PROPOSAL FOR REVIEW
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PROJECT TITLE: |
HUNGARY: ENERGY EFFICIENCY CO-FINANCING FUND (HEECF) |
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GEF FOCAL AREA: |
Climate Change |
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COUNTRY: |
Hungary |
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TOTAL PROJECT COSTS: |
US$25 million to $30 million |
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GEF FINANCING: |
US$ 5.0 million |
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ASSOCIATED PROJECTS: |
IFC lines of credit with Hungarian Financial Institutions |
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GEF IMPLEMENTING AGENCY: |
World Bank |
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EXECUTING AGENCY: |
International Finance Corporation (IFC) |
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LOCAL COUNTERPART AGENCIES: |
Hungary Ministry for Environment and Regional Policy; Hungary Ministry of Industry and Trade; National Bank of Hungary; Hungarian Commercial Banks and Leasing Companies |
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ESTIMATED STARTING DATE: |
July 1, 1996 |
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PROJECT DURATION: |
Five years |
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GEF PREPARATION COSTS: |
None |
HUNGARY ENERGY EFFICIENCY CO-FINANCING FUND (HEECF)
PROPOSED PROJECT SUMMARY
1. The International Finance Corporation (IFC) proposes to establish and administer a US$ 5 million co-financing fund (the Fund or HEECF) dedicated to energy efficiency (EE) project financing in Hungary utilizing GEF funds. The Fund would support EE financing activities of qualified domestic financial intermediaries (FIs) such as commercial banks and bank-owned leasing companies by providing credit enhancement, co-financing and targeted technical assistance. Its goals are to implement cost-effective EE projects, promote development of the EE market and build domestic EE financing capacity. The three target EE subsectors will be: (i) lighting; (ii) district heating; and (iii) industrial motors and processes. This project addresses the mandates of the GEF Operational Strategy's climate change program on "Removing Barriers to Energy Conservation and Energy Efficiency".
2. GEF resources would be used to facilitate and leverage private sector capital, (including domestic bank capital and credit lines supplied to local FIs by IFC, EBRD, EIB, KfW and other international financial institutions or IFIs). Over its proposed five year life, the HEECF would facilitate total EE investments of an estimated US$25 to 30 million or more. Funds would be used for three purposes: (i) direct EE project financing support (85% or US$ 4.25 million); (ii) technical assistance (6% or US$ 300,000); and (iii) Fund establishment and administration (9% or US$ 450,000). Direct EE project financing support would be provided via: (i) credit guarantees, whereby funds would be reserved to cover the guarantee liability; and (ii) medium-to-long term co-financing loans. Technical assistance funds would support marketing and delivery of EE financial services and preparation of specific EE investments. The Fund would use financing methods that seek to preserve and leverage the capital of the Fund to the maximum extent. At the end of the Fund's life remaining funds would be returned by IFC to the GEF Trust Fund unless another approach is found to be warranted.
3. Hungary has significant EE potential which is not being captured due in large part to financing barriers. Domestic FIs can be induced to enter this market if these barriers can be addressed. Conditions in Hungary, including recent energy price reforms, are ready for this initiative and offer an excellent opportunity to demonstrate non-grant GEF financing modalities such as risk sharing mechanisms and contingent loans. By addressing the significant institutional and financial barriers to EE project implementation, this Fund can play a catalytic role in mobilizing capital, contribute to creating a sustainable commercial market to develop Hungary's EE potential and deliver expanded global environmental benefits through reduced GHG emissions. HEECF is complementary to the proposed IFC/GEF Renewable Energy and Energy Efficiency Fund as it will focus on generally smaller projects that are principally financed by domestic commerical banks and bank-owned leasing companies. It is also complementary to other existing or proposed EE financing arrangements within Hungary.
BACKGROUND AND PROJECT CONTEXT
Energy Economy
4. Hungary's patterns of energy use are very inefficient due to historically low, subsidized energy prices and a centrally planned economy. No incentives for efficiency existed in the former non-competitive economic environment. In 1992, energy intensity (total energy input to GDP value of output) in Hungary was over twice the average for western Europe. [Hungary-EC Energy Centre, 1994] Annual total nationwide expenditures on energy approximated 600 billion Hungarian Forints or HUF (US$ 4.2 billion) in 1994, representing almost 17% of GDP as compared with an average of 6-8% in the OECD.
