The Potential Catalytic Role of Subnational Pooled Financing Mechanisms is a policy paper, produced by FMDV. Subnational Pooled Financing Mechanisms (SPFMs) provide cost-effective private capital and public sector financing as a way of funding infrastructure and public services in developing and developed countries. These mechanisms allow local and regional governments and other entities with similar missions and credit characteristics, to access credit markets, where otherwise they would not have been able to. Linking pooled small projects to sources of private capital, they can mitigate repayment risk, diversify a project portfolio and provide professional and technical management that is required to access private funding. Pooling together different projects, SPFMs are perceived as creditworthy and meet the criteria for accessing private funding. These mechanisms have been used to finance water and sanitation, energy, transport, telecom, education, marketplaces and other types of projects in a diverse list of countries.
HOW SPFMS WORK
Most SPFMs require the set-up of a Special Purpose Vehicle (SPV) that have transparent governance structure and processes. These SPVs, whose structure depends on national laws, are responsible for contracting debt and making debt service payments on this debt. They are usually owned by governments, though owners can also include the private sector, development partners, NGOs, etc.
SPFMs must be structured in such a way as to have a high-level of creditworthiness. This can be achieved by using several levels of credit enhancements, which would be cost-prohibitive if applied to individual projects. These enhancements include reserve accounts, cash flow over-collateralization, intergovernmental financial transfers and intercepts, partial credit guarantees, first loss-facilities and subsidies.
BENEFITS OF SPFMS
- Allow obtaining finance for local infrastructure and other essential public services
- Reduce financial burden on national governments
- Reduce costs for local infrastructure projects through financial engineering and economies of scale in all aspects of the project cycle
- SPFMs act as “Market-Makers” that stimulate the development of domestic capital markets
- Enable greater quality of projects and creditworthiness
- Catalyze the adoption of strict market standards, enabling greater results and transparency
- Create “hard credit culture” for local and regional governments
- Advance sustainable development goals and national development goals by reducing costs to end users and improving operational efficiencies in the provision of local services
- Facilitate development effectiveness
CHALLENGES IN MAKING SPFMS FEASIBLE AND EFFICIENT
- High-level and political support
- Reform in institutional, regulatory and legal frameworks
- Stakeholder consultation and consensus with buy-in from private sector
- High up-front structuring costs and need for prudent professional management
- Need for professional expert management of SPFMs
RANGE, STRUCTURE AND TYPES OF SPFMS
While a large range has been used worldwide, developing countries have relied on using funding from development parties in the following areas:
- Assessment and processes enabling needed reforms in legal, regulatory and institutional frameworks
- Capacity-building of relevant government entities
- Preparation of projects
- Development of PFM structure and initial underwriting costs (e.g. financial advisors, legal support, rating agency fees, etc.)
Different levels of SPFMs include:
- A group of local authorities working together on financial issues, without borrowing together
- “Club deal” – two or more local authorities issue bonds without creating a SPV
- Special-Purpose Vehicle (SPV) – acts as an intermediary between local authorities and capital markets
PRECONDITIONS FOR SPFM SUCCESS
- Effective political leadership
- Professional and competent management
- Sufficient long-term committed funds for technical and consultation costs