Special Report No 24/98 concerning risk capital operations financed from the resources of the European Development Funds, together with the Commission's replies (submitted pursuant to Article 188C(4)(2) of the EC Treaty)
Date: 1998-10-15
Institutions: European Court of Auditors
Subjects: European Development Fund, budget appropriation, financing of aid, investment protection, management accounting, venture capital

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Official  Journal  of  the  European  Communities

14.12.98

SPECIAL  REPORT  No  24/98

concerning  risk  capital  operations  financed  from  the  resources  of  the  European  Development
Funds,  together  with  the  Commission’s  replies

(submitted  pursuant  to  Article  188C(4)(2)  of  the  EC  Treaty)

(98/C  389/02)

TABLE  OF  CONTENTS

Paragraph(s)

Page

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.1 — 1.10

General

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.1 — 1.4

Conduct  of  the  audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1.5 — 1.10

RISK  CAPITAL  AS  A  FINANCIAL  AID  INSTRUMENT . . . . . . . . . . . . . . . . . .

2.1 — 2.18

Types  of  risk  capital  financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.1 — 2.5

Intervention  sectors  and  allocation  of  funds

. . . . . . . . . . . . . . . . . . . . . . . .

2.6 — 2.12

The implementation of risk capital operations by the European Investment
Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.13 — 2.18

Tendering  procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.13 — 2.15

Loan  conditions  and  undertakings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2.16 — 2.18

INTEREST  RATES  AND  THE  USE  OF  THE  INTEREST  MARGIN  IN  CASE
OF  ON-LENDING  OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.1 — 3.18

General

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.1 — 3.3

Level  of  interest  rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3.4 — 3.9

Remuneration  of  financial  allocations  from  global  loans . . . . . . . . . . . . . .

3.10 — 3.18

Mechanisms  used  for  covering  the  exchange  rate  risk . . . . . . . . . . . . . . .

3.12 — 3.17

Use  of  the  interest  margin  for  administrative  cost  and  for  development
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
purposes

3.18

PROJECTS  FINANCED  WITH  RISK  CAPITAL . . . . . . . . . . . . . . . . . . . . . . . . . .

4.1 — 4.13

Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.1

Factors  relating  to  the  ‘long-term  viability  of  the  project’

. . . . . . . . . . . . .

4.2

Allocation  procedures  in  respect  of  global  loans . . . . . . . . . . . . . . . . . . . . .

4.3 — 4.4

Disbursement  period  and  disbursement  rate . . . . . . . . . . . . . . . . . . . . . . . . .

4.5 — 4.7

Delay  in  implementation  of  projects  and  actions . . . . . . . . . . . . . . . . . . . . .

4.8 — 4.10

Management  of  global 
Intermediaries  (ECFIs)

loans  by  European  Community  Financial
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4.11 — 4.13

ROLE  OF  THE  COMMISSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5.1 — 5.8

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6.1 — 6.11

TABLES  1—3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ANNEXES  I—II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The  Commission’s  replies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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1.  INTRODUCTION

Conduct  of  the  audit

General

1.1. Projects  or  programmes  financed  under  the  Lome´
Conventions  may  be  financed  by  grant  or  risk  capital
from  the  European  Development  Funds  (EDF)  or  by
loans  from  the  European  Investments  Bank’s  (EIB  or  the
Bank)  own  resources  or  jointly  by  two  or  more  of  these
means  of  financing (1).  This  report  deals  with  the  use  of
risk  capital  resources.

1.2. Risk  capital  constitutes  a  special  method  of
financing  that  exists  under  both  the  Lome´ III  and  Lome´
IV Convention allowing reimbursable financial assistance
to  be  given  under  favourable  conditions  to  priority
sectors  in  African,  Caribbean  and  Pacific  (ACP)  States
and overseas countries and territories (OCT) in particular
where  the  beneficiaries’  capacity  to  borrow  does  not
allow  financing  from  the  own  resources  of  the  EIB (2).

1.3. Risk  capital  funds  forming  part  of  the  EDF (3)  are
administered by the EIB on behalf of the Community and
in  accordance  with  the  Bank’s  Statute  and  the  Financial
Regulations  related  to  the  EDF (4).

these 

totals, 

1.4. The  amounts  earmarked  for  risk  capital  operations
(RCOs)  under  the  Lome´ III  and  Lome´ IV  Conventions
are  respectively  ECU  615  million  and  ECU  850  million.
amounts  decided (5),  net
Of 
commitments and disbursements (for ACP States only) as
at 31 December 1997 are given in Table 1.  Of  the  funds
available  under  the  Lome´ III  and  Lome´ IV  Conventions
88 %  has  been  committed.  However,  only  64 %  of  the
funds  has  been  disbursed  to  the  loan  recipients.

the 

(1)  Article  233  of  the  Lome´

IV  Convention  (OJ  L  229,

17.8.1991).

(2)  Where  in  this  report  the  term  ACP  State  is  used,  this  means
ACP  State  and  OCT  and  if  there  is  a  need  to  refer  to  the
legal  framework  for  risk  capital  operations,  this  is  done  in
relation  to  Lome´ IV  only.  Relevant  provisions  of  the  Lome´
III  framework  will  only  be  mentioned  in  as  far  as  they
comprise  deviations  from  that  for  Lome´ IV.

(3)  See  Article  10(2)  of  the  Internal  Agreement  (IA)  on  the
financing  and  administration  of  Community  aid  under  the
Lome´ IV  Convention  (OJ  L  229,  17.8.1991).

(4)  See  Article  15(1)  of  the  IA.
(5)  Including  amounts  decided  upon  but  for  which  initial

commitment  has  been  annulled.

the 

In  carrying  out  its  audit,  the  Court  has  taken  into
1.5.
account 
the  European
recommendation  of 
Parliament (6)  in  which  it  ‘invited  the  Commission,  the
EIB  and  the  Court  of  Auditors  to  make  regular  and
frequent on-the-spot audits of actions realised by the EIB
under  mandate’.

1.6. The Court’s audit constitutes the third examination
of aid operations managed by the EIB under mandate for
the  EDF (7)  and  has  been  conducted  on  the  basis  of  the
Tripartite  Agreement  concluded  between  the  EIB,  the
Commission  and  the  Court  of  Auditors (8).  The  main
relevant  observations  related  to  its  two  earlier  audits
were:

a)  documentation concerning management of risk capital
funds  by  EIB  in  Commission  files  insufficient  and
insufficiently  used;

b)  the  EIB  acts  more  as  a  commercial  bank  than  as  a

development  bank.

files  still  appeared 

1.7. The  Commission’s 
to  be
incomplete  and  not  fully  utilised  although  extensive
documentation  was  made  available  by  the  Bank  to  the
services  of  the  Commission  and  although  the  filing
system  was  improved  in  the  course  of  the  Court’s  audit.
In  the  course  of  the  audit,  supplementary  information
was  requested  from  the  Bank.

1.8. Generally  speaking,  cooperation  with  the  Bank  has
been  good,  particularly  during  on-the-spot  missions.
However,  some  important  information  was  provided  at
such a late stage that it hampered an efficient conduct of
the  Court’s  audit.

1.9.
Information  concerning 
invitations  to  tender,  other  than 
procurement 
tables 
information,  has  never  been  received.

the  results  of  official
in  the  form  of
containing  only  very  global

(6)  See  resolution  containing  observations  forming  part  of  the
decisions  to  give  discharge  to  the  Commission  for  its
management  of  the  fifth,  sixth  and  seventh  EDF  during  the
1993  financial  year  —  PE  189.073/58.

(7)  See  1984  special  report,  May  1984,  and  the  annual  report
for  the  year  1991,  paragraphs  17.42  —  17.61  (OJ  C  330,
15.12.1992).

(8)  The  Court  also  recently  published  in  its  Special  Report  1/98
observations  regarding  risk  capital  operations  managed  by
the  EIB  from  budget  resources  in  respect  of  the  bilateral
financial  and  technical  cooperation  with  the  Mediterranean
countries  (OJ  C  98,  31.3.1998).

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1.10. The  Court  has  examined  42  RCOs  out  of  which
33  projects  were  visited  on  the  spot (9)  comprising  an
examination  of  the  operations  of  financial  intermediaries
(FIs)  and  of  the  final  beneficiaries  of  the  risk  capital
financing  (cf.  Annex  I).

or  promoting  and  financing  investments  in  ACP  States.
For  a  breakdown  of  the  types  of  risk  capital  financing,
see  Annex  II.

2.  RISK  CAPITAL  AS  A  FINANCIAL  AID  INSTRUMENT

Types  of  risk  capital  financing

2.1. Risk  capital  is  used  for  investment  financing  in
order  to  assist  the  implementation  of  directly  productive
investment,  both  public  and  private,  contributing  to  the
economic  and  industrial  development  of  the  ACP  states
(cf.  Article  263  of  the  Lome´ IV  Convention).

