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Uganda National Roads Authority is proposing to construct a greenfield limited access tolled expressway between Kampala and Jinja to relieve the current congestion on the existing Kampala Jinja Highway, to enhance regional integration, economic and social development at national level, and to ensure overall efficiency of the road network. This project is referred to as the Kampala Jinja Expressway Public Private Partnership Project (“KJE”). Public Private Partnerships involve collaboration between a government agency and a private sector company that can be used to finance, build and operate projects such as KJE.

Private investment is crucial in financing developing countries’ enormous infrastructure needs. This necessitates a strong financial sector, an enabling environment and riskmitigation tools. Increased private sector participation and investment is required to close the infrastructure finance gap. Developing country governments and funders must ensure that the profit motivation of the private sector does not undercut governments’ pro-poor and other development objectives. Because the ultimate goal is sustainable development, private infrastructure investment should be pursued when it is assessed to contribute to the former.

The Project structure is centred on the design, build, finance, operate and maintain model, which shall be handled by the designated Project Company. However, key issues relating to local financing arise. The goal is to encourage participation of Ugandan entities in the implementation of the project in accordance with National Content laws and policies.

Ugandan participation and local content in financing the KJE Project

Local content is the level of use of Ugandan local expertise, goods and services, Ugandan companies, Ugandan citizens, registered entities, businesses and financing and the substantial combined value – added or created in the Ugandan economy through utilization of Uganda human material, resources for provision of goods and services.

Local participation in financing KJE shall be twofold: (i) by the local commercial / development banks and (ii) direct / indirect participation by citizens.

Traditionally, infrastructure projects have been financed through banks, however the implementation of Basel III regulations requires stricter monitoring and disclosures, ultimately leading to higher costs and higher capital requirements. These higher costs are ultimately passed on to the project developers translating to diminished project IRR’s (internal rates of return). The interest rates charged by local banks are not suitable for development of long term projects. Additionally, the short tenor of commercial loans, limited experience in project finance and the unwillingness of international investors to accept the large political, economic, and other risks, or to price for them, frequently makes such finance out of reach for such long term capital intensive projects. Since project income is primarily in Uganda shillings, excessive reliance on foreign funding exposes the initiatives to exchange rate concerns.

Financing the Project

KJE can be financed by loans or an infrastructure bond. Loans are sourced from various financial institutions such as multilateral and bilateral lenders, development banks as well as public and private financial institutions. Bonds are issued by the project company or government and are sold to investors.

I. Loan Financing for Infrastructure

Loans, which provide greater flexibility than bonds, are more frequently used in infrastructure project financing than bonds because they are necessary to adequately fund the capital-intensive building phase of the projects. It is common for borrowers to pay back only a portion of their loan during construction, preventing so-called “negative carry.” Bonds are challenging to refinance, but syndicated loans typically offer borrowers a free call option.

Due to the higher overhead costs associated with acquiring a credit rating, documentation, and administration prior to issuing a bond, loans are therefore more cost-effective for smaller financings.

II. Bond Financing for Infrastructure

An infrastructure bond is a debt instrument issued by governments or private companies to raise finances from capital markets for longterm infrastructure development projects such as water projects, construction works on buildings, facilities such as educational facilities and prisons among others. As they represent the long-term nature of infrastructure finance, which is frequently unavailable from the banking sector, infrastructure bonds can be a more effective type of financing. It can be raised through local or international capital markets secured by or serviced from the cash flows of a specific project without recourse to the sponsors. By buying the bond, the investor is giving the issuer (the project company / government) a loan with an agreement to pay back the face value of the loan on a specific date, and to pay periodic interest payments along the way, as may be determined.

Bond markets provide an impetus for the development of long-term, local currency bond markets, which have the potential to be utilized as a means of financing new projects, refinancing existing assets and developing portfolios.

Infrastructure bonds are designed to have principal and interest payments based on a stream of cash flows from projects rather than the credibility of the issuer. As a result, such bonds require an independent, differentiating appraisal methodology that considers future unpredictable cash flows. The interest payments associated with this bond (and repayment of the principal) are typically funded with a direct linkage to the cash flow revenue generated from the underlying infrastructure project – such as a toll road. These bonds can be used to catalyze investor interest in infrastructure projects.

