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These policies were prepared for use by ADB staff and are not necessarily a complete treatment of the subject.


A. Introduction

1. Article 2 of the Agreement Establishing the Asian Development Bank (the Charter) requires the Asian Development Bank (ADB) to promote public and private capital investment for the development of the Asia-Pacific region and to cooperate with a wide range of institutions in doing so. Article 11 of the Charter stipulates guarantees as one of three basic operational modalities of ADB, along with loans and equity investments. Article 11(iv), in particular, allows ADB to carry out its operations "by guaranteeing, whether as primary or secondary obligor, in whole or in part, loans for economic development participated in by the Bank." Article 14 stipulates the operating principles applicable to ADB's operations. Article 14(xiv) specifies that ADB should be guided by sound banking principles in its operations. Article 15 gives ADB discretion to extend loans or guarantees to an entity other than a developing member country (DMC) without a guarantee from the DMC. Under Article 15.1, ADB is required to reserve the right to terminate its liability under its guarantees with respect to interest by offering to purchase the guaranteed obligation at par plus interest accrued from the date of default to the date ADB exercises its buyout option.

2. Credit enhancement products (CEPs) are risk-sharing and mitigation instruments that facilitate ADB's operations in line with para. 1. ADB's policy with regard to CEPs is set out in the Review of ADB's Credit Enhancement Operations.1 It is based on the following objectives and guiding principles:

(i) Client and development orientation. CEPs will benefit ADB's sovereign and nonsovereign clients in DMCs. They are an integral part of ADB's operations and their application will be demand driven. They will be grounded in and consistent with country strategies and partnership frameworks agreed with DMCs to support development goals, approaches, and priorities articulated in ADB's operational framework, including the Charter and various policy and strategy documents.

(ii) Effectiveness and efficiency. CEPs will increase the effectiveness and efficiency of ADB's assistance in terms of its development impact. ADB will therefore (a) forge effective partnerships with a wide variety of financing partners to mobilize risk-taking capacity for its sovereign and nonsovereign operations (thereby leveraging its balance sheet, filling gaps in the market, promoting investment in countries or sectors, and encouraging participation by financing partners in transactions they would not otherwise want to participate in); (b) focus on its comparative advantages (assuming long-term and/or sovereign risk) while letting its financing partners focus on their comparative advantages (assuming short-term, medium-term, and/or commercial risks); (c) build on the preparatory work

1 ADB. 2006. Review of ADB's Credit Enhancement Operations. Doc. R168-06. Manila.

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undertaken by financing partners; and (d) seek to cover the operational cost of its credit enhancement operations, including risk-adjusted cost of capital, as applicable to its sovereign and nonsovereign operations.

(iii) Market orientation. ADB will seek to complement, rather than compete with, other financing partners and not distort markets where they exist. In the absence of efficient financial markets, CEPs seek to foster market development. In any case, CEPs will conform as closely as possible to best industry practices.

(iv) Competitiveness. ADB will seek to ensure the competitiveness of all financing benefiting from CEPs in the interest of its DMC clients.2

(v) Innovation and flexibility. The policy encourages innovation, new product development, and flexibility in application.

(vi) Transparency and risk awareness. ADB's triple-AAA rating is central to its operations. In light of this, CEPs will (a) follow a principle of risk sharing and transfer to diversify and reduce risk concentration and leverage ADB's balance sheet for greater overall development impact; and (b) be applied in a transparent manner, with sound risk assessments and standards that are in line with industry practice for the risks assumed and those applied by ADB for its comparable direct financing operations, as appropriate.

(vii) Sustainability, safeguards, and other ADB policies. Beneficiaries of CEPs will comply with ADB's environmental and social safeguard policies and other policies applicable to ADB's operations.

B. Purpose

3. ADB's CEPs are instruments intended to facilitate cofinancing and financing partnerships. They are designed to reduce, eliminate, and/or better allocate a range of risks facing ADB's commercial financing partners and to leverage ADB's own capital base. CEPs support ADB's developmental objectives by facilitating investment, trade, and capital flows into DMCs.

C. Product Scope and Scale

4. CEPs are differentiated into two broad categories: guarantees and syndications.

5. Guarantees allow ADB to assume commercial and/or political risks arising under debt instruments provided by other financing partners. Guarantees may be unconditional or conditional and take the form of credit guarantees or political risk guarantees, but are not limited

2 For example, ADB would help the borrower to (i) solicit competitive proposals from prospective cofinanciers, and (ii) carry out a systematic evaluation of such proposals based on criteria agreed with the borrower and in accordance with best practice.


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to such forms. Guarantees increase ADB's risk exposure, but generally to a lesser extent than would be the case under an equivalent direct loan, and create less administrative work during implementation.