IV
2.2. As  specified  by  Article  234  of  the  Lome´
Convention,  risk  capital  may  be  provided  in  the  form  of
loans  or  equity  participation.

2.3. Within the category of loans, global loans constitute
a  special  form  of  conditional  loan  and  can  be  compared
with  ‘credit  lines’  opened  with  financial  institutions.
These  institutions  which  can  be  situated  in  the  ACP
States (financial institutions or small local venture capital
companies) or the Member States of the Community will
— subject to the Bank’s approval — on-lend the funds to
the  final  beneficiary,  in  particular  SMEs,  in  the  form  of
individual  sub-loans  or  equity  participations.

2.4. Loans  with  participating  rights  constitute  a  special
form  of  risk  capital  financing  introduced  by  the  Bank  to
bring conditional or subordinated loans more in line with
the  concept  of  quasi-capital (10).  These  loans  normally
have  remunerations  comprising  firstly  a  fixed  interest
component  and  secondly  a  variable  component  set  as  a
percentage  of  dividends  paid.

In the case of equity participation, risk capital funds
2.5.
are  used  to  acquire  on  behalf  of  the  Community
temporary  minority  holdings  in  the  capital  of  ACP
enterprises  or  institutions  financing  development  projects

Intervention  sectors  and  allocation  of  funds

2.6. The  main  guideline  for  the  Bank’s  interventions  in
the  area  of  RCOs  is  to  be  found  in  Article  236  of  the
IV  Convention.  This  Article  stipulates  that  the
Lome´
Bank  should  finance  in  the  first  instance  productive
projects  and  programmes  in  industry,  agro-industry,
tourism,  mining, 
transport  and
energy  and 
telecommunications  linked  to  these  sectors.

in 

2.7. A  total  amount  of  ECU  406  or  49 %  of  available
funds  under  Lome´ IV  (ECU  270  million  or  45 %  under
Lome´ III)  had  been  allocated  to  the  46  least  developed
ACP  states  in  the  form  of  guaranteed  minimum  amounts
in  the  National  Indicative  Programme  (NIP).  For  14  of
them  (Lome´ IV),  the  amounts  of  RCOs  decided  upon  at
the  end  of  1997  stayed  ECU  1  million  or  more  below
these  minimum  amounts.

2.8. Few  (global)  guidelines  for  risk  capital  financing  of
individual  projects  or  programmes  exist.  Article  233.2  of
the  Lome´
IV  Convention  (Article  197.2  and  3  of  the
Lome´ III  Convention)  gives  criteria  to  be  considered  in
deciding upon the method(s) of financing for aid projects
or  programmes:

(a)  the  level  of  development,  the  geographical  situation
and economic and financial circumstances of the ACP
States;

(b) the nature of the project or programme, its economic
and  financial  return  as  well  as  its  social  and  cultural
impact;

(c)  in  the  case  of  loans  the  factors  guaranteeing  their

servicing.

2.9. The main orientation given by the Bank for the use
of  risk  capital  funds (11)  is  that  it  considers  it  as  an
alternative  financing  instrument  to  its  own  resources  to
be  used  in  cases  where  financing  from  own  resources  is
considered inappropriate. The Bank chooses between risk
capital  and  own  resources  financing  on  the  basis  of:  the
creditworthiness  of  a  country  and  the  overall  economic

(9)  Dominican  Republic,  Guinea,  Haiti,  Madagascar,

Mauritania,  Mozambique  and  New  Caledonia.

(10) Loan  with  equity  characteristics.

(11) Source: EIB reply to a general questionnaire from the Court,

August  5,  1996,  PA/ACP-111/JRL.

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and  political  situation  of  the  country;  the  existence  of
securities  or  guarantees  in  relation  to  the  financing;  the
structure  of  the  project  financing;  and  the  financial
assistance  required.

The  implementation  of  risk  capital  operations  by  the
European  Investment  Bank

2.10. The  criteria  defined  in  the  Lome´ IV  Convention
and  by  the  Bank  are  broad  so  that  any  judgement  as  to
whether  the  financing  of  a  project  is  appropriate  is
subjective. As a matter of fact the financing proposals (12)
examined  do  not  contain  a  clear  and  distinct  evaluation
of the criteria mentioned above in justifying the choice to
finance  the  action  wholly  or  partially  from  risk  capital
resources.  A  more  explicit  justification  however  would
make  the  decision  to  finance  from  risk  capital  more
transparent.

2.11.
In  this  context,  the  Court  found  a  number  of
operations financed from risk capital resources for which
it  is  debatable,  whether  the  risk  elements  that  should  be
inherent  to  this  type  of  operation  were  present  and
whether  they  needed  such  funding.

2.12. These  were:

(a) the  modernisation  of  joint  venture  fishing  fleets  in
Mozambique  and  in  Madagascar  in  which  their
Governments  have  minority  stakes.  The  joint  venture
operations  are  profitable  and  generate  hard  currency
for  repayment  of  the  loans  so  that  other  sources  of
financing  could  have  been  found;

(b) in  the  Dominican  Republic  the  proceeds  of  the  two
global  loans  given  to  a  financial  intermediary  have
been  used  in  its  entirety  for  on-lending  to  established
SMEs  which  had  proven  to  be  successful  in  their
operations.  In  several  cases  the  loan  would  have  been
given  to  the  final  beneficiary  even  without  the  EIB
global loan being available;

(c) the  use  of  risk  capital  funds  in  the  form  of  global
loans  and  a  loan  with  participating  rights  in  New
Caledonia,  where  other  sources  of  funding  could
easily  have  been  mobilised.

Stricter  criteria  and  guidelines  for  the  utilisation  of  risk
capital  funds  should  be  developed,  in  order  to  obtain  an
additional  value  for  development  purposes.

(12) Financing  proposal  for  the  operation  discussed 

in  the
Committee  mentioned  in  Article  28  of  the  IA  for  the  Lome´
IV Convention (OJ L 229, 17.8.1991) or in Article 22 of the
IA  for  the  Lome´ III  Convention  (OJ  L  86,  31.3.1986).

Tendering  procedures

2.13.
In managing the tendering procedures under Lome´
III,  the  Bank  decided  that  contracts  would  be  awarded
under  a  competitive  procedure  taking  into  account  the
specific  character  of  the  project  and  the  type  of
expenditure. However, the Bank did not comply with the
EDF  rule  that  tenders  should  be  open  only  to  firms
having  their  main  seat  in  ACP  or  EU  Member  States.

2.14. The documentation made available by the Bank in
the  form  of  procurement  tables  did  not  allow  the  Court
to  establish  that  the  conduct  of  the  tender  procedure  has
been  in  compliance  with  the  EDF  rules,  i.e.  those
stipulating  that  supplies  should  originate  in  EU  Member
or  ACP  States,  unless  a  derogation  applies.  However,  in
several cases supplies originated in non-ACP and non-EU
Member  States.

2.15. For  the  Cahora  Bassa  project,  the  works  at  the
northern  part  (financed  from  EDF  resources  managed  by
the  Commission)  and  the  southern  part  (financed  from
EIB  own  resources  and  EDF  risk  capital  funds)  of  the
transmission  line  have  been  the  subject  of  two  different
tenders and contracts although they were finally awarded
to  the  same  contractor.  The  reason  for  this  is  that  the
Commission  and  the  Bank  could  not  agree  on  the  tender
conditions  as  EDF  procurement  rules  differed  from  those
used  by  the  Bank  (i. e.  rules  of  origin  on  supplies  from
South  Africa).  The  Court  welcomes  the  change  in  the
Bank’s policy in 1995 by which it now applies EDF rules
at  least  under  Lome´ IV.

Loan  conditions  and  undertakings

they  had  not  submitted 

2.16. Several cases occurred where undertakings by ACP
States  or  beneficiaries  were  not  or  not  fully  met.  In
particular, 
the  necessary
information  such  as  progress  reports,  project  completion
reports, audited financial statements or for the FIs reports
final  beneficiaries (13).
on 
the
analyses  of 
Furthermore, 

the  performance  of 

although  detailed 

the 

(13) See  also  paragraph  1.31  of  Special  Report  1/98.

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beneficiaries’  economic  and  financial  performances  were
received  by  the  Court  during  its  missions,  the  Bank  did
not  confirm  receiving  these  systematically  from  the
intermediaries  (FIs) (14).  On  this  particular
financial 
point, the financial contracts between the EIB and the FIs
are not clear, the respective articles allowing for different
interpretations  as  regards  the  FIs’  obligations.