A separate financing strategy is needed for each stage of an infrastructure project due to the varied risks and anticipated returns. Bank loans and equity investments make up the majority of the finance during the initial stages of planning and construction (greenfield). Bonds can be used to raise money for a project once it reaches the mature stage (brownfield) and generates reliable cash flows. A project’s feasibility can be increased with the assistance of international organizations such as GuarantCo or Multilateral Development Banks, which will make it easier to finance large-scale and long-term capital. In order to strike a balance between a project’s public nature and its commercial viability, it is essential that a risksharing system is developed when these public resources are utilized. This is where financial guarantors such as GuarantCo step in.

The implementation of infrastructure bonds has been fraught with difficulties. In many cases, the bonds issued are not infrastructure bonds in the strictest sense, but rather ordinary government bonds with a guarantee to invest in infrastructure. They have no linked income stream, and the cash flows for the bonds are paid directly out of government tax receipts. There is also no guarantee that the money obtained will be invested in the project as promised, and there is no specific Fund Manager, raising questions about central government’s ability to channel cash to actual infrastructure development. In such cases, government credibility is crucial to ensuring investor confidence, particularly in the issuing of future bonds and the development of a functioning infrastructure bond market.

To convince the private sector to increase its involvement in infrastructure financing, the Government of Uganda needs to consider and implement financial market reforms. Government policy must support bond regulation in order to grow the investor base and create an environment that makes it possible to structure feasible projects. Only then can these bonds be effective at raising capital. This will develop efficient markets for infrastructure bond financing, and foster an investment environment suitable for private sector activities. Contractual, political, and regulatory risks – as well as investor protection provisions – also have to be re-examined. Adequate measures need to be adopted to stimulate local, regional, and international investment in infrastructure bonds. To encourage the successful issuance of infrastructure bonds, institutional, financial, and regulatory requirements are required. By accessing the institutional bond market, project companies are potentially able to reduce the project funding cost.

The Role of Capital Markets

The Capital Markets Authority Act Cap 84 establishes the Capital Markets Authority for the purpose of promoting and facilitating the development of an orderly, fair and efficient capital markets industry in Uganda. The Authority primarily guarantees that investors (both potential and existing) and issuers are better educated about investment and capitalraising prospects in Uganda and the East African region’s capital markets.

Capital markets are a vehicle for raising money for national infrastructure development. The global financial markets are overflowing with liquidity, which is looking for investment opportunities with returns that are above average. The Authority can maximize the most of these funds by promoting investor protection and education in order to lower risk. Current attempts include allowing government assets to trade on the Uganda Securities Exchange (“USE”), allowing retail investors to buy government securities using mobile money, and issuing infrastructure bonds to finance high-quality local private infrastructure projects.

Due to the markets’ increasing interdependence, better coordination is needed. The coordination between the Capital Markets Authority, Bank of Uganda, Ministry of Finance, and other market participants should therefore be strengthened.

One of the major impediments to private sector involvement in financing national infrastructural projects is the limited access to financing options. The Authority recommends the creation of a Bond Market Forum that will catalyze long term financing of the private sector and attract funding from institutional and foreign investors. In order to support the growth of the money, government securities, and capital markets, the Bond Market Forum will serve as a coordinating organization and as a venue to encourage information sharing between investors, regulators, and market intermediaries.

In addition to these benefits by itself, it would also create competition for the banking sector as firms have alternative funding sources, forcing banks to reduce interest rates in the private sector. It would further reduce the crowding out effect from government borrowing as more funding sources for the private sector become available.

Given the limited ability of local banks to provide long-term funding and the shrinking international assistance, the African Development Bank (“AfDB”) encourages project sponsors and governments to turn to domestic institutional investors by issuing infrastructure project bonds. The creation of bond markets that serve as a regulatory framework for infrastructure bonds in the capital markets should be prioritized considering their issuance is one of the government’s main financing goals.

Successful listing of this bond on both primary and secondary markets demonstrates that private capital in local and advanced economies can be used to support the expansion of infrastructure in emerging economies by providing a wider access to finances that can be utilized to fund projects.