5. Hungary produces just over one-half of its primary energy requirements domestically (54% in 1993) from oil, gas, low calorific coal and lignite and nuclear power. Domestic production of oil and gas have peaked and are declining. Oil and gas imports are generally from Russia which had provided these fuels at subsidized prices. Energy use has been dominated by industry. Since 1989, industrial energy use has fallen by 38%, and total consumption by almost 25%, due to the severe economic contraction. In 1992, the public, commercial and residential sectors accounted for 46% of final energy consumption; industry for 31%; and transport for 16%. Heat, delivered as hot water or process steam to industry and district heating systems, represents 17% of final consumption, (compared to 2% average in OECD Europe and 14% in Denmark, the highest OECD country). [IEA, 1995]
6. Total primary energy use in 1995 of 28.26 million tons of oil equivalent was estimated to have been supplied 34% by natural gas, 31% by oil, and 21% by coal and other solid fuels. [IEA, 1995] Total installed electric capacity was 7.26 GW (1993). Peak power loads have shrunk from 6.53 GW in 1990 to 5.61 GW in 1993. Sixty-two percent of electric capacity is provided by fossil-fuel based sources (with 29% by coal, 17% by oil and 16% by gas; 38% of capacity is provided by the Paks nuclear plant). Growth in electricity demand is expected to require net additions to capacity by the year 2000 to meet the needs of new light industry and residential consumers.
7. Electricity, natural gas and heat prices do not yet cover the full costs of supply. Below-cost prices are found in all end-use sectors. Inflation severely eroded real prices by over 45% in the period 1990-1994. As of October, 1994, average end-use gas prices were only one-half the level needed to cover costs. It is variously estimated that electricity prices must rise between 50-80% in real terms over 1994 levels to cover costs. Similar conditions exist in the heating sector. [IEA, 1995] Energy price reforms adopted in 1994 require prices to rise to cover costs. This process has begun. Real energy prices have risen over 30% in 1995. Additional increases are scheduled for 1996 and will be required to continue through 1997, at considerable social and political cost. National policy also requires implementation of peak load pricing beginning in 1997.
8. Utility generation, transmission and distribution functions have recently been organized under separate companies and are being privatized. Utilities are good candidates for EE programs in their own supply, generation, transmission and distribution operations. They have not yet embraced EE or demand side management but could eventually become an important factor in the EE market.
Energy and Environmental Policy
9. A national energy policy, prepared by the Ministry of Industry and Trade (MIT), was adopted by Parliament in 1993. Its priorities are: (i) diversification of supplies and reduced import reliance on Russia; (ii) emissions reductions and environmental protection; (iii) increased supply and demand side efficiency; (iv) mobilization of domestic and international capital for energy sector investment; and (v) increased awareness of efficiency and energy matters by the public and firms.
10. Hungary is a ratified signatory to the UN Framework Convention on Climate Change (FCCC) and made its national communication under the FCCC in 1994. In December, 1995 the National Energy Efficiency Action Plan was formally adopted, which includes a requirement for utilities (electricity, gas, and district heating systems) to develop least cost planning and DSM programs. EE is a cornerstone of government energy and environmental policies. This project is also consistent with Hungarian sustainable development policy.
Capital Market Conditions and EE Financing Activities
11. The Hungarian economy is emerging from a four year recession with recovery being led by private sector investment. The Forint is now freely convertible although it has been subject to a steady devaluation recently of 1-1.5% per month. Hungary's capital markets have recently been dominated by government borrowing to finance its fiscal deficit. Inflation accelerated in late 1994 and 1995 to 29%. Government crowding out has left little medium term (two to five year) credit available except through IFIs. Reducing the deficit is a top priority for concerted government policy. Inflation for 1996 is projected to be 20%. As a result, interest rates have been falling.
12. Current short-term interest rates of the National Bank of Hungary are at 27% (having fallen from 30% since January 1, 1996). Market interest rates range from 29-32% for prime customers to 40%+ range for other less creditworthy customers. At these levels, market interest rates are too high to be attractive for end-users to borrow for EE projects, even when projects pay for themselves from energy cost savings.