2.17. Other  cases  concern:

(a) the  borrower’s  (ACP  State)  failure  to  make  available
to  the  final  beneficiary  foreign  currency  (of  about
ECU 2 million) in exchange for an equivalent amount
in local currency in spite of several reminders given by
the  Bank  during  its  on-the-spot  missions;

(b) ECU  6  million  of  risk  capital  that  was  assigned  to  be
used for the modernisation of a fishing fleet. Although
the  project  as  such  is  being  successfully  implemented,
there  are  concerns  about  the  protection  of  fish
resources  of  the  ACP  State.  Although  data  for  the
total  allowable  catch,  submitted  by  the  borrower,  are
incomplete,  they  already  show  that  the  ceiling  for
total  allowable  catch  was  set  above 
level
mentioned  in  the  financing  proposal  for  the  project.
At  the  same  time,  the  total  number  of  fishing  licences
issued  has  also  increased;

the 

(c) ECU  3,2  million  of  risk  capital  was  assigned  to  the
modernisation  of  fishing  boats  and  the  equipment  for
treatment  of  prawns.  The  Government  of
the 
Madagascar continued to issue further fishing licences
despite  a  commitment  to  the  contrary  and  reminders
from  the  Bank.  The  observed  reduction 
in  the
quantities  of  fish  caught  per  hour  of  fishing  would
already  indicate  that  there  is  over-fishing.

2.18. The  Bank’s  reactions  in  such  situations  have  been
inconsistent: in a number of cases reminders were sent to
the  borrower,  in  other  cases  the  Bank  would  appear  to
have  accepted  the  situation.

3.  INTEREST  RATES  AND  THE  USE  OF  THE  INTEREST
MARGIN  IN  CASE  OF  ON-LENDING  OPERATIONS

Convention.  It  stipulates  that  in  the  case  of  loans  the
interest  rate  shall  be,  in  any  case,  less  than  3 %.  For
Lome´ III  the  Convention (15)  provides  that  the  interest
rate 
the
characteristics  of  each  project  and  shall  not  be  higher
than  8 %.

shall  be  determined  by 

reference 

to 

financial 

institution 

the  ACP  State  or 

3.2. When funds are on-lent to the beneficiaries through
a 
its
in 
Government,  the 
in  the  first
instance  from  a  rate  lower  than  3 %.  Final  beneficiaries
pay higher interest rates unless loans are granted to them
directly  by  the  Bank  or  the  intermediary  on-lends  on  the
same  conditions.

intermediaries  benefit 

to 

enable 

3.3. The  margin  between  the  two  interest  rates  is
destined 
cover
administrative costs, exchange and financial risks and the
cost  of  technical  assistance  given  to  the  final  recipient.
Any  remaining  amount  is  to  be  used  for  development
purposes (16).

intermediary 

the 

to 

Level  of  the  interest

3.4. For  the  projects  examined,  where  loans  were  made
through  the  governments  of  ACP  States  interest  rates
were  generally  set  below  market  rates.

3.5. For loans on-lent to SMEs by a financial institution,
interest  rates  are  usually  set  at  market  level  for  several
reasons:  to  avoid  distortion  of  competition;  to  mitigate
the  risk  of  irregularities  occurring  in  the  selection  of
beneficiaries  (risk  of  corruption);  and  to  make  loan
beneficiaries  self  supporting  in  the  longer  term.  For  the
final  beneficiary  the  only  advantage  of  this  risk  capital
financing  is  that  it  provides  easier  access  to  medium-  or
long-term financing.

General

3.1. The only direct reference to interest rates applicable
to  RCOs  is  made  in  Article  234.1(c)  of  the  Lome´ IV

3.6. Loans  from  the  Bank’s  own  resources  benefit  from
an  EDF  interest  subsidy  paid.  This  could  lead  to  a
situation  where  the  net  interest  rate  on  the  Bank’s  own
resources  loans  to  be  paid  by  the  final  beneficiaries  is
lower  than  that  for  risk  capital  loans.  For  example,  for

(14) See  also  Special  Report  1/98  in  respect  of  the  bilateral
financial  and  technical  cooperation  with  the  Mediterranean
countries,  paragraph  1.31.

(15) Articles  196(3b)  and  199(4).
(16) See  Article  233.4(b)  of  the  Lome´ IV  Convention.

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an  investment  in  a  hotel  complex  in  Guinea,  the  interest
rate  charged  on  the  EIB  own  resources  loan  was  3 %
whilst 
financial
intermediary  was  8 %.

the  risk  capital 

through  a 

loan 

3.7. From  a  development  policy  point  of  view,  the
Bank’s  policy  to  set  interest  rates  for  SMEs  at  market
level and to use more concessional interest rates for larger
sized enterprises in the private and public sector is against
the  spirit  of  the  Lome´ Convention  and  can  lead  to  an
unbalanced  situation  in  the  allocation  of  the  advantages
of  risk  capital  financing  to  the  beneficiaries.

3.8. The  following  examples  are  given  to  illustrate  the
above  situation:

the conditions set in the loan contract concluded between
the  intermediary  and  the  Bank  either  because  ‘reference’
rates  did  not  exist  (for  example  in  Haiti)  or  because
definition  of  the  rates  applied  by  the  FIs  made  a
impossible.  The
‘reference’  rates 
comparison  with 
following cases illustrate problems encountered as regards
the  remuneration:

(a) in  the  Dominican  Republic  the  interest  rates  for  some
sub-loans,  of  which  the  rates  varied  between  20 %
and  26 %  in  January  1997,  were  higher  than  the
‘preferential  rate’  published  by  the  Central  Bank  of
about  20 %  and  applicable  since  October  1996.  This
rate  constitutes  the  reference  rate  for  the  FI  to  set  the
interest rate for its loans. According to the Bank, rates
used  by  the  FI  had  been  in  line  with  the  ‘preferential
rate’  up  to  October  1996.  The  discrepancy  is  now
being  investigated  by  the  Bank;

(a) an  electricity  producing  and  distributing  company  in
the  Dominican  Republic  has  received  a  6 %  loan
under  an  on-lending  agreement  with  the  Government
of  the  Dominican  Republic  and  with  the  exchange
rate  risk  to  be  borne  by  the  beneficiary.  In  the  same
country  SMEs  have  to  pay  interest  rates  of  between
22 %  and  32 %  for  loans  on-lent  to  them  by  a  FI,
however,  with  the  exchange  rate  risks  to  be  borne  by
the intermediary;

(b) in  the  case  of  another  global  loan  to  a  FI  in
Madagascar,  the  finance  contract  stipulated  that
sub-loans  should  bear  a  global  effective  interest  rate
including  cost,  commissions  and  other  remunerations,
reflecting  rates  used  in  that  country  for  operations  of
the  same  nature,  duration  and  amount  and  agreed
upon  by  the  Bank.  In  this  case  it  appears  hardly
possible  to  establish  whether  the  rates  were  set  in
conformity  with  the  Bank’s  guidelines.

(b) in  Mozambique  a  local  subsidiary  of  an  European
enterprise  active  in  fisheries  borrowed  at  an  interest
rate  of  4 %  from  the  Government  through  an
on-lending  agreement.  The  exchange  rate  risk  it  had
to  bear  was  limited  as  its  operations  generated  hard
currency.  Newly  established  SMEs  paid  interest  rates
varying  between  40  and  46 %  on  on-lending
agreements  with  FIs  as  the  latter  had  to  cover  the
exchange  rate  and  the  inflation  risks.

In  such  cases,  the  Bank  should  have  ensured  that
3.11.
‘reference’  rates  mentioned 
in  finance  contracts  do
actually  exist  in  the  countries  concerned  and  allow  for
proper  verification  of  the  interest  rates  applied  by  the
FIs.

In a number of loan contracts (concluded under the
3.9.
IV  Convention)  the  total
provisions  of  the  Lome´
remuneration 
interest
(remuneration)  on  the  loan  to  exceed  3 %,  in  particular
in  the  case  of  loans  with  participating  rights  (see
paragraph  2.4) (17).  Such  additional  yield  is  not  provided
for  by  the  Lome´ Convention.

the  EIB 

allows 

the 

to 

Mechanisms  used  for  covering  the  exchange  rate  risk

In  the  case  of  on-lending  of  the  initial  loan  in  a
3.12.
different  currency,  the  finance  contracts  allocate  the
exchange  rate  risks  between  the  final  beneficiaries  and
the  initial  borrower.

Remuneration  of  financial  allocations  from  global  loans

3.10. For  several  cases  the  Court  was  not  able  to  verify
that the rates applied by the FIs were in compliance with

3.13. Under  Lome´
III  the  risk  was  entirely  for  the
borrower  who  had  to  pay  back  the  loan  in  ecu  or
another  European  currency.  In  the  case  of  an  on-lending
operation  the  risk 
is  (partially)  transferred  to  the
beneficiary  under  the  sub-loan  contract  through  a  higher
interest  rate.

(17) See also annual report for the financial year 1996, volume II
statement  of  assurance,  paragraph  22.24(a)  (OJ  C  348,
18.11.1997).

3.14. The Lome´ IV Convention (Article 234.2) provided
for  a  change  by  stipulating  that:

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(a)  the  risk  is  as  a  general  rule  borne  by  the  Community
in  the  case  of  risk  capital  financing  to  strengthen  the
enterprises’  own  funds;

(b) it  should  be  shared  between  the  Community  and
other  parties  involved  in  the  case  of  risk  capital
financing  for  investments  of  private  sector  firms  and
SMEs.