International Issuance of Infrastructure Bonds in Uganda’s Capital Markets

The International Finance Corporation (“IFC”) has the ability and potential to transform African capital markets by issuing bonds on behalf of African governments and participating as nonresident issuers of these bonds through the Pan-African Domestic Medium-Term Note Programme, which was launched in May 2012. This program enables governments to mobilize 4 capital and close the financing gap for critical sectors such as infrastructure, while also providing private sector solutions that lay the groundwork for long-term and inclusive economic growth.

In order to promote domestic capital markets and broaden access to local-currency lending in Zambia, IFC issued the Zambezi bond in 2013, which was worth 150 million kwacha, or about $28.4 million. Similar to this, in 2014, IFC issued the Umuganda bond, a five-year bond issued in Rwandan francs that raised 15 billion francs (roughly $22 million) in order to increase the amount of long-term local currency financing available to local businesses while bolstering the nation’s domestic capital markets. Both bonds were created to be attractive to a wide variety of domestic and foreign investors seeking to diversify their portfolios. Pension funds, domestic and foreign asset managers, insurance companies, and banks all placed orders for the two bonds, which resulted in oversubscribed order books.

Potential investors can be persuaded to invest in the bond due to the triple A credit grade IFC has been given by Standard and Poor. The government’s efforts to raise money for financing the building of the KJE could be aided by the IFC’s issuance of a local currency infrastructure bond. The Uganda Securities Exchange’s approval, which is a crucial stage in the cooperation between the Government and IFC, must be secured before the Pan-African Domestic Medium-Term Note Programme may be implemented in Uganda.

Investor Development: The Role of National Social Security Funds (“NSSF”)

NSSF is Uganda’s largest contribution scheme and potential institutional investor in KJE. NSSF is a provident Fund that covers all employees in the private sector. By the end of 2020, NSSF’s investment portfolio was at UGX 13.09 trillion (Thirteen Trillion Ninety Billion Uganda Shillings), with 77.25% in Fixed Income, 15.06% in Equities and 7.69% in Real Estate. The real estate projects undertaken in 2020 include Phase I of Lubowa Housing Estate with 306 housing units on 33.2 acres and phase II of Pension Towers, an intelligent and modern commercial complex comprising of 3 towers of up to 32 floors.

The Fund invests mainly in three asset classes and these are; fixed income, equities (listed and unlisted), and real estate. The fixed income asset class is composed of Treasury Bonds, Corporate Bonds, and Corporate Loans. The equities portfolio is composed of both listed and unlisted equities. The listed equities in East Africa include Bank of Baroda, DFCU, Stanbic Bank, Safaricom among others. The unlisted equities include: Trade and Development Bank, Yield Fund (Uganda) among others. This investment portfolio mix is informed by three key factors namely; the long-term funding needs, the need for diversification and reduction of market risk.

In 2012, NSSF announced its readiness to deploy the pool of local savings that were at over two trillion Uganda shillings to initiate and sustain domestically financed public projects through issuance of infrastructure bonds. NSSF believes that infrastructure bonds provide a real opportunity to diversify NSSF’s investments given the dearth of opportunities in the Ugandan market that can absorb the fund’s cash flows.

NSSF has demonstrated its prowess as an investor in infrastructure bonds in Kenya and Tanzania. In 2017, the composition of NSSF’s fixed income portfolio was dominated by medium to longer dated instruments i.e instruments with long maturity periods which include treasury and infrastructure bonds. These bonds have seen a lot of market interest because returns from them are tax-exempt.

NSSF invested in tax exempt infrastructure bonds issued by the Government of Kenya increasing its exposure from Kshs. 4.8 billion to Kshs. 39.0 Billion. In addition, the favorable tax treatment in Kenya (withholding tax rate is 10% for securities with maturities above 10 years and tax exemption for infrastructure bonds) and Tanzania tax-free bonds and higher coupons for long-dated securities made this avenue an attractive proposition for the Fund. The Fund’s realized income also increased by 19% growth from Ugx 1.05 trillion in 2017/2018 to UGX 1.26 trillion in 2018/2019 due to increased gross interest income from Treasury and Infrastructure bonds.