13. Since 1990, the state-owned Hungarian Credit Bank (HCB) has operated an EE financing program using monies granted from Germany and offering financing at well below (just over 50% of) commercial rates. This so-called German Coal Aid Fund (GCAF) has operated as a separate fund wholly segregated from HCB and other commercial capital sources. Its limited capital is now fully lent with new financings possible only with returning principal and interest payments. [HCB, 1996] The GCAF has stimulated demand for EE financing far greater than its resources. While its operations have been successful, it is generally recognized that EE financing in Hungary must move beyond the experience and methods of GCAF toward commercial capital sources and terms.
14. The World Bank has offered a series of credit lines for on-lending to local commercial banks which have been available for EE financing. However, the EE portion of these facilities remained largely undisbursed and the latest facility was recently canceled. Primary reasons why the funds were not used are: (i) high, market-level interest rates; (ii) credits were for foreign exchange lending with all devaluation risks borne by the borrower or participating bank (whereas most project costs require financing in domestic currency); (iii) requirement of full recourse assumed by the participating FI; and (iv) failure to market and connect these funds with project developers and prospective borrowers. Other IFIs have credit facilities currently available on commercial terms which can be applied to EE projects.
15. EC-PHARE, in conjunction with the Hungary-EC Energy Centre, has proposed to establish an EE on-lending financing fund that will offer below market rate financing on parity for up to 35% of a project's cost. The proposed HEECF has been designed to complement the EC-PHARE program when it becomes operational.
Energy Efficiency Potential
16. Various estimates indicate a technical and economic potential to save 20-30% of total energy consumption through EE projects having simple payback periods of six years and less. Many projects have paybacks of two to three years at current price levels. The economic viability of EE projects will improve as real energy prices rise further to full cost-recovery levels by 1997. Investment projects utilizing proven, commercially-available technologies are found in key EE subsectors including lighting, motors, industrial processes, municipal/institutional buildings and district heating.
17. The economic potential for cost-effective EE investments has been estimated at 200-300 billion HUF (US$ 1.4-2.1 billion). The Ministry of Environment estimates that EE investments of a minimum US$ 422 million and up to US$ 1.25 billion are needed over the next five years (1994). MIT estimates indicate a need for up to US$ 4 billion over the next ten years to raise Hungary's energy efficiency to OECD standards. Recently, nationwide investments in EE have been made at rate of less than 2-3 billion HUF (US$ 14-21 million) annually [EGI, 1996]. Thus, there exists a serious EE investment gap.
18. A basic objective and marketing strategy in EE financing is to structure financings so projects pay for themselves from cost savings. Properly financed, using finance terms of three to ten years, projects with simple payback periods of two to six years can generate immediate positive cash flow (with energy cost savings in excess of finance payments) for the energy user. A small but strong nucleus of EE domestic and international businesses are established in Hungary including engineers, equipment manufacturers, contractors and energy service companies (ESCOs). These firms see significant potential in and are devoting their resources to this market but their businesses are constrained by a lack of project financing.
Barriers
19. Hungary is significantly under investing in EE. Financing is a principal barrier for EE project implementation. Financing barriers include: (i) weak credit and unfamiliar risk profiles of energy users which prevents financing from being extended; (ii) extremely cautious bank lending practices at present; (iii) lack of collateral value of EE project equipment; (iv) lack of relevant expertise and capacity within domestic FIs; (v) relatively high transaction costs associated with EE project development and financing; (vi) lack of medium-to-long term financing which is needed to allow projects to be self-financing from energy cost savings; and, (vii) high interest rates which discourage borrowing even when EE projects are cost-effective.
20. Hungarian FIs have exercised extreme caution in their credit practices as economic restructuring affects weaker, uncompetitive and loss-making enterprises. FIs lend only to the best "blue-chip" credits and/or impose excess collateral requirements (up to 200% of loan amounts in liquid collateral) on their borrowers. This approach has reduced the availability of credit to sound medium and small businesses and municipalities. Risk sharing and credit enhancement are good methods to apply to move the market in this context. Over the next two to three years, falling interest rates may result in convergence where market rates become attractive for borrowers, reducing the cost of financing as a barrier; however, the credit and transaction cost barriers are severe and must be addressed to gain the economic and environmental benefits which EE investment offers.
21. Use of IFC funds alone cannot address these barriers as: (i) IFC lends at fully commercial rates and terms; (ii) IFC is unable to provide concessional credit guarantees; and (iii) IFC lends in hard currency whereas EE project costs mostly require domestic currency. IFC has current portfolio investments or lines of credit with Hungarian FIs totaling US$ 35 million which are unlikely to be used for EE financing at present.
