Sovereign Guarantees – In Conversation w/ Gadi Taj Ndahumba

In Conversation w/ Gadi Taj Ndahumba

This video features an interview with Gadi Taj Ndahumba, Chief Legal Counsel at the African Legal Support Facility (ALSF), and focuses on the use of sovereign guarantees on the African continent. The conversation extends far beyond the standard talking points about sovereign guarantees reducing offtaker risk and enhancing project bankability, and Gadi offers important insight into governments’ perspectives on the use of this tool. We discuss how use of sovereign guarantees may affect the perception of a government’s financial position and ability to raise debt, unique considerations for public finance in Sub-Saharan Africa, whether a sovereign guarantee represents a direct or contingent liability, and the difference between an implicit and explicit contingent liability. This conversation will be especially valuable for private sector investors and IPPs who are interested in better understanding the government perspective on this de-risking tool.

If you’d like to be put in touch with Gadi, please reach out to the Pivotal180 team at sales@pivotal180.com

For more materials on sovereign guarantees, check out Pivotal180’s blog series on the topic:

Sovereign Guarantees - In Conversation w/ Gadi Taj Ndahumba

Okay, welcome everyone. Thanks for joining us today. We have a really good conversation coming for you today, and a very special guest. We have Gadi Taj Ndahumba from the African Legal Support Facility, which is a really fantastic organization. I’m a big fan of their work. And today, we’re gonna be talking to you about sovereign guarantees. Sovereign guarantees are a tool that probably a lot of you are familiar with, but maybe don’t have a super in-depth understanding of it or maybe haven’t had the chance to get a really nuanced look at how this tool functions on the African continent. So that’s gonna be a really good discussion but before we get into the meat of that, I would love to give Gadi a chance to introduce himself. Welcome Gadi, and can you tell us a little bit about the ALSF and your work at the organization?

– Thank you, Fiona, and thank you very much for inviting me today. So yeah, my name is Gadi Taj Ndahumba. I’m working at the African Legal Support Facility which is an international organization that provides government support to African countries’ governments for the negotiation with private sector actors in some of the key sectors on the continent, like mining, oil and gas, energy, also sovereign debt and infrastructure in general. The thinking being that for a long-term relationship with the private sector, the government needs to have fair and balanced contracts. So I’m a lawyer. Chief Legal Consult, obviously from the African Legal Facility. So we’re mostly lawyers in my organization and we help the government negotiate these contracts. We work quite a bit in the energy sector, especially with IPPs. So we’ve dealt with a lot of the structuring of these transaction across the continent. We work mostly in Subsaharan Africa, but also a few projects in North Africa and, yeah, across.

– Right, thanks Gadi. Yeah, we’re very happy to have you with us today. You know, Gadi’s an attorney with many years of experience in the power sector. He also has a lot of financial qualifications. So he’s kind of the ideal person for us to talk to about how, you know, a project’s legal structure or the contractual obligations in a project, for example, a renewable energy IPP project, how those contractual obligations impact, not just the financing of that project itself but also financial considerations for the host government or, you know, the host institution. Perhaps the offtaker in the energy project. So yeah, really, really great to have you with us. And so, yeah, we’re gonna talk about sovereign guarantees today and one of the particular angles we’re gonna talk about is from the government’s perspective. How is a sovereign guarantee perceived. The concerns related to it. How this instrument potentially does or does not impact, you know, a debt ceiling or a government’s perceived ability to repay obligations. But again, before we get into those details. Gadi, could you just recap for us, what is a sovereign guarantee? What is this tool and, you know, why is it important in the region where you work and the context where it can be useful or potentially even required?

– Yeah. Yeah, when I came to work at the facility, I think that was one of the first part of the structure that I had not seen in Canada. So I used to practice in Canada before that, also in the renewable energy space. I mean, there are few factors that you need to consider or a few feature of these markets that you need to consider before understanding why the sovereign guarantee is so important. But the first one is that most of the markets in Subsaharan Africa are markets where the utility is still stayed on. So the government still own the utility, obviously. That’s one of the feature.