3.15. Article 234.2(b) also stipulates that on average the
foreign  exchange  rate  risk  shall  be  shared  equally.  This
Article needs clarification as to how it should be applied,
when  and  by  whom  and  how  calculations  for  this
purpose  should  be  made  as  well  as  what  use  is  to  be
made  of  the  results.

3.16. Moreover,  the  Convention  does  not  indicate  what
arrangements are to be made for the exchange rate risk in
case  of  on-lending  of  funds  to  the  non-private  sector  or
other  than  SMEs.

3.17. The  exchange  rate  risk  problem  which  constitutes
a major element in setting the level of the interest rate for
the  on-lending  operation  is  dealt  with  in  different  ways
by  the  Bank  for  reasons  not  evident  to  the  Court:

(a)  in  the  first  of  two  similar  projects  provisions  for
sharing  the  exchange  rate  risk  between  beneficiary
and  Community  are  non-existent  whereas  for  the
other  the  Community  would  bear  at  maximum  25 %
of  the  exchange  risk;

(b) in  another  case,  the  financial  contract  with  the  loan
beneficiary  foresees  that  the  exchange  rate  risks  are
in
borne  entirely  by 
contradiction  with  the  respective  provision  of  the
Lome´ IV  Convention;

the  beneficiary  which 

is 

(c)  in Mozambique, Madagascar and New Caledonia, FIs
had not constituted at the time of the Court’s mission
the so-called exchange rate risk funds as stipulated in
the  finance  contracts.  In  addition,  finance  contracts
do  not  stipulate  for  what  purpose  any  balance  left
from  the  exchange  rate  risk  fund  is  to  be  used  after
the  loan  has  been  repaid.

Use of the interest margin for administrative cost and for
development  purposes

cost  and  development  purposes  were  either  lacking,
contrary  to  the  provisions  of  the  Lome´ IV  Convention,
incomplete  or  not  precise.  The  Bank  should  take  actions
to  ensure 
IV
the  provisions  of 
Convention (18)  on  the  use  of  the  margin  are  being
respected  i. e.  that  any  net  benefit  for  the  intermediaries
is  to  be  used  for  concrete  development  purposes.

the  Lome´

that 

4.  PROJECTS  FINANCED  WITH  RISK  CAPITAL

Scope

4.1. Though  the  investments  forming  part  of  the  RCOs
have  been  adequately  prepared, 
implemented  and
monitored  by  the  Bank,  the  following  observations  are
being  made  which  relate  to  the  long-term  viability  of  the
projects,  the  allocation  procedures  and  disbursement
period  and  rate  in  the  case  of  global  loans  and  delays  in
implementation.

Factors  relating  to  the 
project’

‘long-term  viability  of  the

In the following cases the ‘long-term viability of the
4.2.
project’  is  endangered  even  if  the  preparation  and  the
implementation of the investments have been sound. Even
when  formally  the  Bank  and  the  Commission  have  few
possibilities  to  intervene  after  the  investments  have  been
realised,  they  should  find  ways  to  ensure  that  there  is
effective monitoring at national level of projects to avoid
problems  as  cited  below:

(a)  ECU  13  million  of  risk  capital  were  assigned  to  a
ECU  42  million  investment  plan  to  restore  the
production  capacity  and  to  improve  the  productivity
and  the  reliability  of  the  industrial  installations  of  an
alumina  producing  factory.  Other  investments  in
plant  and  equipment  required  to  guarantee  the
viability  of  the  operations  have  been  canceled  or  put
off  by  the  company  which  has  used  the  funds
becoming  thus  available,  to  offset  losses  that  the
shareholders  had  originally  agreed  to  bear  as  laid
down  in  a  Memorandum  of  Understanding  between
the  two  main  shareholders;

(b) ECU  20  million  of  risk  capital  were  assigned  to  a
ECU  152  million  project  (meanwhile  reduced  to  a

3.18.
In a number of cases, administrative arrangements
for  determining  the  portion  of  the  margin  (including  any
yields  from  participations)  to  be  used  for  administrative

(18) See  article  233.4(b)  of  the  Lome´ IV  Convention.

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ECU  120  million  project)  for  the  rehabilitation  of  a
power  transmission  line  linking  the  hydroelectric
station  in  Mozambique  with  the  electricity  net  of
South  Africa  (RSA).  Because  the  tariff  rate  for  the
supply  of  electricity  to  RSA  (negotiated  in  1975  and
laid  down  in  a  contract  that  cannot  be  changed)  is
considerably  lower  than  the  current  rates,  the  full
recovery  of  cost  will  become  very  difficult,  on  top  of
losses  made  so  far;

(c) ECU  6  million  of  risk  capital  were  assigned  to  the
construction of two facilities (of ECU 3 million each)
for  the  processing  of  cashew  nuts.  The  first  project,
decided  upon  in  1992,  started  its  operations  with  the
1995/96  campaign.  The  second  one  decided  upon  in
1995,  has  been  suspended  by  the  promoter,  due  to
the  unclear  and  risky  situation  in  the  cashew  nut
market.  The  two  projects  suffer  from  an  unclear  and
changing  policy  of  the  government  in  the  cashew  nut
sector;

and 

industrial  plantations 

(d) ECU  14  million  of  risk  capital  was  assigned  to  the
financing of an agro-industrial project comprising the
establishment  of  new  estates  and  facilities  to  process
rubber  and  palm  oil  using  the  output  from  both
(Soguipah).
family 
However,  insufficient  attention  was  paid  to  factors
such  as  access  to  markets,  marketing  of  the  product
and  the  acceptability  of  the  palm  oil  for  local  tastes.
The  sustainability  of  the  operations  that  provides
employment  for  1  686  people  and  work  and  income
opportunities to locals in the region, is uncertain with
accumulated 
the  period  1992-1995
amounting  to  more  than  50 %  of  the  share  capital,
access  to  markets  being  limited  and  the  company
being  heavily  dependent  on  grants  and  loan  finance;

losses 

in 

(e) in  Madagascar  and  the  Dominican  Republic,  the
creation  of  new  jobs  in  five  out  of  the  11  SMEs
visited  by  the  Court  and  having  benefitted  from  the
EDF  risk  capital  funds  to  the  sum  of  ECU  783 000
has  not  reached  the  figures  expected  and  mentioned
in  the  loan  allocation  reports.  In  the  case  of  one  of
these  companies,  the  majority  shareholder  had  not
met its commitment to invest in the newly established
SME  which  then  appeared  to  have  a  negative  impact
on  the  latter’s  commercial  operations  for  the  years
1994  and  1995.

Allocation  procedures  in  respect  of  global  loans

existing  activities.  For  the  cases  examined,  by  far  the
greatest part of the financing from global loans was used
by  FIs  for  financing  the  expansion  of  operations  of
existing  clients (19).  Some  of  them  would  probably  have
received  a  loan  from  the  intermediaries’  own  resources.
Details  of  loan  allocations  are  given  in  Table  2.

In  New  Caledonia  global  loans  had  been  also  used
4.4.
for the refinancing of operations which already had been
the  subject  of  loans  granted  by  the  FI  from  its  ‘own
resources’  or  for  operations  which  had  been  previously
financed  by  the  SME  from  its  own  treasury.  The
additional  value  in  terms  of  development  aid  is  not
evident  in  such  cases.

Disbursement  period  and  disbursement  rate

4.5. Disbursement periods for global loans are set in the
finance  contract  between  the  Bank  and  the  FI  and
normally cover a three-year period with the possibility of
an extension to be decided upon by the Bank. For details
of  disbursement  periods,  see  Table  3.

4.6. The  low  disbursement  rate  in  Mozambique  was
partially  due  to  the  existence  of  competitive  loans  with
less  restrictive  conditions,  as  well  as  to  the  high  inflation
rate  and  corresponding  high,  on-lending  interest  rates
(40-46 %). 
the  general  economic
situation  (devaluation  of  franc  malgache  in  1994)  has
constituted  a  hindrance  for  the  creation  or  expansion  of
SMEs.

In  Madagascar, 

4.7.
In  Madagascar  and  Mozambique  the  financial
intermediaries  did  not  immediately  make  available  the
proceeds of the EIB loans to the beneficiaries. In one case
the  financial  intermediary  retained  ECU  100 000  of  the
EIB  funds  allocated  to  the  final  beneficiary  without  any
explanation being available.

Delay  in  implementation  of  projects  and  actions

In  its  annual  report  for  the  financial  year  1996,
4.8.
Volume 
the  Court
mentioned  the  existence  of  RCOs  for  which  there  had
been  no  disbursement  for  at  least  18  months.