PROJECT OBJECTIVES AND BENEFITS
Specific Project Objectives and Benefits
22. Objectives of the proposed HEECF are to: (i) reduce credit risk on EE financing for eligible local FIs (making transactions possible and gaining credit approval for use of the FI's own funds); (ii) provide targeted technical assistance (in support of partner FI marketing and delivery of EE financing services and preparation of projects for investment); (iii) reduce transactions costs borne by project participants; and (iv) provide or make possible longer term financing term (in order to lower annual finance payments, finance longer payback "deep retrofit" projects and make EE projects attractive to the end-user by allowing them to be self-financing from energy cost savings). The primary objective of HEECF will be reduction of credit risk and reduction of transaction costs.
23. Benefits from the proposed HEECF activities include: (i) implementation of cost-effective EE projects; (ii) mobilization of domestic and international capital for EE; (iii) documentation of the financial structure and environmental benefits of successful EE investments; (iv) promotion of a sustainable, commercially viable EE financing market which can evolve to fully non-concessional finance methods; (v) entry of new domestic FIs in the EE financing market; and (vi) increase in domestic EE financing capacities and expertise. Expanded investment in EE offers economic and environmental benefits including: (i) direct energy cost savings for energy users; (ii) avoided capital costs for new power and transmission/distribution capacity; (iii) reduced foreign exchange costs for fossil fuel imports; (iv) reduced state deficits from direct and indirect energy costs; and (v) cost-effective reductions of global GHG emissions and local pollutants. Importantly, the HEECF would develop, demonstrate and monitor the use of innovative non-grant financing modalities which are suited for EE financing. The lessons learned from the project are likely to have application in other eligible GEF recipient countries and for future GEF projects.
Global Environmental Objectives and Benefits
24. The EE projects supported by the HEECF will generate global environmental benefits by reducing greenhouse gas (GHG) emissions and assist Hungary in fulfilling its commitments under the FCCC. Improving EE is a primary method for cost-effective control of GHG emissions and lack of adequate financing is the primary barrier to EE project implementation. By helping to create a viable commercial market for EE projects and financing, this project would produce on-going benefits through its catalytic effects.
25. Analysis of initial EE projects indicates that Fund support can be applied to gain carbon emissions reductions at costs ranging from US$6-25 per ton. These calculations assume that all Fund support is expended (i.e., that all reserves for credit support are expended and no co-financing loan payments are made). Assuming that all projects supported by the Fund perform financially, the Fund cost for carbon emissions reductions falls to US$1-4 per ton. Total direct GHG emissions reductions achieved by the EE projects supported by the Fund over its expected life are estimated at 750,000 to 1 million tons of carbon.
PROJECT DESCRIPTION
Finance Methods and Guidelines
26. The Fund would enter into credit support and co-finance relationships with Hungarian FIs. HEECF is designed to address the financing barriers by providing incremental financial support at the margin as needed to induce participation of FIs and end-users. The Fund would proceed immediately following its formation to review initial transactions presented by eligible FIs. Development of Fund/FI financing modalities would occur as the credit and finance needs, structure and analysis of individual projects are reviewed by IFC.
27. Primary financing modalities are likely to include: (i) partial credit guarantees on parity or on a first loss basis and applied to both specific transactions and portfolios of transactions; and (ii) co-financing on a long-term basis with extended grace (interest only) periods. When making a credit guarantee, the Fund would reserve a portion of its funds equal to the guarantee liability amount. If the financing performed and the guarantee was never exercised, then these reserves would be freed for use in supporting other investments. When providing co-financing, the Fund would make a loan to the participating FI for its co-financing share. Monies received from loan principal and interest payments would be available to support other investments.
28. The credit guarantee or co-financing participation percentage in any given project would range from 15-50% with an average of 25%. Discussions with FIs indicate that participation in this range will be meaningful to gain credit approval for use of their own capital. Participation percentages may be higher on initial transactions and would be lowered as experience is gained. Credit guarantees are likely to be the most needed and effective Fund operational modality. Use of this method is complementary with use of other IFI monies. Fund credit support can be applied to portfolios of projects as portfolios are assembled. When credit risk can be evaluated on a portfolio basis, and Fund support is provided via a first loss position, guarantee percentages as low as 10-15% can be applied allowing Fund resources to be further leveraged.