– Mm.

– The second one being that the utility is rarely financially viable. So they have some forms of subsidies or at least some support or guarantee coming from the government to help them with their operations. It would be long to explain why this is the case, but it’s just economies in which the big part of the consumer base cannot afford electricity. So you need to either lower the tariff or have some form of subsidies or have different tariff for commercial and regular consumers. The fact that the state-owned utility is not financially viable means that when an IPP entered into a power purchase agreement with the utility, it will be concerned that if the utility is not able to pay, the project will be in trouble. The power plant will be in trouble. Obviously you can’t take your power plant and just leave with it and go into another country. Although there are some solutions where you could do that, but most of them you can’t. So because of that, you want to have a backstop to the obligation of the utility. So what has been quite common and customary in structuring IPP on the continent is to request the government to issue a sovereign guarantee, which will guarantee the obligation of the utility, most of the time, a state-owned utility. So the government has an interest to do that, and that guarantee will only kick in if the utility does not pay. There is different ways to structure the guarantee. It can be a guarantee for every single payment. It can be a guarantee only if there is a termination of the power purchase agreement. So for what they call the termination payment. And one other aspect that is important to understand is that it’s typically not only the IPP but mostly the lenders who will require the sovereign guarantee because they wanna make sure that they have a way to have their debt repaid.

– Mm-hmm.

– So you get into a situation where, for the IPP to be able to provide an affordable tariff, they need to raise some debt because the cost of debt will be lower than the cost of equity. But to do that, the lenders will require a sovereign guarantee. So the government has an incentive or structural incentive to issue a guarantee to ensure that the tariff will be as low as possible. Another aspect that is important to know is that a sovereign guarantee is not necessarily a standalone document. It is a concept that could be a single instrument, a single document, but it’s often within a larger agreement like an implementation agreement or a concession agreement. So it’s not because you don’t see sovereign guarantee in the list of the documents that it’s not. And the concession and implementation agreement are not necessarily required in more developed economies, but on this continent it’s often gonna be there for some other form of guarantee. It’s not really guaranteed but they will take some commitment on the regulation, change in laws, and things like that. So without getting into this, just know that a sovereign guarantee is not necessarily called as such. It can be within a larger agreement. As long as it’s with the government and not the utility.

– Okay, that’s helpful. It’s not necessarily a separate document.

– Yeah.

– Like, it could be-

– Could be.

– Part of a proposal.

– Yeah.

– Could be. Okay, so that’s helpful. Thanks, Gadi. Yeah, for our viewers who know a little bit about project finance, this all starts to make sense because in the context of an IPP project where the IPP is responsible for, you know, designing, building, but also financing the project and owning it, operating it for, you know, several decades probably. The security of the cash flow coming from the offtaker is really key. Gadi said, you can’t just walk away with your power plant and do business elsewhere. So, yeah. Feeling secure about the cash flow coming from the offtaker is kind of the bedrock of financing power plants and having the government back that up can be really useful. So yeah, I guess we can see how a sovereign guarantee is really attractive and beneficial from the private sector side and can facilitate their investment. Can facilitate their ability to access, perhaps, debt from another financial institution. That’s all well and good. But from the government perspective, sometimes we see governments a little bit hesitant to issue sovereign guarantees or they’re kind of wary of using this tool. Could you tell us a little bit about why that might be and what those concerns are?

– Yeah. So what’s interesting at the ALSF, the African Legal Support Facility, is that we work always on the side of the government. It’s actually quite rare in the market to always be in the shoes of the government and try to understand how the structure affects them, and not only on a project level. ‘Cause typically, I mean, as experts, if we’re only project specific, we have a tendency to only look at that and understanding how this structure can be viable is one step. But for the government, it has to understand also the impact on a wider sector, but also honor wider government finance. And sovereign guarantees, have been there for quite some time but I would say in the last six to eight years, they became a bit more controversial.