II  statement  of  assurance (20), 

4.9. The  Court  has  found  a  number  of  projects  for
which  implementation  has  been  severely  delayed  for  a

4.3. Global  loans  for  on-lending  to  SMEs  are  used  for
both  the  set  up  of  new  activities  and  the  expansion  of

(19) See  also  Special  Report  1/98,  paragraph  1.30.
(20) OJ  C  348,  18.11.1997,  paragraph  22.12.

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variety  of  reasons,  leading  to  a  situation  where  risk
capital  funds  have  been  committed  without  the  funds
being  effectively  used:

disbursement 

(a) in  December  1994,  a  finance  contract  was  concluded
for  the  rehabilitation  of  a  crude  oil  pipeline.  The
provisional 
foresaw
disbursements  of  ECU  9  million  for  the  period
1995-1997.  At  the  end  of  the  year  1997,  only  ECU
0,4  million  had  been  disbursed  but  the  annual  report
on  the  conduct  of  the  operation  as  at  31  December
1995  compiled  by  the  Bank  did  not  contain  any
particular  remark  in  respect  of  the  delay;

timetable 

regional 

(b) a ECU 14 million loan to the Government of Ethiopia
for  a 
telecommunication  project  was
disbursed  for  ECU  0,6  million  only  at  the  end  of  the
year  1997,  although  the  project  was  estimated  at
appraisal 
in  December  1996.
Disbursement  of  the  remainder  of  the  loan  has  been
blocked  because  of  serious  problems  with  the  tender
for  the  switching  of  telephone  lines,  identified  by  the
Bank (21)  but  not  yet  solved  by  the  latter;

to  be  completed 

the 

for 
commercial 

(c) in  the  Dominican  Republic,  the  Bank  granted  in
December 1994 a ECU 15 million conditional loan to
design,
the  Government 
implementation, 
commissioning  and
operation  of  investments,  as  part  of  a  wider  project
with  estimated  cost  of  ECU  47  million,  in  the
transmission network in the capital city and the South
and  East  parts  of  the  country.  The  project,  expected
to  be  commissioned  by  the  end  of  1996  had  not
started  by  the  end  of  1997.

study, 

4.12. According  to  the  ECFIs  visited  by  the  Court  the
reasons  for  the  low  utilisation  rate  are:  the  time  it  has
taken  for  the  facility  to  become  known,  the  limitations
set  for  the  amounts  of  individual  allocations,  and  a  lack
of  suitable  projects.  Disbursement  is  further  delayed
because  of  the  time-consuming  set  up  of  legal  and
administrative  frameworks  within  which  investments  are
to  operate.

4.13. Acknowledging  that  it  is  important  that  risk
capital  funds  are  made  available  widely  and  at  different
the
levels,  some  participations  were  noted  where 
funding
efficiency  and 
arrangements  are  questionnable:

transparency  of 

the 

the 

(a) in  the  case  of  investments  in  venture  capital  funds
(VCF) there appeared to be four levels through which
funds  pass  before  they  reach  the  final  beneficiary  (the
SME)  which  would  appear  to  be  costly  (commissions
and  fees)  and  time  consuming;

(b) for  an  investment  in  Guinea  (Conakry),  two  different
forms  of  financing  from  risk  capital  were  used
through  two  different  intermediaries  in  combination
with  the  direct  financing  by  the  Bank  from  its  own
resources  under  a  variety  of  conditions.

5.  ROLE  OF  THE  COMMISSION

4.10. Therefore, the Commission should, in consultation
with  the  Bank,  formulate  a  policy  on  the  decommitment
of  ‘sleeping’  balances  of  RCOs.

5.1. As already mentioned (see paragraph 1.3), the Bank
administers  risk  capital  from  the  Fund’s  resources  on
behalf  of  the  Community  and  also  undertakes  the
financial  execution  of  operations  carried  out  with  risk
capital.

Management  of  global  loans  by  European  Community
Financial  Intermediaries  (ECFIs)

4.11. A  global  amount  of  ECU  15  million  has  been
made available to ECFIs in the form of conditional loans
(see also paragraph 2.3). The utilisation rate of this ECU
15  million  facility  has  been  rather  low:  at  August  1997,
four  and  a  half  years  after  the  finance  contracts  were
signed  and  nineteen  months  after  the  initial  allocation
period  had  expired,  100 %  of  the  global  loan  amount
had  been  allocated  but  only  42 %  disbursed.  In  seven  of
the  twelve  EU  Member  states  (B,  D,  EL,  IRL,  I,  L,  P)  no
use  had  been  made  of  the  facility  so  far.

the  Council  and 
finance 

the  guidelines 
cooperation  defined  by 

5.2. Based  on  Article  11  of  the  IA,  ‘the  Commission
shall  be  responsible  for  implementing  the  aid  policy
for
defined  by 
development 
the
ACP-EEC  Council  of  Ministers  pursuant  to  Article  325
of  the  Convention’.  For  this  purpose  and  to  ensure  a
certain  coordination  between  the  Commission  and  the
Bank,  the  IA  mentions  the  exchange  of  information
between 
(see
paragraph  1.7).

the  Commission (22) 

the  Bank  and 

5.3. To  fulfil  its  role  stipulated  in  Article  11,  it  would
therefore  be  of  primary  importance  for  the  Commission
to  follow  critically  the  appraisal  process  carried  out  by
the  EIB.  However,  on  the  operations  which  have  been

(21) See  EIB  periodic  progress  report  dated  22.10.1996.

the  IA.

(22) See  for  example  Articles  12(1)  and  12(2),  17(4)and  30(4)  of

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examined  in  the  course  of  the  audit,  the  Court  has  only
found  very  little  written  evidence  of  active  participation
be  it  in  the  Commission’s  files  or  in  the  minutes  of  the
Article  28  Committee.  The  quality  and  scope  of  the
reactions  to  the  Bank’s  proposals  by  the  central  services
of 
the  exchange  of
information  with  Delegations  depends  mainly  upon  the
initiative  of  the  respective  Commission  officers.

the  Commission  as  well  as 

clear  how  and  to  what  extent  the  Commission  has
fulfilled  its  obligations  under  the  articles  of  the  IA.

6.  CONCLUSION

5.4. The formulation of guidelines for the procedures to
follow and the main elements to be considered in giving a
reaction  to  the  proposals  of  the  Bank  would  make  such
reactions  more  transparent  and  valuable.

6.1. The  manner  in  which  risk  capital  operations  have
been  prepared,  implemented  and  monitored  by  the  Bank
does  not  give  rise  to  observations.  Nevertheless,  the
transparency  and  effectiveness  of  the  operations  can  still
be  improved.

5.5. Article 33.6 of the IA provides that the Commission
shall  draw  up  periodically,  in  agreement  with  the  Bank,
lists of the information it receives from the latter in order
to  assess  how  the  Bank  is  carrying  out  its  brief  and
encourage  close  coordination  between  the  Commission
and  the  Bank.

5.6. For  the  purpose  of  such  assessment,  a  number  of
reports  envisaged  by  the  IA  could,  in  principle,  be  very
helpful  such  as:

(a) the  report  on  the  evaluation  of  the  projects  to  be
provided  periodically  by  the  Commission  and  the
Bank  to  the  Council,  in  particular  in  relation  to
development objectives set (23). However, these reports
have  not  been  produced;

(b) the  report  on  the  execution  of  operations  financed
from  the  fund  resources  managed  by  the  Bank  to  be
provided  yearly (24).  However, 
these  reports  are
mainly  based  on  the  commitments  of  funds  following
financing  decisions  taken  and  on  economic  data
presented  in  the  appraisal  stage  of  the  operations.

5.7. For  none  of  the  operations  examined  by  the  Court
the Bank made an ex post evaluation of projects financed
with risk capital resources. No information on evaluation
is  thus  provided.

5.8. The  Commission  has  not  carried  out  any  audit  or
evaluation missions or activities in relation to risk capital
operations  either.  Based  on  the  above,  it  is  therefore  not

6.2.
Important information was provided by the Bank at
a  late  stage  which  hampered  an  efficient  conduct  of  the
Court’s  audit  (see  paragraphs  1.8  —  1.9).

6.3. The  criteria  which  should  guide  the  allocation  of
risk  capital  resources  are  very  general.  The  Bank  is  thus
more  or  less  free  to  choose  between  risk  capital  or  its
own  resources  in  making  loans.  The  justification  of  the
decision  to  use  risk  capital  funds  for  a  project  does  not
clearly  emerge  from  the  project  appraisal  documentation
(see  paragraphs  2.10  —  2.12) (25).