29. The Fund would have review and approval rights on all transactions undertaken. Partner FIs would have primary responsibility to originate, structure and perform due diligence and credit analysis on transactions for support by the Fund. To originate a transaction, the FI, following appropriate initial commitments from the project developer and end-user, would conduct its credit analysis. The financing requirements of the project -- total credit amount, term, cost of funds -- would then be matched against what the FI, based on its credit analysis, can offer. The difference -- in terms of needed credit support and longer term monies -- would constitute the financing "gap" which the FI would submit for Fund support. Fund management by IFC must then concur with the credit and financing analysis. The structure and amount of financial support would be the subject of negotiation. The majority of project financing would derive from the FI's capital, giving them clear incentives to make prudent recommendations.
30. Several initial transactions have been identified. They include: (i) a large scale indoor EE lighting project in municipal/institutional buildings for a major municipality to be supplied by a domestic lighting manufacturer (estimated to achieve 5 MW in load reduction); (ii) a series of EE streetlighting retrofits; and (iii) comprehensive EE retrofits for two district heating systems which include meters, controls, heat recovery, boiler upgrades and insulation. These transactions are in the advanced stages of development and have total financing requirements of over US$ 5 million.
31. Several potential FI partners have expressed interest in participating. The Fund will focus initially on bank-owned leasing companies. Hungary's financial sector includes an active and growing leasing industry. Leasing offers a flexible, streamlined approach to equipment finance of all types and has been commonly used to finance EE projects in North America and Western Europe.
32. The FI partners and the Fund will actively seek opportunities for co-financing with IFC, EBRD, EIB, the EC-PHARE program and other IFIs. IFC is also considering establishment of a new credit line for several Hungarian bank-owned leasing companies with which the HEECF could also provide its EE co-financing.
Environmental Investment Guidelines and Monitoring of GHG Mitigation
33. The Fund will apply rigorous environmental screening in its investment activities. Transactions to be supported will be reviewed to be fully consistent with World Bank Group environmental policies as applied by IFC in its environmental review procedure for FIs. HEECF will also comply with relevant GEF policies as dictated in IFC's GEF procedure including full disclosure of information that is not confidential for legitimate business reasons. A key element of HEECF operations will be monitoring and evaluation of its transactions and projects over time including GHG emissions reductions achieved as well as payment histories, financial performance and energy savings.
RATIONALE FOR GEF FUNDING
34. The HEECF responds to the GEF's objectives of seeking cost-effective means to reduce GHG emissions. The HEECF is consistent with and responds to the mandate of the GEF Operational Strategy. The HEECF seeks to: (i) facilitate and leverage private sector capital, applying its resources in an incremental fashion to remove existing financing barriers to EE project implementation; (ii) develop and use innovative non-grant financing modalities; (iii) encourage entry of new EE financing players; (iv) build domestic EE financing capacity and experience; and (v) accelerate implementation and acceptance of commercial EE technologies and generally promote development of a sustainable EE project and financing market. IFC's analysis indicates conditions in Hungary are ready for this initiative. The HEECF can make possible financing for EE projects which would not otherwise be available from commercial sources under current conditions. The HEECF would leverage its resources and over its proposed five year life, considering the capital mobilized of domestic and international FIs and energy end-users, it is estimated to facilitate total EE investments of at least US$25 to 30 million.
PARTICIPATION AND SUSTAINABILITY
35. The HEECF, and the projects it supports, will involve participation from key stakeholders including domestic FIs, international FIs, EE businesses, Government of Hungary officials, NGOs and others. Domestic FIs are central participants and the primary channel for directing Fund resources. International FIs with Hungarian operations will participate as their capital is accessed and blended with the resources of the domestic FIs and the Fund. Hungarian EE businesses of all types -- equipment manufacturers, engineers, contractors, energy service companies -- will participate to deliver EE services, implement projects and co-market EE financing with domestic FIs. Energy-users commit significant management and financial resources to develop EE projects in their facilities and assume payment obligations for project financings. The HEECF is designed to mobilize and support the activities of these three stakeholder groups -- FIs, EE businesses and energy users -- as the prime participants in EE project implementation.
