private partnerships.
Benchmarking bulk water tariff pricing allowed overcoming of political
challenges. The Trust was responsible for providing bulk water and sewerage
services to the Municipality, which was then in charge of distribution and bill
collection. Potential issues over setting bulk water tariffs were overcome by
benchmarking the tariffs against those charged by another large government
parastatal.
There is high potential for replication in areas where industry has a stake in
improving outcomes. Private sector companies can provide reliable revenue
streams and can pledge such revenues in exchange for increased security of
supply. A prerequisite for reproducing this model would be to identify private
companies that have a high demand for water and steady revenue streams.