– Mm.

– It’s not often framed that way but the one way I like to frame it is that government have been, African government, trying to develop their energy sector are told by development finance institution. You should try to keep some of your liquidity and some of your finance potential for part of the economy and part of your social programs that you cannot finance through the private sector. So you should leave the assets and the activities that can be financed by the private sector to the private sector. So you can use your public finance potential in social programs, education, hospitals, and things like that. Hospitals could be partly privatized but some of it cannot, and things like that. There was this discourse. It’s also a really fair argument, but at the same time, it becomes difficult for a government that are being told this as a first step and then issue guarantees and are told that the guarantee is ultimately a contingent liability. And we’ll get into what it means, but that guarantee has an impact on their borrowing capacity. So typically what you will hear on the market is the guarantee will affect the balance sheet of the government.

– Mm.

– What is meant by that is that the government will have more difficulty raise debt to borrow if they have issued a lot of sovereign guarantees, which is a bit counterintuitive if you take it with the initial argument that-

– Yeah.

– the private sector financing is supposed to help you-

– Mm-hmm, yeah.

– have more funding for the rest of your activities. If then you’re told, but the sovereign guarantee that you issued in this part of your economy or sector is actually affecting your ability to fund the rest. So what you’ve seen in recent years is more and more government pushing back on issuing the sovereign guarantee, and the argument was there is a contingent liability that will occur or appear or stem from the sovereign guarantee and that contingent liability will affect my balance sheet. So I don’t want to issue it. If the private sector wants to fund that IPP, they can, but I don’t want to be involved and have a contingent liability. Contingent liability. Let’s try to explain that really quickly.

– Mm-hmm.

– So contingent obviously. So it’s not a direct liability. So normally you’re not supposed to… And this is the same for a government or for a company, you’re not supposed to see a contingent liability in your liability column on your balance sheet. It’s not a direct liability.

– Mm-hmm.

– It will be contingent to an event. So in the case, if we take the IPP.

– Okay.

– The government is only on the hook for the payment, either of the termination payment or the periodic payment if its utility does not pay-

– Mm-hmm.

– The IPP. So you don’t really have liability, right? It’s the same way-

– Mm-hmm.

– Your mother will guarantee your rent payments and she will only step in if you, as the children or the child, I should say, don’t pay when you’re a student at university. Right?

– Mm-hmm.

– But it’s still potentially a liability. So the contingency of that liability makes it that the government has to treat it in a specific manner when it comes to public finance, and this is where there is a bit of debate on how exactly it will unfold.

– Mm-hmm.

– But ultimately, what you also have to take into consideration, and we can get into this a little bit later, is that public finance on this continent is a bit different than it is in most developed economies because you need to also not validate but have the view of the IMF on your finance. I mean that this will count a lot in the way your public finance are perceived by other countries, but also investors and lenders for government as well.

– Mm-hmm. Yeah, so it’s kind of an additional consideration that governments in Sub-Saharan Africa have that maybe is not as present in perhaps, you know, the U.S. or Europe.

– Exactly, and Canada.

– Okay. Just to recap, make sure I’m also understanding properly. So the sovereign guarantee would originally function as a contingent liability-

– Mm-hmm.

– Not a direct liability. It would only become a direct liability in the case that, for example an IPP project, the utility defaults on its obligations for the project and then the government must step in. It’s otherwise not a direct liability on its balance sheet.

– Exactly, exactly.

– Okay.

– So it really converts from the moment it becomes a due and payable.

– All right, so taking all this into account. From your perspective, do you find this to be a reasonable concern or a reasonable path to go down for governments that are, you know, perhaps in support of an IPP project? They want the project to happen but they’re thinking maybe the sovereign guarantee isn’t the way to go. It’s gonna be a problem for us when it comes to debt sustainability or ability to access more debt. Can you share a little bit of your take on that?

