This article was written by James Douglass (partner), Greg Stonefield (partner), Barri Mendelsohn (managing associate) and Francis Iyayi (associate).
For the next five years, Nigeria is reported
to require US$166 billion to provide energy
and infrastructure for its growing population.
Demand for energy and infrastructure in Nigeria,
Africa’s largest economy, is ever increasing as
its population grows. Consequently, so has the
demand for viable financing solutions to support
investment in such infrastructure projects, which
according to the African Development Bank
has an infrastructure deficit of US$300 billion. In
fact, overall infrastructure spending (and in turn
demand for financing) in Nigeria is expected
to grow from US$23 billion in 2013 to US$77
billion in 2025.
Where will this financing come from? Nigeria
has recently attracted Chinese financial
and technical support for its ambitious
infrastructure plans. This article will look at the
role and significance of Chinese investment
and key trends relating to how Chinese
infrastructure financing transactions are
typically structured.
Nigeria’s infrastructure challenges have
become protracted due to a number of
reasons, which include:
- dwindling oil revenues, which makes up
around two third of the country’s revenue
due to the fall in global oil prices;
- instability in Nigeria’s oil producing Delta
region, due to a series of attacks on oil
pipelines in southern Nigeria by militants
causing crude output to hit the lowest
levels in decades;
- US dollar scarcity; and
- currency exchange risk volatility.
According to the Nigerian Bureau
of Statistics, these macroeconomic
challenges have obstructed infrastructure
investment in Nigeria and contributed to
Nigeria’s gross domestic product ("GDP")
growth rate contracting 13.7% in the
first quarter of this year to a 25 year low.
Nigeria’s GDP growth is forecasted to be
3.8% in 2016, as investments will seek to
somewhat rebound an economy, which
has grown around 7% per annum for the
past decade.
In light of the challenges, President
Muhammadu Buhari’s government intends
to address the infrastructure funding gap
and support businesses which now need
competitive, cheaper and longer term
financing to fund infrastructure and other
related projects in Nigeria.
China and Nigeria loan
commitments
One of the mechanisms to address the
infrastructure funding gap has been a US$6
billion loan commitment from China to
fund infrastructure projects in Nigeria. It is
understood that the Nigerian government
can access this credit facility by identifying
and putting forward the relevant projects to
the Chinese presumably through a series of
tranches in respect of each identified project.
The loan commitment coincided with a
currency swap deal agreement between the
Industrial and Commercial Bank of China
Ltd ("ICBC"), which is China and the world’s
largest bank, and the Central Bank of Nigeria
(“CBN”). The swap deal should facilitate the
settlement of Nigeria-China trade by removing
the dollar from transactions and trading
instead in yuan, whilst in tandem boosting
imports from China, whose exports represent
some 80 per cent of the total bilateral trade
volume. It is anticipated that this in turn should
reduce the demand for dollars on the CBN.
The swap deal also fits neatly in CBN’s plans
to diversify its foreign exchange reserves
away from the dollar by switching a stockpile into yuan. This may accelerate plans by the
Nigerian government to issue its first ‘Panda
Bond’ (renmibi-denominated bonds sold by
overseas entities in mainland China), to plug
the current record budget deficit currently
standing at approximately US$11.1 billion and
assist to improve the value of the naira, which
has weakened against other currencies and
choked off growth in the economy.
The entry into these two agreements
also coincided with the signing of several
memoranda of understanding (“MoUs”) and/or
definitive agreements for several infrastructure
development projects, which reportedly include:
- North South Power Company Limited
and Sinohydro Corporation Limited
(“SCL”) signing an agreement valued
at US$478 million dollars for the
construction of a 300MW solar power in
Niger State;
- Granite and Marble Nigeria Limited and
Shanghai Shibang signing an agreement
valued at US$55 million for the
construction and equipping of a granite
mining plant;
- Infrastructure Bank of Nigeria and
SCL signing an agreement for the
construction of a greenfield expressway
for Abuja-Ibadan-Lagos valued at US$1
billion;
- the signing of a US$2.5 billion agreement
for the development of the Lagos Metro
Rail Transit Red Line project in Lagos
State;
- and
the signing of a US$1 billion facility for
the establishment of a hi-tech industrial
park in Ogun-Guangdong Free Trade
Zone in Ogun State.
More recently, the Nigerian National Petroleum
Corporation (“NNPC”) arranged an investor
roadshow in China with the objective to
bridge the funding gap in the country’s oil and
gas infrastructure sector, including pipelines,
refineries, power facilities and upstream
projects. MoUs between NNPC and several
Chinese counterparties were signed worth
approximately US$80 billion.
Experience of Chinese
infrastructure financing
transactions
In light of the above, the financing structures
for the funding of these projects by Chinese
counterparties may not vary too much from
western project financings. However, from our
extensive experience of advising sponsors,
borrowers and lenders on a significant number
of China outbound infrastructure financing
transactions there are certain dynamics one
can expect to encounter.