6.4. The use of different types of financing (direct loans,
loans  via  an  ACP  State,  global  loans)  has  led  to  unequal
treatment  of  final  beneficiaries:  while  some  benefit  from
the  3 %  maximum  interest  rate  mentioned  in  the  Lome´
Convention, the others have to pay market rates. Though
not  the  only  determining  factor,  the  effects  of  exchange
rate fluctuations play an important role in setting interest
rates  above  the  3 %  level.  These  effects  and  thus  the
justification  for  higher  interest  rates  can  be  calculated
only after loans have been fully repaid. In addition, in the
case  of 
total
loans  with  participating  rights, 
remuneration  to  the  EIB  —  being  at 
least  partly
dependent  on  the  result  of  the  beneficiary  enterprises  —
could  well  exceed  the  3 %  limit  (see  paragraphs  3.4  —
3.9).

the 

6.5. The  principle  of  an  average  equal  sharing  of  the
foreign  exchange  rate  risk  introduced  by  the  Lome´ IV
Convention is limited to investments in the private sector
or  in  SMEs  and  further  needs  to  be  clarified.  Different
formulae  were  used  by  the  Bank  in  order  to  adhere  to  it
administrative
sometimes 
arrangements  (see  paragraphs  3.12  —  3.17).

rather  heavy 

involving 

(23) See  Article  30.6  of  the  IA.
(24) See  Article  33.5  of  the  IA.

(25) See  also  paragraphs  1.22,  1.24  of  Special  Report  1/98.

C  389/54

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6.6. Provisions concerning the use of the interest margin
by  the  financial  intermediary  are  often  not  clear.  The
Bank  should  ensure  that  finance  contracts  stipulate
precisely  how  the  amount  of  the  interest  margin  is  to  be
used  and  that  any  such  use  is  in  compliance  with  the
provisions  of  the  Lome´ IV  Convention  (see  paragraph
3.18).

6.7. Support  to  the  private  sector  through  global  loans
has  been  given  mainly  to  existing  —  instead  of  emerging
— SMEs which moreover often benefitted from financing
from  the  FIs’  other  resources  (see  paragraphs  4.3  —
4.4) (26).

6.8.
In  a  number  of  cases  the  effectiveness  of  the  RCOs
for  development  purposes  is  hampered  by  the  fact  that
the  disbursement  of  funds  is  delayed  or  because  the
long-term  viability  of  the  operations  financed  is  being
threatened  (see  paragraphs  4.2,  4.8  —  4.10).

6.9. An ex post evaluation function is needed to provide
information  about  the  viability  of  operations  having
benefitted  from  risk  capital  finance  and  their  real
contribution  to  the  economic  and  social  development  of
the  ACP  states.  Such  an  evaluation  system  should  be

developed  in  cooperation  between  the  Bank  and  the
Commission  (see  paragraph  5.6).

6.10.
In addition, the Commission should have played a
more  active  role  at  the  appraisal  stage  and  regarding  the
evaluation  of  the  overall  effects  of  RCO  on  the
development  of  the  ACP  State.  Guidelines  should  be
developed  setting  out  the  responsibilities  of  and  the
procedures  to  be  followed  by  the  services  concerned  (see
paragraph  5.8).

fact, 

6.11. The  preceding  recommendations  are  made  in  the
context  of 
improving  the  existent  systems  of  the
management  of  RCOs.  However,  alternative  systems
should  be  considered.  As  a  matter  of 
the
Commission’s  role  in  the  management  of  the  RCOs
seems  to  be  limited  in  practice  to  an  exchange  of
information  with  the  Bank.  The  involvement  of  the
Commission in a number of tasks (appraisal, accounting,
monitoring and evaluation), which are indeed not clearly
defined,  are  not  adhered  to  by  the  Commission.  It  is
therefore  that  the  Court  proposes  alternatively  that
consideration should be given to the possibility to entrust
the  entire  management  of  RCO  to  the  Bank  outside  the
European  Development  Funds.  In  this  context  it  is  noted
that  repayments  of  risk  capital  funds  and  the  received
yields  on  the  funds  already  remain  outside  the  EDF.

This report was adopted by the Court of Auditors at the Court meeting of 14 and 15 October
1998.

For  the  Court  of  Auditors

Bernhard  FRIEDMANN

President

(26) See  also  paragraphs  1.25  —  1.30  of  Special  Report  1/98.

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Table  1

Utilisation  of  risk  capital  funds

Amount
available

Amout
decided

Net
commitment

%

Amount
disbursed

%

(in  Mio.  ECU)

Lome´ III
—  Loans
—  Direct  participations

Lome´ IV
—  Loans
—  Direct  participations

600,0

825,0

644,5
1,0

500,0
1,0

645,5

501,0

763,0
24,5

732,5
24,5

787,5

756,5

TOTAL

1 425,0

1 433,0

1 257,0

83
0

83

89
3

92

88

494,5
0,5

495,0

395,0
16,5

411,5

906,5

83
0

82

48
2

50

64

Table  2

Loan allocations (*)

Project

Total  number  of
allocations

Value
(million  ECU)

Number  of
allocations  to
newly established
companies

6  MOZ  071
7  MAG  050  +  MAG  051
7  HA  028
7  DO  014  +  7  DO  031
6  NC  011  +  7  NC  017  +  NC  016
7  GPR  003

TOTAL

(*)  Including  participations.

3
11
12
144
15
27

212

1,9
1,1
1,8
11,0
7,8
15,0

38,6

2
9
3
—
2
18

34

%

67
82
25
0
13
67

16

C  389/56

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Table  3

Disbursement  periods

Project

Disbursement  rate

Time  period  elapsed

Observation

Cancelled  for  the  rest

6  MOZ  071

6  MAG  050

7  MAG  051

7  HA  028

7  DO  014

7  DO  031

6  NC  11

7  NC  17

7  GPR  003

32 %

10 %

40 %

100 %

100 %

100 %

100 %

70 %

42 %

After  3  years

After  3  years

After  2,5  years

After  2  years

After  2  years

After  3  years

After  3  years

After  3,5  years

After  4,5  years

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ANNEX  I

Table  I.1

SUMMARY  OF  RCOs  EXAMINED

Country

Intervention  sector

Amount  in  million  ECU

Committed

Disbursed

Mozambique

Sub-total

Madagascar

Global loan

Agro-industrial

Fisheries

Energy

Agro-industrial

Energy

Energy

Agro-industrial

Agro-industrial

Agro-industrial

Agro-industrial

Agro-industrial

Global loan

Global loan

Agro-industrial

Sub-total

Guinea

Industrial

Water

Hydro-electric  power  stations

Hydro-electric  power  stations

Water

Agro-industrial

Thermal  power  stations

Sub-total

Mauritania

Energy

Mining

Mining

Mining

Mining

Sub-total

Dominican  Republic

Global loan

Energy

Global loan

Sub-total

Haiti

Global loan

Sub-total

6,0

3,0

6,0

20,0

3,0

38,0

2,0

13,5

1,3

4,4

0,4

1,0

1,8

1,0

1,0

3,5

29,9

13,0

6,0

19,0

6,0

8,0

14,0

20,0

86,0

5,0

10,0

10,0

1,5

5,0

31,5

3,0

15,0

8,0

26,0

4,0

4,0

1,9

3,0

4,7

12,5

—

22,1

2,0

13,5

1,3

4,4

0,4

1,0

1,8

0,1

0,7

3,5

28,7

13,0

6,0

6,0

—

7,4

14,0

17,3

63,7

4,9

10,0

10,0

1,5

5,0

31,4

3,0

—

8,0

11,0

4,0

4,0

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Country

Intervention  sector

Amount  in  million  ECU

Committed

Disbursed

New  Caledonia

Global loan

Global loan

Loan  with  participating  rights

Sub-total

Uganda

Global loan

Ethiopia

Sub-total

Sub-total

Telecommunications

Telecommunications

Lesotho

Centrales  hydrauliques

Sub-total

Sub-total

Air  transport

Air  transport

Energy

Global loan

Regional

General

TOTAL

3,0

4,0

2,0

9,0

15,0

15,0

6,0

14,0

20,0

15,0

15,0

15,0

22,0

18,0

15,0

70,0

3,0

3,0

2,0

8,0

13,0

13,0

4,6

0,6

5,2

12,5

12,5

11,0

22,0

0,4

8,0

41,4

344,4

241,0

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ANNEX  II

Table II.1

BREAKDOWN (*)  OF  RISK  CAPITAL  FINANCINGS

Direct  loans  and  pariticipations

—  Loans

—  Participations

Indirect  loans

—  ACP  States

—  Global  loans

—  Other  development  banks

—  ECFIs

Total

Lome´ III

Lome´ IV

Amount  decided

%

Amount  decided

%

122,5

1,0

418,7

88,6

14,7

—

645,5

19

0

65

14

2

0

100

122,0

24,5

411,0

209,3

5,7

15,0

787,5

15

3

52

27

1

2

100

(*) Amounts  calculated  by  the  Court  on  the  basis  of  data  submitted  by  the  EIB.

C  389/60

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COMMISSION  REPLIES

1.  INTRODUCTION

Conduct  of  the  audit

1.7. The  Commission  has  undertaken  a  major
reorganisation  of  its  files  concerning  the  documentation
made  available  by  the  Bank.  The  Commission  holds  all
documentation  concerning  the  major  steps  of  risk  capital
operations  from  1993  to  the  present:  financing  proposal,
Article  28  Committee  opinion, 
financing  decision,
financing  execution  of  payments  and  reimbursement.
Since  1997,  these  files  have  been  readily  available  and
regularly utilised.