– Yeah, so it’s definitely a valid concern and I totally understand where they’re coming from with this. Again, the impact or at least the perceived impact of sovereign guarantee on your balance sheet, as it is often put, and I’m not totally aligned with that description of it, but that’s often said. It is really frustrating when you’re trying to actually-

– Yeah.

– allocate your public finance potential to other programs but you’re told that what you have allocated to the private sector ultimately affects your ability to borrow for other sectors. So I totally understand that. However, I’m not sure. Actually my perception or my analysis of the impact of contingent liabilities is that whether or not you issue a sovereign guarantee, if your state-owned utility takes on obligation, such as a PPA with an IPP-

– Mm-hmm.

– Whether or not you have a sovereign guarantee, you will have a contingent liability. And the reason why I’m saying this is if you understand it, that’s the reason why I, specifically, named the IMF a little bit earlier. Is that if you look at the way the finance… Sorry, the public finance-

– Mm-hmm.

– is perceived for a country on this continent, it’s often through the analysis of the IMF through Article 4. So the IMF looks at the public finance of a government. They make an assessment of it. They look at the balance sheet. They look at other aspects of the economy, and ultimately will give a view on the financial strength of the government. That process involves not only an assessment of the direct liabilities. The revenue, obviously-

– Mm.

– but the direct liability of a government. It will take into account the contingent liability and the direct liability of the state-owned enterprises. So what happens is they take a view that any financial economic actor of a country that are what we could easily refer, and we have that expression in the U.S I believe, too big to fail.

– Yeah.

– So the actors that are too big to fail.

– What it reminds me of to.

– Exactly. Are computed in their analysis. So what they will do is they will look at not only again, as I said, the government finances, but for our example, they will look at the utility because the utility is a vital, vital actor of the economy. Without a utility, you don’t have the most important actor of the electricity market. And if your electricity market fails, you’re economy basically fail. So in theory, and it’s not always the case, but normally you will see an analysis of the full balance sheet of the utility or at least the biggest obligation of the utility. And they will be either consolidated with the balance sheet of the government or assessed individually, but they will be stress test in the same way-

– Mm.

– As the contingent liability that the government level will be stress test. And when we say stress test, is they’re gonna look at some factors. Potential variation or economic variation that would impact the financial strength of the government, and one of the big one is the currency devaluation. So they look at how much the currency can devaluate before the government is in trouble. So technically if a state-owned utility signed a PPA in which the obligation that are typically guaranteed by the sovereign guarantee.

– Mm.

– If these obligations are at the utility level, they will be assessed in the IMF analysis. So the contingent liability is still there because the government needs to step in to save its utility if its utility fails. Right, because it’s such an important actor. The sovereign guarantee allows the government to do two things. It allows the government to actually put a framework on that contingent liability because it agrees with the lender, beforehand, some of the notice and cure periods that will allow the government to intervene to try to avoid the obligation to become fully due. Right? So if, for example, the government has issued a sovereign guarantee in which there is a notice period and they’re informed that the utility has failed to pay and will be in full breach within 60 days, for example. It allows the government to step in before. Make the payment before the big bulky termination payment becomes due.

– Mm-hmm.

– So there is a way of structuring this notice period and cure period for the government to actually have first ensured that it’s aligned with its own internal processes to have the ability to intervene. ‘Cause government cannot pay just in one-

– Yeah.

– In one go, right? Like it has to authorize payment and have some internal processes that are completed. So if you don’t know your contingent liability becomes due, you won’t be able to intervene in time. But if the lenders and the IPP have obligations towards the government to inform them of a default, they have some ability to anticipate this liability. So that’s one of the factors. The second one is it gives them an ability to look into what the utility is doing because we had a few example across the continent where the utility took on some really big PPAs and not necessarily with bad intentions. It’s just sometimes you’re trying to plan your sector, and you want to get some electricity on the grid and you take on a big obligation through the PPA. But overall, if the ministry of finance is not informed and ultimately on the hook for it, it’s really problematic. They should know what type of obligation their utility is taking on. So they can actually map them across their different state-owned enterprises or companies-

– Mm-hmm.