Uganda has not implemented infrastructure bonds due to the ongoing controversy about who should issue the infrastructure bond: the government, the Bank of Uganda, or another entity. In Kenya, these bonds are issued by the National Treasury. Kenya issued its first infrastructure bond of Kshs 18.5 billion ($249.16 million) in February 2009 to build roads, develop a geothermal energy project, and boost water and irrigation systems. The coupon rate was 12.5% over 12 years; redeemed in three stages in 2015, 2017 and 2021. The 2009 pioneer bond in Kenya laid ground for other Kenyan government agencies to issue their own specific infrastructure bonds. In June 2022, the Central Bank of Kenya published a prospectus for an infrastructure bond offer for a total value of Kshs. 75 Billion with an 18 year tenor to facilitate funding of infrastructure projects in the FY 2021/2022 budget estimates.

NSSF’s participation has the potential to encourage other institutional investors and local banks to partake in financing this project given its financial credibility.

Incentivizing Local Participation in Bond Investment

In order to encourage the participation and involvement of local banks and institutional investors in the financing of the KJE, a strong legal framework specific to the unique nature of these bonds and key players ought to be established. Additionally, potential investors should be incentivized by the exemption of withholding tax on interest income, an increase in agency commission, the bond qualifying for statutory liquidity requirements, listing on the Uganda Securities Exchange, and allowing holders to use it as collateral to acquire loans from banks and banks to pledge it as collateral for repos. The infrastructure bond should also give an attractive coupon rate. Furthermore, the involvement of guarantors such as GuarantCo can play a fundamental role in providing the necessary assurances and security which would increase the confidence of the local participants in the finance sector who need to give large amounts of their products or services, usually on credit, to complete their part of the project.

Financial Guarantees

Ugandan banks and other financial institutions can be encouraged to finance this project through provision of guarantees. The aim of these guarantees is to manage the risk and safety of long-term projects. Essentially, guarantees promise that if the company carrying out the project defaults on any of its loans, the guarantor will cover the costs and losses.

The Role of Guarantee Companies such as GuarantCo

GuarantCo is part of the Private Infrastructure Development Group (PIDG), which is funded by the governments of the United Kingdom, Switzerland, Australia, and Sweden, through the PIDG Trust, the Netherlands, through FMO and the PIDG Trust, France through a stand-by facility and Global Affairs Canada through a repayable facility.

GuarantCo provides credit solutions that transfer risk from investors to fund projects that would afterward promote economic growth, improve people’s lives, combat poverty and realize the United Nations Sustainable Development Goals. This in turn would facilitate the development of local capital markets. The majority of Ugandan banks are not accustomed to contributing sizable amounts of funding to infrastructure projects with durations longer than three to five years. Long-term local currency infrastructure guarantees and loans are now a popular asset class for capital. The credit risk of a long-term infrastructure project is one that may take five to fifteen years to complete. By giving local banks and institutional investors, such as pension funds and insurance firms, the confidence to participate, infrastructure project finance can be offered with an adequate quantity and tenor.

GuarantCo’s Financial Services

GuarantCo’s financial services target shortlisted bidders for the concession. For local currency lending solutions, GuarantCo provides guarantees that bridge the gap between a project’s financial requirements and the terms provided by the local market. GuarantCo’s credit risk is comparable to or lower than that of low-income countries because of its high credit ratings.

A standard format might not always be suitable, so GuarantCo’s solutions are designed to be flexible to meet the specific needs of funding an infrastructure project in local currency. Instead of pursuing a methodology for risk mitigation, their business structure is designed to encourage risk transfer. They can provide a variety of contingent solutions, depending on the demands of a specific project, including joint guarantees, counter guarantees, first loss guarantees, tenor extension or liquidity guarantees, partial credit and partial risk guarantees, and first loss guarantees.

A typical guarantee amount available from GuarantCo for any single transaction is between US$5 to US$100 million (in local currency terms). Guarantees can be offered up to 15 years and where required can be extended up to 20 years subject to donor approval. Guarantee limits are set at 50% of a company’s long-term debt position on its balance sheet.

I. Guarantee over local currency loan

This arrangement will involve GuarantCo extending a partial credit guarantee to the recipient or the debt supplier, possibly in conjunction with additional guarantors. A partial credit guarantee (PCG) represents a promise of full and timely debt service payment up to a predetermined amount. The guarantee amount may vary over the life of the transaction based on the borrower’s expected cash flows and creditors’ concerns regarding the stability of these cash flows. It protects against underpayment of scheduled debt service on the underlying loan between the beneficiary and the borrower up to the maximum amount of the guarantee.