36. Government officials and NGOs have important roles in promoting and sustaining a favorable policy environment for EE. The HEECF concept has been discussed with and received the endorsement of Hungary's: Ministry for Environment and Regional Policy; Ministry of Industry and Trade and its Hungarian Energy Office (HEO); National Bank of Hungary; Hungary-EC Energy Centre; and the Energy Club, a leading energy efficiency and environmental NGO. It has also been discussed with staff of the World Bank resident mission in Hungary and EBRD's Energy Efficiency Department. An Advisory Board will be formed with membership from Ministry for Environment and Regional Policy, MIT, HEO, National Bank of Hungary, the Hungary-EC Energy Centre and NGOs to advise the HEECF and closely coordinate with other national initiatives and policies.
37. The HEECF will contribute to creation of a sustainable commercial marketplace for EE project implementation and financing. Financial support will be provided at the margin as needed to induce domestic FI participation. The profile of EE financing as an important market opportunity will be raised within domestic FIs. Payment and financial performance histories on EE project financings, including their ability to be self-financing through energy cost savings, will be documented. These materials can be used for promotion to both FIs and end-users for further project development and financing. Entry of domestic FIs into the EE financing market will be accomplished and their expertise increased. The experience gained and increase in EE market size will reduce transactions costs for and encourage development of subsequent projects. Entry of additional financing sources will encourage competition, lower rates and promote greater marketing efforts and market penetration. GEF resources will be leveraged with capital from domestic and international FIs, opening the way for these resources to subsequently be used for EE financing on a fully sustainable, commercial basis over the medium to long term.
PROJECT FINANCING AND BUDGET
38. GEF support of US$ 5 million is requested, to be used for three purposes: (i) direct EE project financing support (85% or US$ 4.25 million); (ii) technical assistance (6% or US$ 300,000); and (iii) Fund establishment and administration (9% or US$ 450,000). Direct EE project financing support, channeled through domestic FIs, will be provided in the forms of credit guarantees and co-financing loans as discussed earlier. TA monies would be utilized by participating FIs for: (i) general support for staff and marketing EE project financing services; and (ii) project-specific support for preparation of EE financing transactions and programs. The FI would be required to match general support funds on a cost-sharing basis (generally at least 50/50). Project-specific support would be applied for project investment preparation in the later stages of project development (not feasibility studies) and would be provided on a contingent loan basis (i.e., repaid upon closing of project financing). Fund set-up and administration includes expenses required to implement the program and monitor results.
INCREMENTAL COSTS
39. Market research indicates baseline activities in this sector represent serious underinvestment in EE projects, including those which are economic on their own energy cost saving merits and therefore have apparent negative incremental costs. Failure of seemingly "win-win" projects to be implemented under current conditions represents significant lost opportunity to realize the global environmental benefits offered by EE project development. It may also indicate that the institutional and financial barriers to EE project implementation noted earlier tend to increase EE project transactions and development costs, overwhelming project economics and offsetting the apparent negative costs. While the costs of overcoming these barriers are difficult to quantify, they prevent EE project implementation and financing from occurring. An active GEF-supported program is needed to surmount these barriers. GEF support is crucial to create confidence in participants that these projects are, in fact, sound and profitable. Application of GEF resources through the proposed HEECF can overcome the initial mistrust and disinterest of beneficiaries resulting in appropriate decision-making and achievement of desired "win-win" outcomes. Fund financial support will be provided at the margin and will be determined on a case-by-case basis through analysis of the financing "gap" or costs and risks which cannot otherwise be borne by project participants.
RISKS
40. Primary risks associated with HEECF operations include: (i) credit risks of the specific EE financing transactions; (ii) mobilizing participation from domestic FIs; (iii) generating adequate flow of sufficiently creditworthy EE project financing prospects; and (iv) adverse changes in policy, energy price, macroeconomic and capital market conditions in Hungary. Of these, the credit risks are by far the most important and must be evaluated on a case-by-case basis. To succeed, the participating FI must identify, evaluate and close transactions which have credit risk profiles that are appropriate for FI financing and call for levels of financial support acceptable to the HEECF. The parties must agree on the needed levels and mechanisms of Fund support. The FI may request higher levels of support than the Fund is willing to provide or which, if it does provide, reduces the leverage of Fund resources. Once transactions are funded, risk of default by participating borrowers will remain as an on-going operational risk which is addressed through transaction monitoring.