1.8. The  EIB  and 
its  Audit  Committee  constantly
endeavoured to provide the Court of Auditors with every
assistance  by  providing  the  supplementary  information
requested,  preparing  the  logistics  of  the  visit,  helping  the
Court to select meaningful samples to include in the visit,
holding a pre-visit general briefing on how risk capital is
the  various  mandates  as  well  as
used  under 
project-specific  meetings  with 
loan  officers  and/or
responsible Heads of Division on the projects included in
the visit, arranging for EIB staff familiar with projects to
accompany the joint visits and providing information and
documentation  in  answer  to  post-mission  requests.

In  any  event,  the  EIB  has  always  acted  in  accordance
with the tripartite agreement. At the Court’s request, this
agreement  is  now  being  renegotiated.

1.9. The  EIB  provided 
the  Court  with  standard
procurement  tables  for  the  requested  projects  where  an
official  call  for  tender  was  applicable.  The  EIB  is  at  the
disposal  of  the  Court  should  it  require  any  further
information.

2.  RISK  CAPITAL  AS  A  FINANCIAL  AID  INSTRUMENT

Intervention  sectors  and  allocation  of  funds

2.8  to  2.10. Under  an  internal  agreement  between  the
representatives of the Governments of the Member States
meeting in the Council on the financing and management
of  Community  aid,  an  Article  28  Committee  was  set  up
is  made  up  of
at 
representatives of the Governments of the Member States;
a  representative  of  the  Commission  also  takes  part.  The
Committee  thus  guarantees  transparency,  in  particular
vis-à-vis  the  Member  States.

the  Bank.  This  Committee 

At  nearly  all  of  its  meetings,  the  Article  28  Committee
receives  several  proposals  for  financing  under  the  Lome´
Convention,  so  that  detailed  comment  in  each  report  on
the  background  to  the  reasons  for  using  risk  capital  is
not  required.  Most  reports  do  provide  a  succinct
justification  (e.g.  non-creditworthiness  of  the  country),
and  usually  the  justification  is  rather  obvious.  The
question  of  the  utilisation  of  risk  capital  as  against  the
EIB’s  own  resources  is  only  rarely  raised  as  an  issue  for
discussion, and where there are particular aspects on this
point  they  are  discussed  during  the  meetings  to  the
satisfaction  of  participants,  as  far  as  we  are  aware.

2.12(a) That  the  fishing  projects  in  Mozambique  and
Madagascar  are  profitable  and  generate  hard  currency  is
a  positive  feature  and  fully  justifies  the  operations.  We
would  make  two  comments.

(i)  One  cannot  conclude  that  if  a  project  is  profitable,
financing can always be found from other sources. In
Mozambique  and  Madagascar  a  few  years  ago  (and
still  today)  it  was  very  difficult  to  find  sources  of
long-term  financing  for  private-sector  projects,  on
account  of  the  hazards  and  uncertainties  of  doing
business  in  those  countries.

(ii) The  EIB  seeks  under  its  Lome´ mandate  to  encourage
private  sector  investors  to  invest  in  and  manage
profitable  ventures  as  is  the  case  of  the  two  projects
cited  by  providing  part-financing  of  the  projects.  It
should  be  remembered  that  financing  from  risk
capital  is  designed  to  be  repaid,  so  it  is  important  to
try 
to  be
successful.

to  select  projects  which  are  going 

2.12(b)  and  (c) The  statement  does  not  sufficiently
reflect  the  very  particular  function  fulfilled  by  the
financial  intermediaries  in  the  Dominican  Republic  and
New  Caledonia.  The  Financial  Intermediaries  (FIs)  help
to  introduce  and  develop  ‘banking  habits’  among  SME
clients,  offering  investment  finance  at  prevailing  prime
market  rates  through  a  network  of  qualified  field  service
employees.  Alternative  sources  of  finance  for  such  SMEs
would  be  money-dealers  offering  very  short-term  loans
(weekly  or  monthly)  at  significantly  higher  interest  rates.

The  implementation  of  risk  capital  operations  by  the
European  Investment  Bank

Tendering  procedures

2.13  to  2.15. Until  recently,  the  EIB  applied  its  normal
procurement procedures (bidding open at least to EU and

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ACP  suppliers)  to  projects  financed  from  risk  capital
resources, as well as to projects financed from the Bank’s
own  resources  —  in  the  interests  of  achieving  the  most
economically  advantageous  bids  for  the  project.  The
Cahora Bassa project in Mozambique was an example of
this policy. Following consultation with the Commission,
the  EIB  applies 
the  more  restrictive  procurement
procedures  of  the  EDF  for  risk  capital  financing.

Loan  conditions  and  undertakings

interest 

costs  on 

comparison  between 

With  regard  to  the  hotel  complex  in  Guinea  (point  3.6)
any 
the
own-resources  loan  and  the  risk-capital  operation  needs
to  be  nuanced:  for  the  own  resources  loan,  the  borrower
incurs  an  additional  cost  for  the  provision  of  guarantees
acceptable  to  the  Bank  (as  regards  the  risk  capital
operation,  the  advantage  to  the  final  beneficiary  is  not
intended  to  reside  in  the  interest  rate,  but  rather  in  the
other  financial  conditions  attached  to  the  quasi-equity
nature  of  the  operation).

It  is  true  that  ACP  governments  and  borrowers
2.16.
often  do  not  comply  with  obligations 
to  supply
information to the Bank in good time. The EIB monitors
the  situation  and  chases  up  borrowers  continuously,  but
certainly  not  with  100 %  success.

remuneration  or  profit 

3.9. The  Lome´ IV  Convention  caps  interest  payable  on
risk  capital  loans  at  3 %  per  annum  but  places  no  limit
on 
sharing.  Frequently  a
profit-sharing  component  is  added  to  a  fixed-interest
component  on  a  financing  operation,  which  is  not
prohibited  by  the  Lome´ Convention.

2.17(b)(c)(d) See  2.16  above.  It  should  be  noted  that
fishing licences and quotas are a notoriously difficult area
in  many  countries  of  the  world,  including  in  the  EU.
Where  public  administrative  capacity  is  weak,  as  is  the
case  in  Mozambique  and  Madagascar,  difficulties  can
certainly  occur,  even  despite  close  monitoring  by  the
EIB.

2.18. See  2.16  above.

3.  INTEREST  RATES  AND  THE  USE  OF  THE  INTEREST
MARGIN  IN  CASE  OF  ON-LENDING  OPERATIONS

Remuneration  of  financial  allocations  from  global  loans

3.10 to 3.11. Since finance contracts are standardised as
far as possible, it is not surprising that mention should be
made  of  ‘reference’  rates  even  if  in  some  cases  there  are
no  ‘reference’  rates.  The  EIB  therefore  checks  the  rates
according  to  quarterly/half-yearly  reports  produced  by
the  Central  Bank.  This  can  only  be  done  after  the  event,
because  the  Central  Bank  publishes  the  rates  with  a  time
lag  without  modifying  the  standard  terms  of  the
financing contract.

Level  of  the  interest  rates

Mechanisms  used  for  covering  the  exchange  rate  risk

3.4  to  3.8. The  EIB  has  certainly  not  deliberately
developed  any  policy  which  might  contravene  the  spirit
of  the  Convention.  In  setting  the  interest  rates  that  are
applied to projects which it finances, the EIB has, on the
one  hand,  to  respect  the  conditions  of  the  Lome´
Convention  which  specify  subsidised  rates  and,  on  the
other  hand,  to  take  account  of  the  need  to  ensure  that
end-borrowers,  notably  in  the  private-sector,  pay  rates
these  can  be
more  akin 
determined. This can indeed give rise to some anomalies,
but:

to  market  rates,  where 

(i)  it  is  quite  normal  for  a  loan  to  a  strong  borrower
with a strong guarantor to be at a lower interest rate
than  a  less  well  secured  loan  (so  an  own-resources
loan  might  well  have  a  lower  interest  rate  than  a
riskier  loan  made  from  risk  capital),  and

(ii) a  loan  in  a  local  ACP  currency  will  normally  carry  a
significantly  higher  nominal  interest  rate  than  a  loan
in  ecu  because  of  the  underlying  rates  of  expected
price inflation.

3.13. Under Lome´ III the borrower had to pay back the
loan in ecu or the equivalent in a European currency. The
exchange risk was based solely on the ecu and not on the
ecu  or  another  European  currency.

3.14  to  3.17. As  regards  risk-sharing,  the  key-words  in
the  last  sentence  of  Article  234(2)(b)  of  the  Lome´
Convention  are  ‘on  average’,  i.e.  over  all  risk  capital
projects.

