Mark Magaletsky: Lending to UZ without Government Guarantees is Rather the Norm

Mark Magaletsky Senior banker with EBRD 07 March 2012 12:50

As the head of infrastructure and energy at the Ukraine office of the European Bank of Reconstruction and Development (EBRD), Mark Magaletsky oversees the EBRD’s operations in the transportation, municipal infrastructure, energy, and natural resource sectors in Ukraine (which account for 56 projects worth a total of more than USD 2.5 billion), as well as policy dialogue with central and local government agencies. With 14% of the disbursed funds, the transport sector is presently is the largest of the bank's credit projects in the real sector of the Ukrainian economy.

Private businesses can do the same as the government

 

Will the enactment of the law on seaports influence your willingness to provide loans to the port sector?

It will be good if the law is redrafted and adopted at the second reading. It has many positives. This will provide a good impetus to the industry.

What aspects of it need to be redrafted?

I will not go into details because that is a matter for experts. However, the basic idea is to restore order in the industry and bring the rules of the game into line with the realities and the needs of the economy. The port industry in Ukraine was created on the basis of state ownership. However, a host of private operators has emerged alongside state-owned ports, and these private operators operate within a very wide range of legal schemes and forms of cooperation - from fully private terminals to all kinds of cooperation and investment agreements of various degrees of complexity and depth.

The result is disparate and not always stable interaction between participants on the market of port services and unequal conditions of existence for state-owned ports and private terminals. The idea of the law is to define clearly what a state-owned port can do and what it cannot do, the rights of private operators, and the operating models for them. Overall, this is a good opportunity to reconsider the dogma that says that private businesses cannot do the same things as the state.

Do you think the law will actually attract investors to the maritime industry?

In principle, in the port industry, unlike many others, there is real interest from real investors, and additional serious investment can be expected to come into the industry if the market is offered a good cooperation model.

Does the EBRD have any concrete work in progress regarding future projects with private companies at ports?

We have one project that has already been implemented - a "dry port" in Odesa together with the Euroterminal company - and it has already gone into operation. Negotiations with other private operators, which I cannot yet name, are at various stages, but I think that it will become public knowledge in the near future.

Lending to Ukrzaliznytsia without government guarantees is rather the norm

 

At what stage is the signing of a new loan agreement with Ukrzaliznytsia and what kind of project is involved?

We currently have three existing agreements with Ukrzaliznytsia that were signed at various times since 1999. At present, there is a plan to disburse a new loan tranche of EUR 62.5 million for the final project for purchase of freight cars. On our part, all the necessary decisions have been made and we are ready to sign it any day. The only thing we are waiting for is completion of all the procedures on the part of Ukrzaliznytsia.

Which procedures specifically?

Since we are talking about a state-owned enterprise, it has to perform certain procedures in order to obtain the right to sign credit agreements. In this case, it has to be agreed at the government level.

How long will it take?

I think everything can be done in one month or two, but we do not know how quickly it will be done.

The terms of the agreement remain the same as they were for the previous loan tranche?

Yes, we are financing part of the purchase - 85%. The loan is being provided without government guarantees.

Why is Ukrzaliznytsia the first in the transport sector to receive EBRD funds without government guarantees?

The question should phrased in another way: why were the first two agreements signed with government guarantees? It was a relatively forced measure. The railway is a monopolist in nature and a good borrower in practically all countries. Therefore, it is rather the norm to provide loans to such a borrower without government guarantees. The only thing is that we are talking about very large scale, billion-dollar projects.

In what other transport sectors are you willing to provide loans without government guarantees?

Such examples already exist. For example, the financing of the Ukraerorukh air traffic control enterprise.

The first agreement with this organization was signed quite a long time ago, are there any new projects?

Yes, this is our second project with Ukraerorukh. Funding is provided for a whole range of components, mostly for purchase of equipment and modernization of air navigation systems. A loan of EUR 56.8 million without state guarantees is planned. The agreement has not yet been signed, although it has received all our approvals. Like Ukrzaliznytsia, Ukraerorukh is now performing the procedures necessary for government approval.

What is the difference between the creditworthiness of Ukrzaliznytsia and Ukravtodor, with which you work only under government guarantee?

Ukravtodor is not a profit-making business entity. It is a specific structure, largely an organization financed with state funds. It actually operates only with state budget money and its finances are inseparable from state finances. Ukrzaliznytsia is another matter: although it is called a state administration, it consists of state-owned enterprises that are its subdivisions - regional railways and a number of specialized companies - and they work in the market, provide services, and generate revenues.

Ports are also economic entities, although owned by the state. Are you willing to provide funds to them without government guarantee?

