DFC replaces OPIC
The Overseas Private Investment Corporation changed in January into the United States Development Finance Corporation. The DFC is endowed with enhanced authority meant to enable it to compete more effectively with China’s support of infrastructure in emerging markets.
Several enhancements have been well reported in the trade press. These include the doubling to $60 billion of the maximum size of the agency’s portfolio (up from OPIC’s $29 billion), its authorization to make equity investments, the abolition of US eligibility requirements for the beneficiaries of guaranties and political risk insurance, and the transfer to DFC from US Agency for International Development of the Development Credit Authority.
This article looks in detail at how the so-called Build Act under which the DFC will operate differs from the OPIC statute and identifies assorted ways in which DFC’s capacity has been enhanced, or at least is different, relative to OPIC.
Several of those differences will substantially increase both the availability and attractiveness of DFC’s financial products.
DFC may make loans or guarantees “upon such terms and conditions as [DFC] may determine.” This broad authority relieves DFC from various constraints on OPIC’s lending programs. OPIC could make direct loans only to projects involving US small businesses or cooperatives. Other financing had to be provided by issuing loan guarantees of commercial financing. Nor could OPIC provide direct loans to for oil or gas extraction projects. OPIC had an annual cap of $4 million on guaranteed loans for financing extractive projects. None of these constraints continue as a statutory matter. What constraints might continue as an underwriting or policy matter remains to be seen.
Although the Build Act relaxes OPIC’s requirement of a US connection, it does not eliminate the relevancy of US connections. The DFC must give preferential consideration to projects involving United States citizens. The extent to which the absence of US ownership or other connections may impede access to DFC support is not yet clear.
OPIC’s lending operations were tied in two ways to supporting investment by US entities. First, the beneficiaries of OPIC guarantees had to be “eligible investors,” although the statute did not restrict the ownership of the borrowers or project sponsors. Recognizing the fundamental focus of its statute to encourage US investment in emerging markets, OPIC self-imposed a rule of thumb whereby OPIC would only make or guarantee loans to projects that are at least 25% owned by US citizens. Since this was not a statutory requirement, this restriction was relaxed on occasion, but not often.
In recent years OPIC revised the 25% US ownership rule of thumb to allow the requirement for a US connection to be satisfied not only by ownership, but also by other US involvement, such as procurement or US contractors in the construction or operation of the project.
But even this limitation blocked OPIC’s support of meritorious projects lacking adequate US connections. This impaired OPIC’s competitiveness with other development finance institutions that had no such nationality restriction. Ironically, even US investors could be incentivized to avoid using OPIC support when developing a project jointly with non-US investors.
While DFC will value US involvement in projects, it faces no bright line impediment from supporting purely international projects.
The DFC is expected to offer a maximum loan size well above OPIC’s $400 million limit (absent special board approval).
The DFC can provide financing for up to 25 years (versus a 20-year limit on OPIC-guaranteed financing).
For guaranteed loans, the corresponding equity investment cannot be less than 20% of the guaranteed loan amount. (In contrast, the OPIC statute permitted loan guarantees of no more than 75% of the total investment committed to any project.) Eighty percent leverage is unusual in DFI-financed projects, so this is unlikely to be a practical issue. Although the Build Act imposes no leverage limitation on direct loans, there, too, underwriting concerns will similarly limit the ratio of debt to equity.
The DFC may make local currency loans and guarantees so long as the DFC board determines there is a substantive policy rationale for doing so. OPIC, in contrast, could provide financing in foreign currencies, but only to projects involving United States small businesses or cooperatives.
OPIC could only provide loans to projects sponsored by small businesses. Thus, most OPIC financing for large projects was implemented as OPIC-guaranteed loans, funded by placing certificates in the bond market. The DFC statute has no such restriction on direct lending to projects sponsored by large companies. The future of OPIC’s loan guarantee funding program will depend on its commercial competitiveness now that the statutory requirement is gone.
