DOCUMENT OF THE EUROPEAN BANK

FOR RECONSTRUCTION AND DEVELOPMENT

TELECOMMUNICATIONS,
INFORMATICS AND MEDIA
OPERATIONS POLICY
 CONTENTS

1. TELECOMMUNICATIONS, INFORMATICS AND MEDIA IN THE BANK’S

COUNTRIES OF OPERATIONS ........................................................................................................1
1.1 SECTOR DEFINITION ...................................................................................................................1
1.2 RECENT DEVELOPMENTS ............................................................................................................1
1.3 EBRD INVOLVEMENT IN THE SECTOR TO DATE .........................................................................5
2. STATE OF THE SECTOR: ISSUES AND REQUIREMENTS...............................................7
2.1 CURRENT POSITION ....................................................................................................................7
2.2 REQUIREMENTS: REFORMS AND INVESTMENT ...........................................................................15
3. BANK’S OBJECTIVES IN THE SECTOR .............................................................................17
3.1 PROMOTION OF PRIVATE SECTOR INVOLVEMENT .....................................................................18
3.2 COMMERCIALISATION AND LONG-TERM FINANCIAL SUSTAINABILITY.......................................20
3.3 DEVELOPMENT OF REGULATORY STRUCTURES AND CAPACITY ...............................................22
3.4 ENVIRONMENTAL IMPROVEMENT AND ENERGY EFFICIENCY ....................................................24
3.5 PROJECT EVALUATION AND LESSONS LEARNED .......................................................................24
4. INVESTMENT PRIORITIES AND OPERATIONAL APPROACH....................................26
4.1 OPERATIONAL PRINCIPLES: STAYING AHEAD OF THE MARKET ................................................26
4.2 TECHNICAL CO-OPERATION ......................................................................................................37
4.3 CO-FINANCING SOURCES ..........................................................................................................38
4.4 PROJECTED LEVEL AND COMPOSITION OF EBRD FINANCING ..................................................40
4.5 PROCUREMENT .........................................................................................................................41

ANNEX 1 TRANSITION IMPACT OF PROJECTS IN THE TELECOMMUNICATIONS, INFORMATICS AND

MEDIA SECTOR

SUPPLEMENTARY INFORMATION (Separate Booklet)

SECTION 1 OVERVIEW OF BANK COMMITMENTS IN THE TELECOMMUNICATIONS, INFORMATICS AND
MEDIA SECTOR

SECTION 2 TELECOMMUNICATIONS REGULATORY PROJECTS

SECTION 3 TECHNOLOGY CHOICES

SECTION 4 TELECOMMUNICATIONS, INFORMATICS AND MEDIA GLOSSARY

 EXECUTIVE SUMMARY

This document reviews issues and requirements in the EBRD’s Telecommunications,

Informatics and Media Sector (the “Sector") and sets out objectives and strategy for
the Bank’s involvement.

Through its activities and investments in the Sector, the EBRD makes an important
contribution to the transition process with the objective of establishing a fully
liberalised, market-led, financially self-sufficient Sector. In its financing of
operations in the Sector, the Bank pursues the following transition-related objectives:
• Promoting sustainable network expansion, increasing the density of telephones
and improvement in quality of service
• Fostering emergence of innovative and advanced communications services
crucial for overall competitiveness of businesses within the country
• Assisting the incumbent operator and the government to accelerate privatisation
• Developing appropriate regulatory and legal frameworks
• Extending development of the Sector beyond basic telephone services, including
media, which promotes access to communications and information.

The relative focus on these objectives will depend on the transition stage of any
particular country. The Bank's unique capability to cover the full private-public
spectrum of operations allows it to help the Sector throughout all stages of the
transition from state-owned monopolistic operator to liberalised competitive market-
led environment. This is achieved through a number of steps, for example,
establishing a regulatory framework, promoting sound corporate governance and
responsible market behaviour by Bank clients, promoting competition by encouraging
introduction of mobile operators, second operators and advanced service providers,
efficiency improvements in the incumbent operator and, in many cases, its
privatisation. This evolution has led to a move from sovereign guaranteed to
corporate financing, thereby giving the EBRD the operational flexibility needed to
assist the public sector whilst maintaining its priority for private sector participation.