The payment of GuarantCo’s fees and the rights and obligations of the borrower, GuarantCo, and the beneficiary following a potential call under the guarantee must all be covered in a recourse agreement between the borrower and GuarantCo. A recourse is a legal agreement that allows the lender the ability to repossess pledged assets if the borrower fails to meet the debt obligation. Lenders benefit from recourse loans because they are guaranteed some repayment, either in cash or liquid assets. Companies that use recourse debt have a lower cost of capital since there is less underlying risk in lending to that firm.

In this regard, GuarantCo, through a funding Special Purpose Vehicle (“SPV”), would lend the project company (one established for purposes of borrowing finances for the construction of the KJE) a fixed or floating rate amortizing loan for a particular tenor.

The Funding SPV would initially raise capital via a three (3) to five (5) year bridge loan. This loan would be guaranteed by GuarantCo and funded by local banks.

II. Guarantee over local currency bond

This guarantee is similar in structure to a guarantee over a currency loan, but with the Bond Trustee serving as the beneficiary in most cases on behalf of all bondholders. The Project Company will then engage in a bond arrangement with the Bond Trustee holding these bonds on behalf of other bondholders, and GuarantCo will be obligated to do the same by guaranteeing the Bond Trustee.

To reduce default risk and provide credit enhancement to its bonds, the issuing entity may seek an additional guarantee for the bond it intends to issue, resulting in a guaranteed bond. A guaranteed bond is one that has its timely interest and principal payments guaranteed by a third party, such as a bank or insurance company. The bond guarantee eliminates default risk by establishing a backup payer in the event that the issuer is unable to fulfill its obligation. If the issuer is unable to make interest and/or principal payments on schedule, GuarantCo will step in and make the necessary payments in a timely manner. The issuer pays the guarantor a premium for its protection, usually ranging from 1% to 5% of the total issue.

In respect of the KJE, the bridge loan would be refinanced by a ten (10) to twelve (12) year infrastructure bond which would be guaranteed by GuarantCo. This bond would be rated, listed and subsequently offered to local and regional investors.

The Listing Rules do not define who a bond trustee is or provide for their roles and responsibilities. Bond trustees are usually financial institutions that are granted trust powers, such as a commercial bank or trust company. This entity, in turn, has a fiduciary duty to the bond issuer to enforce the terms of a bond indenture and must act on behalf of the issuer, rather than in its own interests. The bond trustee oversees the implementation of a bond, which is a contract between a bond issuer and a bondholder. A trustee sees that bond interest payments and principal repayments are made as scheduled, and protects the interests of the bondholders if the issuer defaults.

The trustee’s name and contact information are included in the bond indenture, which highlights the terms and conditions that the issuer, lender, and trustee must adhere to during the life of the bond. The section of the bond indenture that lists the bond trustee’s role is important as it gives a clear indication of how unforeseen incidents will be handled.

Guarantee benefits

i. To the financier GuarantCo transfers the financier’s risk to an AA-/A1 business. Additionally, GuarantCo ensures efficient capital treatment of the longterm bonds and capacity building in sustainable long-term finance using a variety of financing options.

ii. To the borrower/issuer GuarantCo’s support would play a critical role in assisting to build further capacity in Uganda’s capital markets by providing access to new proof of capital (e.g., local currency loans and bond markets) and increased overall return on investment as was done in other African countries. For example, in Zambia, GuarantCo participated in the Ulendo Road Infrastructure Note Programme, by providing a renewable ZMW 165 million (approximately US$15 million) liquidity guarantee to investors which covered interest payments for RINP tranches providing funds to local road contractors in Zambia. This expanded access to working capital to continue projects and facilitated the Zambian government’s ambitious road programme.

Conclusion

Domestic sources can meet a large portion of Uganda’s infrastructure investment demands. Engaging key stakeholders such as Parliament and the Ministry of Finance, Planning, and Economic Development is critical for legislative and financial reform of the existing legal and regulatory framework, which can encourage institutional investors and local banks to participate in the financing of the KJE project. To promote the issuing and investment in locally denominated infrastructure bonds, local capital markets must be strengthened.