Historically, Chinese infrastructure financing
in Africa was often structured as commodity
linked and government to government
(“G2G”) transactions. In this instance, the
Chinese lenders would extend a loan to
the government or the Ministry of Finance
(“MoF”) in respect of an infrastructure project
to be constructed by a Chinese contractor
in exchange for access to a commodity (in
the case of Nigeria, crude oil). This G2G loan
is then secured by a sovereign guarantee
provided by MoF and security is taken over
the commodity offtake arrangements.
Whilst in some cases this model may still
prevail, going forward, we are also seeing
a shift in the funding dynamics from China.
Chinese counterparties are in some cases
moving away from G2G transactions (not
in its entirety) and are willing to engage with
private sector sponsors on a business to
business (“B2B”) basis. As such, Chinese
counterparties (mostly state owned
enterprises) with an appetite to operate in
Nigeria or lend to Nigerian projects are doing
so on an arm’s length basis and paying particular attention to project specific risks and
project bankability issues.
The mechanism used to document the
obligation of a contractor to construct the
infrastructure project is the turnkey contract,
which is typically in the form of an Engineering,
Procurement and Construction (EPC) contract.
Chinese EPC contractors have emerged
as serious, technically competent and
economically competitive players in the global
infrastructure space. What makes Chinese
EPC contractors even more competitive now
for Nigeria is their ability to procure project
financing from their relationship banks (like
ICBC), export credit agencies (like China Exim
Bank) and development finance institutions
(like China Development Bank and China-
Africa Development Fund) all supporting the
export of the EPC contractor’s services (and
any Chinese manufactured equipment). These
participants are particularly active on China
outbound transactions into Nigeria. In addition,
we expect to see the Asian Infrastructure
Investment Bank (an international development
financial institution that aims to support the
building of infrastructure in Asia) feature more
on these infrastructure financings after recently
confirming that it intends to expand its lending
activities beyond Asia and into Africa.
Features of Chinese outbound loan
agreements can (but not necessarily always)
include relatively longer tenures and at times
cheaper margins compared to domestic
bank lenders, though much depends on the
individual facts, such as the nature of the
projects and the domestic risk profile.
Financing structures
In the case of the NNPC related financings,
we would expect to see a guarantee from
MoF in addition to security over a long term
crude offtake arrangement with NNPC. In
the case of pure infrastructure financings
on a B2B project, we have seen Chinese
lenders focus less on the points relating
to micro-project risks during the diligence
process. This is perhaps because finance
from Chinese lenders is typically given on the
basis that there are enforceable guarantees
(often bank guarantees) in place from various
counterparties participating in the project.
Project guarantees have formed the basis of
the security package that Chinese lenders
have sought to have in place. Depending
on the nature of the project, guarantees are
sought from the following counterparties
(amongst others):
- equity providers and sponsors (in
proportion to their equity interest in the
project);
- feedstock suppliers;
- project offtakers;
- and
the EPC contractor.
Therefore, the counterparties providing
these project guarantees will also need to
get comfortable around the project risks
associated with the development.
Human resourcing
Human resourcing of Chinese funded and
EPC contracted projects has proven to
be a controversial issue for stakeholders
involved in these infrastructure projects. It
goes without saying that one of the political
upsides of financing infrastructure projects is
the microeconomic benefits that would derive
from such projects (i.e. direct and indirect job
creation). There is perhaps a misconception
(this may be due to historical factors) that
Chinese EPCs not only come with their
equipment but also with their own human
capital. This approach is seen to prevent job
creation opportunities for local workers and
the negative backlash can often frustrate the
progress of infrastructure projects in-country.
Going forward, Nigeria and its Chinese
counterparts will need to address up-front the
topic of human resourcing of Chinese funded
and EPC contracted projects. Whilst it is
reasonable to expect that the EPC contractor
would want to have its lead engineers and
trained workers on the ground to construct the
project, this however, needs to be tempered
with the needs of the host country in order
for its people to benefit from job creation
opportunities.
Conclusion
The MoUs signed between Chinese
funders/EPC companies and the Nigerian
government/indigenous companies marks
a new direction towards finding financing
solutions that will work for Nigeria. It is
important to note that historically, some MoUs
have been signed between China and Nigeria
with very little progress made or projects
financed to completion.
There is still a process of education from
both participants in respect of understanding
how each counterparty operates, the project
risks they are willing to accept and devising/
documenting structures on a project-byproject
basis that can work in a Nigerian
context, but which also satisfies the funding
requirements of Chinese parties.
It goes without saying that collaboration
between the two countries in relation to
infrastructure projects can work (for Nigeria, it
needs to work) and over the coming months
King & Wood Mallesons hope to play a
significant role in facilitating to financial close
projects between China and Nigeria that can
bridge the infrastructure gap.
More articles from Made in Africa Issue 15:
Permanent Capital Vehicles - Are they worth it?
UNPRI publishes a standardised DDQ on responsible investing
Asian Influence - Singapore’s increasing role in Africa
Financial regulation in South Africa - New developments
Africa mining M&A in 2016 and beyond