In response to progress in economic and political transition, commitments and

pipeline development have increasingly been focussed on the private sector and
privatisation activities. This shift is even more pronounced in the pipeline where all
projects under preparation now involve private and non-sovereign operations.
Increasingly, the Bank will look for opportunities beyond basic telephone service
development in this technology-driven industry, such as data, informatics, media,
internet and other value added services.

The decreasing share of sovereign operations has been accompanied by a shift in

geographical focus. To date, the majority of the Bank's activities in the Sector has
been concentrated in advanced transition economies and EU accession countries.
Increasingly, the EBRD is working in medium or early transition countries with a
reliable foreign sponsor on private sector projects or participating in privatisation
activities. It will use its capacity to manage transition-related risk to mobilise support
from private investors and commercial banks for investments in the Sector. In
countries where the economic transition process is less advanced and where
macroeconomic conditions and uncertainty over fiscal capacity adversely affect the

ii
credit quality of public sector borrowers, the EBRD may need to secure its loans
through sovereign guarantees. In such difficult circumstances, the Bank will leverage
its activities by close co-ordination with other IFIs which may be better suited to
address related macro-economic issues. The Bank's operations in these countries will
generally be selective, transition-oriented and of a strategic nature; in any event, such
operations would be accompanied by conditionality to promote Sector reform and
would require a clear undertaking by the Government to pursue the path to
liberalisation of the Sector through appropriate regulation. The EBRD will also
continue to play a special role in Emergency Reconstruction Projects, e.g. in Bosnia
and Herzegovina and, possibly, Tajikistan.

The Sector’s development involving a mix of public and private sector participants is
especially well suited to the Bank’s mandate. As a catalyst for economic
development, the Sector will support all other sectors by extending access to a wide
variety of essential services, delivering information transfer and promoting popular
access to information. Transition progress in this Sector will have a high
demonstration factor on other sectors.

The Bank ensures that its activities in the Sector are additional. The Bank assumes
and manages transition-related risk that commercial banks are not willing to take and
provides financing with tenors/terms that match the specific needs of the Sector and
which are not otherwise available in the market. The Bank has significant experience
in Telecommunications, Informatics and Media throughout the Region and its
potential role in the Sector's investment financing is well understood by the market.
The demand for EBRD financing indicates that it is seen as a key player in the Sector, a
position which has been reinforced since the recent events of the emerging markets
financial crisis and the contagion to other countries in the Region.

The EBRD intends to fully utilise the range and flexibility of its financing instruments
in the Sector, increasingly providing equity as part of its financial structuring and
exploring means of providing local currency funding, and, through continuous
innovation and risk absorption, play a leading role in rapidly developing markets,
thereby paving the way for future commercial financing.

The proposed strategy provides a flexible approach, tailored to the transition stage of
the host country, that responds to the highly complex, varied, technology driven and
ever-changing needs of the Sector, promotes required reforms in the provision and
financing of Telecommunications, Informatics and Media infrastructure and services,
furthers good governance and reflects the comparative advantage of the Bank.

iii
 1. TELECOMMUNICATIONS, INFORMATICS AND MEDIA IN THE
BANK’S COUNTRIES OF OPERATIONS

1.1 SECTOR DEFINITION

The Telecommunications, Informatics and Media Sector (the “Sector”) – or more

generally the Communications Sector – covers traditional fixed-line switched
telephony services, principally voice-based, value-added services such as cellular
mobile and data transmission, advanced services such as satellite phones and
internet, entertainment, information technology and media services such as cable
television, TV network distribution, and publishing. Traditionally, there has been a
clear distinction between the various elements within the Sector but with the global
convergence within the telecommunications, informatics, consumer electronics and
related industries, this is no longer the case. Even within the basic voice services
market segment, the traditional transport mechanism of fixed line has been
augmented by new technologies such as wireless in the local loop, cellular and, soon,
widely available satellite communication technologies, together with internet-based
voice service.