– ‘Cause they can also be in other sector. Not only electricity. So they can map them and try to understand how much contingent liability the government actually has, and it can act on trying to reduce them or at least put money on the side and things like that. Obviously it doesn’t always happen, but that’s the ideal scenario and that’s only possible if you know about your contingent liabilities.

– Mm-hmm. Makes sense, yeah. Yeah, it makes a lot of sense having the transparency and understanding upfront. So essentially there’s this situation we have where it’s assumed that, at least, you know, by the IMF or maybe broader capital markets, that because the utility or similar state-owned institutions are so crucial to the country’s operation and economy, the government’s gonna step in and bail them out anyways if they default on a PPA. So much better to know about it upfront and also potentially would be a… Would you say, like a less messy process if they did need to step in? If the government did need to step in because they’d be clear on the process and the timing and their exact role in the end?

– Yeah. And I’m not an expert in that, but there’s also some thinking around… So you can look at the PPA and it has to be assessed and analyzed. But you can look at the PPA and the cure period in the PPA, right-

– Mm-hmm.

– and then you can make sure that with the cure period of sovereign guarantee, the payment is not possible within 12 months. It’s often negotiated down ’cause they wanna have the ability to get their money-

– Mm-hmm.

– before a year. But if you’re the government and you’re involved and you actually wanna structure this in the way that is the most optimal for you, what you will do is to make sure that if there is a bulk payment or a termination payment to be paid, it will not be within the year, right. Because-

– Mm-hmm.

– What would happen is if they start a year and they have a contingent liability of sometimes you have a power plant that can cost a billion dollar, for example. That’s a lot of money, but it’s possible. You would have a significant reserve payment. Even if you have 30% of probability that the contingent liability becomes a direct one. Right?

– Mm-hmm.

– So if you do have that in a year. Normally, within a year. I mean, normally you would have to make that reserve account to set it up in the same year. But if you cannot have a situation where you need to pay within a year because you have cure periods that would bring it due, and it’s not atypical to see a year and a half before the full payment is due because they have some instruments in between that the IPP can pull on for liquidity until you get there. If you have that, that means that the government does not necessarily have to put a lot of liquidity on the side or at least to put some line in their budget for it. And as the year progress and the probability increase for X reason, then they can start anticipating that for the next budget of next year and try to have some visibility. Because one of the issues, you also don’t want a power plant to push the government to have a lot of lines-

– Mm-hmm.

– and reserve account just because they’ve issued a sovereign guarantee. So there is some accounting there to be done, but that can be structured through the understanding and optimizing that instrument. And as you said, it’s definitely less messy if you’ve been informed from the first breach and you could-

– Mm-hmm.

– as the government, participate through the discussion to try to fix the situation. I mean, ultimately it’s also for the lenders to be sure that the government is fully aware of that project, right, ’cause utilities have some form of autonomy. And that’s totally fine, but for such a huge investment which will require a sovereign guarantee, the lenders through that instrument are making sure that the government is fully aware and endorses that financing. And it makes sense, since you hardly see how you could build all of this if the government is not aligned with this.

– Mm-hmm.

– There’s so many license aspect, environmental aspect, land issues. Land on this continent

– Mm-hmm.

– is definitely something you need to make sure is properly secured and respect some different sets of law.

– Mm-hmm.

– There’s not only the law, but some traditional rights on the land that you have to consider. So there are various aspects that make it so that I can understand why a lender would want to make sure-

– Mm-hmm.

– that the government is fully endorsing that project. And it’s really rare that a government is gonna issue a sovereign guarantee for a project and they’re not endorsing it. So, yeah.

– Having everyone at the table, at least everybody understands the obligations from the beginning.

– Yeah.

– Less messy.