Let us say that there have not been worthy proposals, but we are willing to consider projects with ports.

Did the beginning of railway reforms somehow affect the cost of loans to Ukrzaliznytsia? Are loans to it cheaper now than loans to, say, a private company that also buys railcars, such as Interlizinvest, to which the bank provided a loan last year?

One cannot say that the adoption of the laws on reform has a calculable result. In general, of course, the transformations are positive, but the cost of money depends on a host of other factors, such as the country risk, funding, and the market situation for a specific business. As for the cost of credits for a particular company, we do not disclose this information; it is confidential.

Why was the beginning of the reform of Ukrzaliznytsia such a fundamental issue for the bank?

Its current structure does not meet the requirements of Ukraine at this stage because the country’s economy has progressed much further ahead. That operating format contains many things that were inherited from the Soviet system of management. The idea is, firstly, to bring the functional structure of the railways in line with the requirements of today and, secondly, to create clear and attractive conditions for operation of private businesses in this sector because there is good interest from private capital and there is the need for investments. Ukrzaliznytsia cannot meet this requirement on its own, and it does not need to.

We finance the purchase of vessels 

What area of lending to the private sector in the transport industry do you consider most promising today?

It is probably the port industry, rail transport, and shipping. Regarding the latter, we already have projects in this sector, albeit small ones. The Ukrrichflot company was a client of the bank for a long time. Among the unusual examples is the Nibulon grain trader. Although it is not directly a transport company, its development strategy includes the use of River Dnipro as a waterway. Therefore, we have financed the purchase of vessels for them, both - transport and towing vessels. The latest shipping projects that are now coming out include an agreement with the Sevastopol-based Yugreftransflot company, to which we plan to provide a loan of USD 10 million for purchase of a fleet. The board of directors of the bank will consider this project next week.

Does the EBRD set any requirements regarding where assets for which it is providing credits - a fleet or railcars -should be purchased?

The only requirements are that purchases should be optimal from the financial and technical point of view. There is absolutely no pegging to specific companies or countries.

Do the conditions for provision of funds to private and state companies differ?

Those funds that the bank provides under state guarantee are in a separate category. The standard financing terms and conditions, which are the same for all projects, apply to them regardless of country. The margin for them is 1%, i.e. the cost of credit is LIBOR + 1%. It is clear that this rate does not reflect the risks, which may be different for different countries, but this decision regarding loans to the public sector was made when the bank was founded. However, if a loan is being provided for a project without government guarantee, then the conditions are practically the same for the public and private sectors.

We are talking about new approaches in the road sector

 

Does the bank set certain conditions regarding reform of Ukravtodor, since its structure is as convoluted as that of Ukrzaliznytsia?

I do not agree with your analogies. Ukravtodor does not combine administrative and economic functions. One cannot say that the SJC (the Automobile Roads of Ukraine state joint-stock company, which is a subsidiary of Ukravtodor that implements contracts for routine repair and operational maintenance of roads) is part of the structure of Ukravtodor, although it is subordinate to it. In principle, the SJC lives its own life and the proportion of work performed by the SJC out of the total volume of work in the road sector is constantly decreasing. If you look at the main large-scale projects that are currently being implemented, you will not see the SJC anywhere there. Take our projects for example - outside contractors perform all the contracts. Yes, the SJC still has road-maintenance functions but the issue of creating a competitive environment in this area is being considered.

What are currently the main areas of reform in Ukravtodor?

The first is separation of its administrative functions from its business functions, but this essentially happened a long time ago. The second is reform of the funding system in the sector. At a time, the road sector was financed with revenues from sales tax and was not tied to the use of roads. This system has been changed, and the sources of funds for financing road construction are now taxes that are tied directly to the use of roads. The next stage of the reform is decentralization. Separation of national roads, which are under the purview of Ukravtodor, and regional roads, which will be transferred to local authorities, is taking place.

Is anything changing in the system for management and maintenance of the road network?

Yes, we are now drafting OPRC (Output- & Performance-Based Road Contracts) maintenance contracts under our project. This term refers to contracts that are linked to the final result. Here is an example: you need to repair a road after the winter, and you invite a contractor to repair the defects. However, in this case, the contractor is interested in the volume of the work being big enough, and it is desirable for the contractor for these defects to reappear one year later. That is the kind of motivation.

What scheme is the EBRD proposing?

We are taking about a different approach, in which payment is based on results. That is, the contractor receives a section of the road, and he is responsible for ensuring that this section of the road is in a normal condition after a certain period. He receives money for this. Under such a motivational mechanism, he has no interest in seeing the repaired defects reappear. We are currently working with Ukravtodor to develop a mechanism for introducing these types of contracts in Ukraine.