Historically in the Bank’s countries of operation (the “Region”),

Telecommunications, Informatics and Media has essentially been limited to voice
services provided by a supply-led, monopolistic, wholly state-owned operator. With
the availability of, and demand for, new services, opportunities increasingly exist for
private sector operators to enter the market, hence, creating significant demand for
financing. Whilst there continues to be an appetite for investment in the Sector
globally, the Bank continues to be highly additional in attracting foreign investment
into the Region, especially in the less advanced countries. This position has been
reinforced since the events in August 1998 which led to the emerging markets
financial crisis and resulting contagion to other countries in the Region.

1.2 RECENT DEVELOPMENTS

The telecommunications authorities of Central and Eastern Europe and the Former
Soviet Union are undertaking major infrastructure development programmes and
structural reforms to adjust to new market pressures and to enhance prospects of
further economic growth through better communications. This is being done against
a background of rapidly evolving new services, convergence with information
technology and related industries and a fundamental shift in the Sector worldwide
from concentration on a single voice service towards an all embracing multi-media
service. Convergence (Figure 1) manifests itself through the integration of
communications, computers and customers equipment with one objective –
interchange of information in any form. Global change in industry structure and the
move towards liberalised, competitive, private sector markets is having – or will
have – an increasing impact. The general trend for lower telephone charges,
especially for international settlement rates, will have a negative financial impact on
many countries in the Region – see Section 3.2.

1
 Telecommunications
Figure 1: • Fixed networks
• Mobile networks
Convergence • Satellite networks
• Value-added networks
• Virtual networks

• Database
• Cable industry
• Online services

• Intelligent networks
• Computer -Interactive
telephony Multimedia
integration
• Internet service
provision
IT Industry • Computer Entertainment and
• Computers games Information
• Operating • Conditional • Broadcasting
systems access systems • Publishing
• Set-top boxes • Digital film • Films
• Databases effects • Music
• Applications • Education

Source: Spectrum

There has been significant progress in the Sector in moving towards an open and
competitive market economy in the Region, perhaps more so than in most other
infrastructure sectors. A dynamic and efficient Telecommunications, Informatics and
Media Sector can have important spillover effects into other parts of the economy and
society, stimulating economic development by lowering transaction costs and assisting
the transition to democracy through everyday access to basic communications services
and information. Promoting competition and private sector participation are key for
dynamism and efficiency in the Sector and remain central elements of the Bank’s
strategy. Resources have primarily been targeted towards private sector operations and
assistance to the privatisation of the dominant operator which have acted as the major
spur for Sector development, establishment of an independent regulatory regime and
competition.

2
The Bank has played a crucial catalytic role in accelerating reform in the Sector on the
Region’s Governments’ agendas through both its direct intervention and conditionality
in its banking operations. Technical assistance has been focussed on supporting
development of a framework for regulation in those market segments where regulation
is appropriate and necessary, thus creating an environment in which a liberalised,
competitive private sector can flourish. Although this two-track approach has been very
successful in most cases (as reflected in improvements in the performance of the
dominant operators and the emergence of private sector providers in niche value-added
market segments), the underlying tension between transition and competitive
environment should not be underestimated. A major challenge is to seek harmonisation
between privatisation and liberalisation to ensure balance between (1) the need to attract
a strategic investor (perhaps by offering a period of monopoly operation) in order to
maximise privatisation receipts to the Government, and (2) the benefits to the consumer
through increased competition and choice at the earliest opportunity.

Despite significant achievements during the past seven years, there remains a critical
shortage of Telecommunications, Informatics and Media services in the EBRD
countries of operations as indicated by the low penetration of telephone lines, long
waiting lists and shortage of non-basic telecommunications services. Widening
differences exist between countries in terms of access availability, quality of service and
general sector development - particularly between CEE and CIS countries. The key
lever for addressing this imbalance is private sector entry, especially in
Telecommunications, Informatics and Media services and related businesses. Much
will be technology driven (in the sense of applications and services made available by
technological advances), but the main challenge will be to mobilise the significant
private sector capital required. This will only be achieved by simultaneously addressing
the weaknesses in the Sector structure and the legal and regulatory framework. Rapid
advances in technology and availability of services will increasingly provide the
opportunity for deregulation within the Sector as has already happened with internet
services.