Allocation  of  100 %  of  the  FOREX  risk  to  a  final
beneficiary  in  certain  cases  is  perfectly  consistent  with
Article  234  of  the  Convention  (and  indeed  it  would  be
illogical to exonerate a promoter from FOREX risk if his
entire sales proceeds were denominated in FOREX — far
better in such a case to examine the other types of risk to

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which  he  might  be  exposed,  and  provide  for  mitigating
measures  against  those  risks).  Article  234  says  that  the
FOREX  risk  should  be  shared  equally  on  average,  and
this  is  what  the  EIB  aims  to  achieve  across  the  board.

merely  of  refinancing  its  own  contribution,  in  so  far  as
this is a supplementary contribution and does not replace
that  of  the  FI.

As  a  matter  of  fact,  under  most  of  the  small  business
financing  schemes  (global  loans)  from  risk  capital,  the
on-lending to SME sub-borrowers is denominated in local
currency  —  as  typically  SMEs  sell  into  the  local  market
rather  than  the  export  market.

Use of the interest margin for administrative cost and for
development  purposes

3.18.
In  selecting  the  FI  or  DFC  (development  finance
corporation),  the  EIB  pays  careful  attention  to  the
soundness  of  its  financial  situation,  its  development  role
and  its  support  to  the  country’s  economy.  In  this  regard,
most of the DFCs are non-profit-making institutions with
a strong developmental impact, particularly in relation to
small  enterprises.  These  criteria  are  in  accordance  with
Article  233(4)(b)  of  the  Lome´
IV  Convention,  First
Financial Protocol.

4.  PROJECTS  FINANCED  WITH  RISK  CAPITAL

Factors  relating  to  the 
project’

‘long-term  viability  of  the

4.2. While it is true that the EIB and the Commission no
longer 
intervene  directly  vis-à-vis  beneficiaries  once
investments  have  been  made,  they  do  maintain  indirect
supervision through their political dialogue with the local
authorities.

It  is  impossible  to  imagine  any  risk-capital  operations
where  there  is  not  a  danger  that,  in  a  number  of  cases
and  in  spite  of  all  the  guarantees  provided,  long-term
viability  may  be  jeopardised  by  measures  originating
within  or  outside  the  firm  in  question.

Fortunately the risks cited in the report as examples have
so  far  not  become  a  reality,  which  puts  their  significance
into  perspective.

Allocation  procedures  in  respect  of  global  loans

4.4.
In  the  context  of  a  global  financing  plan  where  the
rate  at  which  financing  is  implemented  cannot  be  fully
guaranteed, it is often the case that either the beneficiary
firm,  using 
the  Financial
Intermediary  (FI),  through  additional  temporary  loans,
acts  as  a  ‘bridge’.  In  fact  the  EIB’s  intervention  consists

resources,  or 

its  own 

Disbursement  period  and  disbursement  rate

loan 

in  Mozambique  was  made
4.6. The  global 
alongside 
loans  from  the  World  Bank  (from  IDA
resources)  and  the  French  development  aid  programme:
none  of  the  three  loan  facilities  was  very  successful.  Part
of  the  reason  for  the  slow  utilisation  of  the  funding  was
the  insufficient  level  of  the  margins  for  the  FIs,  and
during  the  allocation/disbursement  period  of  the  loan
facilities the split of the total margin between the Central
Bank and the FIs was renegotiated — with the result that
the  margin  allowed  to  the  FIs  was  increased  over  the
initial levels, on both the EIB and the World Bank credit
facilities alike.

Delay  in  implementation  of  projects  and  actions

4.9(a) The finance contract for the project was signed in
December  1994,  but  disbursements  only  started  in  1997
(and  are  continuing  in  1998).  This  project  is  being
co-financed by the EIB with the World Bank (credit from
IDA  resources),  and  coordination  between  the  two
institutions is close, notably as regards monitoring of the
project.  There  were  a  number  of  tough  conditions  prior
to first disbursement which had to be fulfilled by Zambia
including  some  sectoral  reform  issues  and  this  explains
why  disbursements  could  not  be  started  for  a  period  of
over  two  years.

4.9(b) The  problems  have  since  been  resolved  and  the
remainder  of  the  loan  is  being  disbursed.

4.9(c) The  main  reason  for  the  delay  was  the  previous
government’s  lack  of  resolve  to  carry  out  vital  sector
reforms,  in  particular  the  ratification  of  the  Electricity
Law, which is an important condition of disbursement in
the  EIB’s  finance  contract.  The  law  has  been  stalled  in
Congress  for  two  years  due  to  political  bickering  ahead
of  the  1996  presidential  election  and  the  tug-of-war
between  two  different  vested  interests  (private  power
investors  versus 
stand-by  generating
equipment).  The  new  government  is  pressing  ahead  with
sector  reforms  and  disbursement  of  the  loans  has  taken
place.

importers  of 

4.10. Every  quarter,  the  Commission  and  the  EIB  take
stock  of  dormant  commitments;  after  taking  account  of
the  information  exchanged  and  analysing  the  situation,
the  EIB  asks  the  Commission  to  decommit  the  unused
funds.

14.12.98

EN

Official  Journal  of  the  European  Communities

C  389/63

Management  of  global  loans  by  European  Community
Financial  Intermediaries  (ECFIs)

and 

4.11 
Appropriate
modifications were made to the follow-up ECFI II facility
approved  in  April  1998.

4.13(a) Points 

noted. 

4.13(b) As 
indicated  above  (see  3.4  to  3.8),  any
comparison  between  interest  costs  on  the  own-resources
loan  and  the  risk-capital  operation  needs  to  be  nuanced:
for  the  own  resources  loan,  the  borrower  incurs  an
additional cost for the provision of guarantees acceptable
to  the  Bank;  as  regards  the  risk-capital  operation,  the
advantage  to  the  final  beneficiary  is  not  intended  to
reside  in  the  interest  rate,  but  rather  in  the  quasi-equity
nature  of  the  operation,  a  shareholders’  advance.

5.  ROLE  OF  THE  COMMISSION

5.2  to  5.4. The  Commission  services  and  the  EIB  work
closely  together  at  the  time  of  the  ‘programming’  of
Community  aid  at  the  start  of  a  Convention  (e.g.  the
signing  of  the  National  Indicative  Programme  and  the
EIB’s  Annex  thereto).  Close  contacts  (often  informal)  are
maintained  between  EIB 
and  Commission
delegations  throughout  the  ACP  during  the  life  of  a
Convention.

staff 

Article  33(5)  stipulates  the  role  of  the  Commission
concerning  the  operations  financed  by  the  resources  of
the  fund  and  managed  by  the  Bank.  Each  year  the
Commission  receives  from  the  Bank  a  report  of  the
financial  execution 
in  coordination  with  the  Bank
(coordination  meetings  take  place  at  all  levels).

On the basis of the draft proposals prepared by the Bank,
the  Commission  consults  the  geographical  desks  (and  if
necessary  the  delegations)  concerned  and,  accordingly,
presents  its  observations,  comments,  suggestions  and
objections  to  the  Bank.

5.7. As  a  rule,  the  reports  by  the  EIB’s  Evaluation  Unit
have  a  thematic  or  sectoral  basis.  The  Unit’s  work
programme  covers  all  of  the  EIB’s  operations  and  takes
into  account  the  preponderance  of  the  Bank’s  activity
inside  the  Union.  At  present  there  are  no  plans  for  any
study  involving  EDF  risk  capital.

6.  CONCLUSION

The  Commission  and  the  EIB  note  with  satisfaction  that
the Court does not have any observations with regard to
the  manner  in  which  risk  capital  operations  have  been
prepared,  implemented  and  monitored  by  the  Bank.

As  regards  the  Commission’s  role,  it  is  worth  stressing
that  both  Article  1  of  the  Lome´ IV  Financial  Protocol
and  Article  10(2)  of  the  Internal  Agreement  state  that
risk capital is to be managed by the EIB. In so doing the
EIB  acts  on  behalf  of  the  Community,  not  of  the
Commission (Article 10(2)). This is confirmed by Articles
58(1) and (2) of the Financial Regulation for the seventh
EDF.

is  called  on 

the  Commission 

Where 
to  assume
responsibility  for  the  reliability  of  the  EDF  accounts,  its
responsibility  is  confined,  in  the  case  of  operations
financed  under  EIB  management,  to  checking  that  the
amounts  entered  in  the  accounts  match  the  information
supplied  by  the  EIB.

With  regard  to  the  issue  of  evaluation  of  the  risk  capital
operations, the Commission will carry out a review of the
overall  effects  of  risk  capital  operations  on 
the
development  of  the  ACP  States  before  making  concrete
proposals  for  any  post-Lome´ Convention.

5.6(a) The Council receives Article 29/33 reports, which
serve  to  meet  the  obligation  to  provide  information
mentioned  by  the  Court.

Finally, the Commission feels that the Member States are
particularly well served when it comes to transparency, as
their  representatives  sit  alongside  the  Commission  on  the
Article  28  Committee.