6. Syndications enable ADB to transfer some or all of the risks associated with its loans and guarantees to other financing partners.3 Syndications thus decrease and diversify the risk profile of ADB's financing portfolio. Syndications may be arranged on an individual, portfolio, or any other basis consistent with industry practices. Syndications may be made through a variety of structures, including the following:

(i) Fronting arrangements, which allow ADB to transfer or pass through all risks and share associated recovery rights with syndicate members with respect to a loan or guarantee provided by ADB under its name. Fronting arrangements constitute funded risk participations by third parties whereby ADB does not assume any credit risk on the underlying project. ADB also does not assume any counterparty risk on the performance of the financing partner. These arrangements include the lenderof-record (LOR) and guarantor-of-record (GOR) structures, whereby all the financial risk of the LOR or GOR tranche is typically borne by the syndicate members or, with regard to funding risk, by the borrower. The borrower has no contractual relationship with the institutions that participate in either an LOR or a GOR structure. ADB maintains responsibility for the administration of an LOR or GOR structure, including collecting and transferring payments of interest and repayments of principal under an LOR structure and recoveries under any LOR or GOR structure. A form of LOR widely known in the marketplace is the B loan.4 Fronting arrangements may combine various forms of CEPs. For example, ADB may provide a political risk guarantee for the benefit of B loan participants.

(ii) Nonfunded risk participation arrangements,5 which enable ADB to transfer risk and to share any associated recovery rights with respect to a loan or guarantee provided by ADB with one or more syndicate members. Under such arrangements, ADB may provide funding or risk-taking capacity against an undertaking by the syndicate member to compensate ADB in case of loss, for example, when ADB has better access to long-term, fixed rate local currency than its financing partners. In such instance, ADB may assume counterparty performance risk with respect to syndicate members. As with the LOR and GOR, upon default by the borrower and payment of scheduled payment by the participant, the risk participant will not have the right to step into the rights of or subrogate ADB against the borrower.

3 Depending on whether ADB retains risk or not, there may or may not be a contingent financial liability to ADB. 4 A B loan is a tranche of a direct loan nominally advanced by ADB (usually in foreign currency), subject to eligible

financial institutions taking funded risk participations within such a tranche. It complements an A loan funded by ADB. 5 Such arrangements might also be referred to as reinsurance depending on the parties involved and how and what risks are transferred.

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(iii) Sell-down arrangements, which allow ADB to fully pass on certain risks through transfers or assignments without any further contractual obligation by ADB with regard to the risk passed on.

7. Risks Covered. Guarantees and syndications allow ADB to share a wide range of risks that are inherent to its own lending operations with eligible partners. These include, but are not limited to, the following:

(i) political risks associated with expropriation, currency inconvertibility or nontransfer, political violence, breach of contract, and other events arising from political causes; and

(ii) credit risks associated with a borrower's inability to fulfill its debt service and repayment obligations on time because of events of a commercial nature.

8. Risk Sharing. Guarantees will be structured with a view to aligning the interests of ADB and its financing partners by ensuring that the financing partner shares some of the transactional risk. As a general principle, ADB will seek risk-sharing arrangements that set ADB's net exposure under a guarantee at the lowest level required to mobilize the necessary financing while maintaining a participation that is meaningful to its financing partners. However, within its prudential and other limits, ADB may be permitted to guarantee up to 100% of principal and interest under a financing partner's debt instrument if this is required from a business perspective.6

9. Eligible Financing Instruments. CEPs may support a variety of financial instruments that constitute debt obligations, but may not support financing provided under official development assistance.7 Debt obligations can be funded or unfunded and take many forms, including, but not limited to, (i) senior, subordinated, mezzanine, and convertible debt; (ii) project or limited recourse finance; (iii) tier 2 capital raised by banks; (iv) shareholder loans; (v) capital market debt instruments, including synthetic or structured securities, and related underwriting and liquidity support arrangements; (vi) performance, bid, advance payment, and other payment bonds and forms of bond issuances; (vii) letters of credit, promissory notes, bills of exchange, or other forms of trade finance instruments; and (viii) other forms of scheduled or contingent liabilities that constitute debt.

10. Eligible Financing Partners. CEPs may be undertaken with a wide range of international and local financing partners in the public or private sector, including, but not limited

6 For example, ADB may guarantee 100% of principal and interest in the case of guarantees for securitizations with respect to the assets held by an originator. In such cases, ADB will usually seek to share and mitigate risks further through syndication arrangements.

7 As defined by the Development Assistance Committee of the Organization for Economic Co-operation and Development, this comprises financial flows to developing countries and multilateral institutions provided by official agencies (including state and local governments or their executive agencies), with each transaction meeting the following test: (i) it is administered with the promotion of economic development and welfare of developing countries as its main objective; and (ii) it is concessional, with a grant element of at least 25% (calculated at a discount rate of 10%).


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to, commercial banks, development banks, insurance companies, pension funds, capital market participants, export credit agencies, export-import banks, suppliers, investors, insurers, reinsurers, and other commercially-oriented entities. ADB may share risks with official agencies (that is, those that exercise a public policy mandate) provided they do not obtain their transactional capital from official development assistance sources and do comply with marketbased principles in their operations, including the provision of commercial financing terms.8 ADB will assess on a transactional basis the suitability of financing partners to participate in any guarantee or syndication arrangement.9

11. In addition to the foregoing criteria, the following criteria apply to syndicate members under LOR and nonfunded risk participation arrangements: (i) for foreign currency loans, the transactional financing cannot be sourced from the country of the borrower or the project;10 and (ii) a syndicate member cannot require national content or tied procurement for its financing.