The Build Act bars the DFC from offering subordinated loans unless a substantive policy rationale exists. These finance programs have normally provided senior debt, so subordinated debt would most likely only be considered if a compelling policy reason motivated the proposal. This new constraint is unlikely to prove restrictive as a practical matter.
Political risk insurance
The Build Act expands enormously the range of potential PRI coverages compared to the OPIC statute.
Under the OPIC statute, coverage had to fall within one of three baskets: expropriation, political violence or currency inconvertibility (and, as to that, covering only dividends and the proceeds from the sale of the insured business). Where variations on those themes, such as coverages against breach of contract, denial of justice or forced abandonment, were called for, the coverage had to be rooted, often through creative legal analysis, in one of the statutory authorizations. Some potentially appealing coverages could not be offered because they did not fit into any statutory box.
The Build Act, in dramatic contrast, broadly authorizes DFC to issue coverage against “any or all political risks.” It then mentions currency inconvertibility and transfer restrictions, expropriation, war, terrorism, civil disturbance, breach of contract and failure to honor financial obligations as examples of what can be covered, but without limitation to those perils.
The mere fact that broader coverage is legally permissible does not mean that, as either an underwriting or policy matter, it would be wise to offer it, but where an innovative coverage makes business and policy sense, DFC is now free to offer it.
The elimination of the eligible investor restriction for insured investors is key to the reinvigoration of OPIC’s political risk insurance program.
OPIC’s slice of the PRI market had declined in recent years, with investors turning increasingly to the World Bank Group’s Multilateral Investment Guarantee Agency or the growing private market, where no such eligibility restrictions apply. (MIGA does have its own eligibility requirements, but they are substantially less restrictive.) OPIC’s eligible investor requirements were particularly problematic in large projects with a multinational sponsor group, where OPIC could support the US investors, but not the others, introducing an imbalance that complicated shareholder relationships. OPIC responded by structuring reinsurance arrangements in which ineligible investors could benefit from OPIC coverage, but those complications came at a price. Often the preferred solution was to avoid OPIC involvement in the project, undermining the effectiveness of OPIC’s insurance program.
DFC’s insurance authorizations are expanded not only to increase the scope of possible coverages and the relaxed eligibility requirements, but also to broaden the range of potential beneficiaries beyond the private sector. The Build Act authorizes coverage in favor of both foreign public-sector entities whose purposes are similar to the DFC and certain specified multilateral financial institutions.
That extension of eligibility could be more restrictive than it sounds. Only 12 multilateral organizations are included: four branches of the World Bank Group as well as the largest regional development banks. Dozens of smaller regional multilateral development banks are not included. These smaller MDBs often invest jointly with the listed institutions, so the limit on the new statutory authority is unfortunate. That limitation could likely be addressed in a transaction by arranging the unlisted entities as B lenders behind those authorized to receive DFC support. However, that would introduce a structuring complexity that would make deployment of DFC support more expensive. Better would be to interpret the scope of foreign public sector entities referred to in the DFC statute to include not only bilateral agencies, but also multilateral organizations.
Public-sector agency demand for political risk insurance is a recent phenomenon. Both bilateral and multilateral development banks have had the view that their character as government affiliates or associations of sovereign nations, typically including the host country, was adequate mitigation for political risks. A few projects have departed from that tradition, with DFIs seeking political risk coverage from MIGA. This provision will enable DFC also to service that market.
Among the most publicized innovations in the Build Act is its authorization for DFC to make equity investments.
While Congress granted OPIC legal authority to make equity investments in the 1990s, Congressional misgivings over the appropriateness of the federal government holding ownership interests in private companies prompted Congress not to fund the program. OPIC engineered a way to provide equity support to projects indirectly. It made or guaranteed loans to private investment funds that, in turn, used the loan proceeds, together with funds invested by limited partners, to make equity investments in OPIC-qualified projects.
Although OPIC’s investment funds program originated as an alternative to having authority to invest equity directly, having that authority will likely invigorate rather than lessen the demand for the investment funds program.