41. Mobilization and deal flow risks are viewed as manageable at present. Excellent FI candidates have indicated interest in participating. Several initial transactions have been identified and the general pool of transactions is growing through the development activities of local EE firms. Recent experience in Hungary, including the direct experience of GCAF, indicates that a sufficient flow of transactions can be generated. The change in economic conditions risk is uncontrollable but is seen as diminishing as energy price and macroeconomic reforms and trends move in the right direction.
INSTITUTIONAL FRAMEWORK AND PROJECT IMPLEMENTATION
42. This Fund is proposed to be administered locally in Hungary by IFC/Budapest with support from a local EE financing specialist and a Supervisory Committee to include representation from IFC (IFC/Budapest, IFC's Technical and Environment Department and Europe Region Investment Department). The Supervisory Committee would provide oversight and review Fund transactions as proposed by the FIs and recommended by program staff. Management tasks include: (i) development of Fund/FI relationships; (ii) review of EE project financing transactions; (iii) negotiation/documentation of Fund/FI and project-specific agreements; (iv) fiduciary management of funds including asset/liability management, disbursements, collections, reinvestment, recordkeeping and reporting; (vi) operation of the Supervisory Committee and Advisory Board; (vi) provision of technical assistance, including preparation of EE project financings and development of EE financing programs; (vii) monitoring of Fund transactions, including exercise of Fund rights under the financing agreements and documentation of financial performance, energy savings and GHG emissions reductions; and (viii) evaluation activities.
ANNEXES
ANNEX 1: LETTER OF COUNTRY ENDORSEMENT BY DESIGNATED OPERATIONAL FOCAL POINT
ANNEX 2: TECHNICAL REVIEW
LETTER OF COUNTRY ENDORSEMENT BY DESIGNATED OPERATIONAL FOCAL POINT
TECHNICAL REVIEW
HUNGARY: ENERGY EFFICIENCY CO-FINANCING FUND (HEECF)
COMMENTS ON THE FUND CONCEPT AND DESIGN
1. This project would help reduce transaction costs for energy-efficiency financing in Hungary, a problem that many of us engaged in that field in the formerly-planned economies have, for many years, identified as a serious constraint on investment. Many studies have demonstrated that high internal rates of return are available for a large variety of energy-efficiency investments, and that these investments would provide highly cost-effective greenhouse gas mitigation. Other studies have noted the ironic fact that these investments are not occurring. Observers agree that the principal reason for this "market failure," if you will, has to do with difficulty in identifying the ultimate customer in an era of privatization, in developing adequate business plans in a cash-short region, and providing collateral or security for loans. Many of these problems -- which are correctly identified in the captioned proposal -- fall in the category of "transactions costs." I believe that this proposal would begin, in a small way, to address these issues.
2. The following specific comments respond directly to questions posed in the Technical Review terms of reference.
"(a) Comment on 1) the proposal's global priority or importance in the area of climate change mitigation."
I can think of no mitigation options with greater cost-effectiveness than those of the energy efficiency markets targeted by this proposal. Also, I can think of few areas of mitigation with more barriers or constraints to implementation. The proposal correctly identifies the problem, and appears consistent with Hungary's National Communication to the Framework Convention on Climate Change. Incremental costs are sufficiently large and important to merit GEF involvement.
"(b) its effectiveness in achieving catalysis of energy efficiency through overcoming market barriers to such financing;"
I believe that "buying down transaction costs" and providing related measures to facilitate efficiency investing can best be overcome by activities such as the assistance described in this proposal. The "up-front" costs, including the cost involved in helping project proposers understand how to prepare proper business and financial proposals, often are the key obstacles to facilitating energy-efficiency investment.
"(3) the adequacy of project design;"
In general, I think the project design is adequate. I would caution that the scope should not be allowed to expand. Effective implementation will require focus and concentration of services. It should be most fruitful to concentrate on reducing up-front transactions costs and compensating for the lack of security for loans--these are the key problems that inhibit investors.
"and the feasibility of implementation and operation."
I believe, based on experience in helping develop related (but not identical) projects and proposals in Poland, Hungary, Russia, and China, that this idea can be implemented in a straightforward manner. I can think of no serious obstacle to its effective operation.
CONCLUSION
With the above caveats, it is my professional judgment that the proposed project has merit , meets GEF operational criteria, would produce the intended results, and should be approved.