12. Further to the criteria in para. 10, the following additional criterion applies to participants under guarantee and GOR arrangements: for guarantees of foreign currency loans, the guaranteed funds must be sourced offshore, or at the time the guarantee is issued, it had to have been possible for the guaranteed funds to have been transferred outside the country of the borrower or the project.

13. Eligible Countries and Obligors. Any country eligible for loans from ADB's ordinary capital resources or from the Asian Development Fund can benefit from ADB's CEPs. CEPs can support sovereign, subsovereign, or nonsovereign borrowers, with or without direct sovereign indemnity or counterindemnity from the host country.

14. Sovereign Counterindemnities. Sovereign counterindemnities for guarantees are important risk mitigation instruments for ADB. For nonsovereign operations, they are optional, but in some cases may be required from a business perspective to make a transaction happen. A sovereign counterindemnity may enable ADB to apply sovereign loan equivalent-based pricing (para. 21), to extend tenors, and to increase limits, as transactions benefiting from such counterindemnity are not subject to ADB's nonsovereign exposure limits. For nonsovereign operations, a sovereign counterindemnity may be considered, in particular, if (i) the DMC or the project benefits from improved financial terms that translate into public benefits, or (ii) the obligor is owned in whole or in part by the public sector or is under direct or indirect control of the sovereign. Counterindemnities may also be appropriate for political risks that are under the control of the host government. For countries that can borrow only from Asian Development

8 In case of financing partnerships on noncommercial terms with official agencies, other arrangements for parallel or joint cofinancing that do not entail credit enhancement and risk transfers may take place, including contractual arrangements on procedural coordination or administrative and agency functions provided by ADB.

9 This will also include a consideration of the participants' financial health or creditworthiness. 10 However, for local currency loans, domestic institutions or offices or branches of a foreign institution that sources

financing locally in the country of the borrower are eligible to be syndicate members. (While there is no convertibility or transferability risk with a local currency loan, the syndication structure still benefits borrowers by simplifying administration and documentation, as ADB is the sole lender of record, and by completing the client's financing plan.)

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Fund resources,11 sovereign counterindemnities will be considered only if the underlying project has a strong development impact and does not undermine the country's debt sustainability.12

15. Participation Requirement. Any ADB financing instrument13 can satisfy the participation requirement for a guarantee provided that both the guarantee and ADB's anchor intervention have the same development objective and relate to the same sector or project, and that the guarantee is processed according to standards that are no less rigorous than those for direct, noncontingent investments by ADB, taking into account (i) the types of risks being guaranteed, (ii) the risks to ADB inherent in the guaranteed obligations, and (iii) the recourse to ADB following a payment under the guarantee.

16. Guarantee Facilities. ADB can provide guarantees through individual transactions or through facilities under which ADB may issue multiple guarantees. A guarantee facility may be processed as a multitranche financing facility,14 and should have a predefined aggregate exposure limit and a defined range of guaranteed risks and eligibility criteria for multiple guarantees to be issued by ADB there under. Once the Board approves a facility, management may approve subsequent transactions issued under the facility in accordance with procedures set out in the framework financing agreement and/or the related report and recommendation of the President with respect to the facility. Each guarantee issued under a facility will require an appropriate level of due diligence and analysis of the risks assumed by ADB and ADB's recourse following payment under a guarantee. This will include, but not be limited to, an appropriate and satisfactory review of legal, commercial, and financial matters.

17. Timing. Guarantees can be processed for approval at the time of processing and approval of the project or program that satisfies the participation requirement (the anchor investment), or at any time thereafter during implementation of the anchor investment and before ADB closes the related loan, equity investment, or technical assistance account. Syndications can occur before the financial close or during the tenor of the underlying ADB financing depending on market conditions; the status of the associated project; and the need for ADB to adjust its portfolio exposure from time to time, as necessary. If a guarantee is presented to the appropriate authorities for consideration subsequent to the approval of the report and recommendation of the President or technical assistance paper for the underlying anchor

11 Group A countries under ADB's graduation policy. See ADB. 1998. A Graduation Policy for the Bank's DMCs. Manila.

12 Although the underlying loan would normally be financed from market sources, the counterindemnity for any CEPs provided by ADB may be counted against the Asian Development Fund lending ceiling for the country. The final assessment in this regard will be made during processing, and will also take the project structure, the scope of coverage, and the country's debt sustainability (including the ability of the country or project to indemnify ADB with foreign exchange in case of default) into account. The assessment of debt sustainability would normally entail consultations and understandings with the International Monetary Fund, as appropriate.

13 Such as project loans, program loans, multitranche facilities, sector loans, sector development programs, equity, project grants, technical assistance grants, or any other financing form that the Board may approve.

14 The Pilot Financing Modalities and Instruments Project (R194-05) approved the use of a multitranche financing facility (paras. 34--43), and approved its application to guarantees (para. 42). ADB. 2005. Pilot Financing Modalities and Instruments. Manila.

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