Melding DFI support and private limited partner funding in investment funds has proven to be an effective combination. Although OPIC was an early mover in that arena, as other agencies that were able to make equity investments joined the OPIC-supported funds as limited partners, a tension arose between OPIC and those agencies, who bristled at OPIC, who they saw as a sibling entity, enjoying superior legal rights as a lender. With equity authority, DFC is now equipped to support such ventures on terms equal with the other DFIs.
Equity authority of course also opens the door to investing equity directly into projects. Although the Build Act allows DFC to allocate up to 30% of its up-to-$60 billion portfolio to equity investments, the near-term impact of the program has been limited by the Office of Management and Budget’s restrictive interpretations of that authority, which could severely restrict the supply of equity funding. DFC’s current understanding is that equity investments can proceed if, as a matter of government accounting, DFC treats them as grants, with no projected recovery from the outlay and with any return counting as unexpected income. This extremely conservative approach reduces the amount of funding that might otherwise have been available, but lets the program proceed.
In a new authorization not available to OPIC, DFC is authorized not only to invest in investment funds, but also to establish and fund its own enterprise funds dedicated to making investments in commercially sound developmental activities. This authorization, which is subject to prior consultation with the Secretary of State, the Administrator of USAID and other relevant agency heads, is along the lines of an existing USAID program that traces back to the enterprise funds established for countries in eastern and central Europe in the wake of the Soviet Union’s collapse. The Build Act also authorized transfer of that program to DFC, but the Trump administration has decided to keep it at USAID.
The Build Act authorizes DFC to make grants to fund the costs of feasibility studies in support of development projects. No restriction is imposed on eligibility, so they appear to be available to both private companies and prospective host governments. The terms are to include cost sharing with the grantee and providing for reimbursement of the grant if the project goes forward.
A new authority charges DFC’s chief development officer, in coordination with USAID, to provide technical assistance grants, especially for small projects in “the most underdeveloped areas.” DFC’s support can include development of risk mitigation tools, provision of transaction structuring support, delivery of training and knowledge management tools for engaging private investors, partnering with private-sector entities that provide access to capital and expertise, and provision of technical assistance.
Although OPIC had been authorized to provide grants to microfinance and microenterprise clients, the DFC’s authorizations represent a substantial increase in scope and funding.
The Build Act transferred the Development Credit Authority from USAID to the DFC.
The DCA offers partial guarantees (typically 50%, but as high as 100%) of commercial bank loans made in local currencies to qualifying borrowers in emerging markets. These guarantees are intended to encourage private lenders to extend financing to underserved borrowers in new sectors and regions.
The sovereign loan guarantee program was also transferred to DFC from USAID, but only to administer the existing portfolio, which consists of roughly $21 billion in outstanding loan guarantees to the governments of Israel, Jordan, Iraq, Tunisia and Ukraine.
Key policy criteria
The DFC board, like the OPIC board, may not approve any project likely to have significant adverse environmental or social impacts unless, at least 60 days prior to the vote, an environmental impact assessment or initial environmental audit is made publicly available.
The DFC is further required to apply best practices with respect to environmental and social safeguards, and include in any contract relating to the project, provisions to ensure the mitigation of any such adverse environmental or social impacts. This states explicitly what OPIC has already required in practice. If an environmental impact assessment finds that mitigation is needed, OPIC has required that these terms be reflected in the relevant transaction agreements. DFC will do the same, whether or not the project requires board approval.
The DFC’s requirements with respect to workers’ rights are substantially identical to those for OPIC.
The Build Act has introduced new requirements regarding boycotts and terrorism.
The DFC must investigate whether a project it plans to support is related to any person demonstrating an intention to support a boycott against a government friendly to the United States. Further, the DFC is prohibited from supporting a government-related entity if the Secretary of State determines that the government has supported acts of international terrorism or has engaged in gross violations of internationally recognized human rights. While OPIC was required to take into account human rights and fundamental freedoms in determining whether to support a project, the Build Act requirements regarding boycotts and supporting terrorism are new.
The Build Act directs the DFC to give preference to projects falling within various categories.