– Yeah.

– That’s a technical term. You can write that down, less messy.

– Less messy.

– For next time.

– Yeah, I’ll use it next time.

– Yeah. Great, okay. Yeah, that’s really interesting. So in essence, by avoiding the sovereign guarantee, you’re actually not avoiding a contingent liability-

– Yeah.

– in the end. Okay. So much to say about that-

– Okay, yeah. Obviously you could take the really like rigid analysis or view that you’re saying if the government does not issue a guarantee, they don’t have to pay for the PPA. That is true if you only look at the legal mechanism.

– Mm-hmm.

– But the concept that I’m referring to is what they call an implicit guarantee.

– Mm-hmm.

– At the end of the day, if your utility does not pay the PPA and it’s in default and ultimately becomes bankrupt, what you gonna do? As a government, you need to have a utility that supplies electricity. Especially in jurisdictions where typically, for distribution and transmission, it’s a single entity and they have a monopoly, right.

– Mm-hmm.

– So even if you would want to create a new one, that’s not something you can do within a couple of years.

– Yeah.

– Like you have to change your laws and everything. Obviously that would be weird to do that, to try to avoid some obligation from the utility but it would be a complete disaster with economic ramification that are too dire to think that the rational decision of the government will be to let the utility fail. But ultimately if the government understands that the utility is an important actor of its economy, it will step in, and this is almost always the case. So whether or not the sovereign guarantee is in place, there’s highly likely that there is a contingent liability.

– Mm-hmm. I guess so, yeah. Well, I’m hoping that for the viewers, this at least gives understanding of the complexity of these considerations that governments have to take into account. It’s not a simple matter of just agree to a sovereign guarantee. There’s so much behind it. Yeah, a lot of concerns and considerations that are really valid, that even if we aren’t going to be working for governments, ourselves, perhaps, or as government advisors, I think it’s really useful for those in the private sector, IPPs or otherwise, to have a window into these government perspectives and concerns and at least have some respect for the process behind the curtain, so to speak.

– Mm-hmm.

– So yeah, I really appreciate you sharing this perspective today, Gadi. I’ve learned a lot. I think our viewers are gonna learn a lot from it, but are there any other kind of last words or, you know, insights you wanna share that maybe we missed in this very in-depth discussion that we’ve gone through today?

– No, there’s definitely so much more to talk about on this very topic and I might have jumped a few steps in the analysis. So do reach out to me or look at some more literature on this if you really wanna understand everything. But I think it gives good pointers on some aspects of that discussion and some of the key issues for African governments and African jurisdictions-

– Mm-hmm.

– and in these jurisdictions. And you will see if you speak with an IPP that is structuring projects on this continent, they will tell you right away, a sovereign guarantee is needed for any sizable project.

– Mm-hmm.

– So that’s definitely something that you can read a lot about. Please, if I did some jump in the logical analysis, bear with me. I can have a longer conversation on the topic if someone is interested. It’s definitely a really, really interesting topic and something that is not unique but really present on this continent. And if you understand that-

– Mm-hmm.

– there’s some value you can bring to a discussion whether on the government side or on the IPP side, because it’s also really important for IPPs to understand the concern on the other side of the table and try to find ways to a alleviate that and bridge the gap to ultimately bring more power and electricity on the grid, which is ultimately the objective.

– Definitely. Yeah, a very complex topic. The ALSF also has some really great written resources on this if you wanna go in more in-depth. So we can make sure that the viewers have access to those as well.

– Mm-hmm.

– Now that we’ve peaked your interest, you can go deep on the topic. But yeah, this was fantastic. Gadi, thank you so much for sharing your perspective but also your expertise and your very deep knowledge of, you know, the power sector and how these projects are implemented on the African continent. So yeah, it’s been a pleasure. We’ll have to have you back sometime and we’ll leave it there today. Again, we can connect the viewers with some resources afterwards for further learning. Thanks, Gadi.

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