However, preferences are clearly not requirements. For instance, as discussed below, there is a preference for projects involving US persons as well as a preference for projects that involve US small businesses, but the terms of the small business preference (which is a percentage of the portion of DFC projects that involve US persons) suggests that not all projects are expected to involve US persons. The impact of satisfying a preference in overcoming shortcomings of a potential project remains to be seen.
In the meantime, the Build Act provides the following six preferences.
The first involves host countries. The DFC must prioritize supporting projects in low-income and lower-middle-income countries. The DFC must “restrict” support to projects in upper-middle-income countries, unless the US president certifies to Congress that such support furthers the national economic or foreign policy interests of the United States and such support is designed to produce significant developmental outcomes or provide developmental benefits to the poorest population of such a country. DFC’s interpretation of “restrict” will be important.
Although generally the Build Act expands DFC’s authorities relative to those enjoyed by OPIC, the now-disfavored projects in upper-middle-income countries have been important to OPIC’s operations. For instance, in fiscal year 2018 in Latin America and the Caribbean, excluding projects in upper-middle-income countries (and high-income countries, where one project was supported) would have blocked 13 of the 16 projects that were supported and all but $69.4 million of the total of $959.5 million in financings that closed (excluding regional projects). In Africa, most projects could have gone forward, but projects undertaken in Botswana and Namibia would have been blocked.
If projects in upper-middle-income countries are to be supported only on an exceptional basis, then the DFC will be significantly more constrained than OPIC with respect to where it can deploy its lending and insurance operations. However, if “restrict” were interpreted as only supporting projects with, for instance, substantial developmental benefits, OPIC could continue to play an important role in infrastructure projects in all of its traditional markets.
Small businesses are another preference. The agency is instructed to endeavor to ensure that at least 50% of DFC-supported projects that involve US persons involve US small businesses. This differs from the OPIC target of involving small businesses in 30% of all the projects it supports. Whether the DFC’s small business target is higher than that of OPIC depends on whether more than 60% of DFC’s projects involve US persons.
US involvement is preferred. The DFC must give preferential consideration to projects sponsored by or involving private-sector entities that are United States citizens or entities owned or controlled by United States citizens. As discussed earlier, this relaxes OPIC’s traditional 25% minimum US equity requirement and the more recent requirement of a US connection. DFC’s openness to supporting projects with no US private-sector involvement remains to be seen, but where other DFC goals are met, the inability to appeal to this particular preference seems unlikely to be preclusive. In fact, projects without US involvement are clearly contemplated. The small business preference is based on the portion of DFC projects that involve US persons, suggesting that not all will. In any event, DFC’s ability to support projects with no US connection is a significant expansion of DFC’s authority beyond that of OPIC.
The DFC is to give preferential consideration to projects in countries that comply with international trade obligations. The US Trade Representative is to provide DFC with guidance as to the countries that qualify for this preference.
The DFC must give preferential consideration to projects in countries where the government embraces economic policies that promote private enterprise, including market-based economic policies, the protection of private property rights, respect for the rule of law and combatting corruption and bribery.
Finally, women’s empowerment is important. OPIC moved to support women’s economic empowerment in 2018 when it hired a managing director of global women’s issues, who created the “2X” initiative, an initiative to move clients in the direction of supporting women-owned, women-led and women-supporting businesses. The Build Act enshrines the agency’s commitment to women’s economic empowerment, and an office has been created within DFC to focus on these issues. The DFC is instructed, when providing support to projects, to consider the impact of its support on women’s economic opportunities and outcomes and to prioritize the reduction of gender gaps and to maximize development impact by working to improve women’s economic opportunities.
The Build Act provides a seven-year (from October 5, 2018) authorization for DFC to operate, but given the time required to implement the transition from OPIC, a bit more than 5.5 years remain before Congress will again need to consider and approve DFC’s continuation of its activities.
Given that OPIC had been operating on year-to-year authorizations for the last several years, the seven-year authorization under the Build Act is a substantial win for the new agency and will give DFC management an opportunity to implement its new authorities without a constant threat of closure hanging over its operations.