Although many countries have introduced some competition in non-basic services,

competition in basic fixed-line service is rare. This is expected to change during the
next few years as commitments made under EU Accession or WTO obligations are
implemented. One of the remaining challenges is to support the establishment of an
effective regulatory framework. In most countries, the regulatory framework is
inadequately developed so that even when competition is permitted, the reality is that
there are many barriers to the emergence of new services or to new operators trying to
penetrate the market, particularly in the areas of licensing, pricing and interconnection
rules. Such unpredictability deters private investment. Another particular challenge
that needs to be addressed is a legacy of the past, where the Government was
simultaneously owner, operator and regulator of the telecommunications industry,
which led to inevitable conflicts of interest. This makes the Telecommunications,
Informatics and Media Sector particularly sensitive to political influence. Reform of
tariffs from historically low levels, which are highly cross-subsidised, to cost-based
structures also brings specific social issues.

Privatisation of the incumbent fixed line operator. The incumbent fixed line operator
tends to provide the ideal candidate for early privatisation amongst the major state-
owned entities, both within and beyond the Region. A number of such privatisations
have already taken place and more are slated during the next two years. Privatisation by

3
attracting a strategic investor with the benefit of financial resources and management
with operating know-how has been the preferred privatisation mechanism, but other
methods including IPO have been successful. In the case of Matav (Hungary), three
stages of privatisation have been undertaken (two stages involving a strategic investor
and the third stage using an IPO) and in 1999, Eesti Telecom (Estonia) followed up its
earlier strategic investor privatisation with an IPO on local and international markets.
Privatisation proceeds have generally funded Government budgets and have provided a
valuable source of income available for non-telecommunications related uses. However
the proceeds may also be used to finance the privatised company, as was the case with
SPT in the Czech Republic, or to provide support to the Sector through establishing
rural development or universal service funds.

Improving corporate governance. The conditionalities contained in Bank operations

and preparation for privatisation have been major drivers in encouraging the incumbent
operators to become more efficient. The Bank has been a major catalyst for
improvements in corporate governance by encouraging creation of autonomous legal
entities separate from direct ministry control. Significant pressure has been exerted on
these entities to change their financial and accounting systems to international
accounting standards. Progress to adopt such standards has been slow in some countries,
despite undertakings from the Bank’s clients (through Loan Agreements) and
Governments (through Guarantee Agreements), due to the delay of the national
accounting commissions to move national standards towards the international norm.

Growing private sector involvement. Private sector financing continues to play a

significant role in fostering new companies, generally in cellular network operations,
paging and value added services such as internet. The more successful examples have
generally involved a joint venture operation between local investors and western
operating companies with in-depth experience of the particular field. The conditions for
private sector participation are generally improving across the Region, although greatest
progress is being made in the more advanced countries, especially the EU accession
countries where open markets within the next few years is a pre-condition of accession.
Economic and financial fundamentals are also more positive, particularly in the
advanced transition countries, reducing affordability constraints of higher tariffs for user
charges and increasing the debt absorption capacity of the service providers. The less
advanced countries have not made so much progress due to delay by the authorities in
implementing effective legislation, particularly in respect of corporate governance,
bankruptcy, tax regime and facilitation of inward investment. On the supply side, a
growing appetite for risk among international operators and investors is contributing to
better and more diversified conditions in the market, although evidence suggests that
this may have taken a setback due to contagion effects of the recent emerging market
crisis.

EU accession. For the ten countries concerned (Czech Republic, Estonia, Hungary,
Poland, Slovenia, Bulgaria, Latvia, Lithuania, Romania and Slovak Republic),
accession to the EU exerts special pressures for liberalisation of markets to full, open
competition with consequential pressure on the incumbent operator for investment in
the Sector and rebalancing of tariffs. The large gap in penetration, quality and range of
services between acceding and present EU members in Telecommunications,
Informatics and Media services will have to be narrowed for both accession and
economic reasons. Prolonged persistence of such gap would place a strain on the
cohesion of an enlarged EU and distort competition within the single internal market.

4
The European Union stipulates adoption of the telecommunications acquis
communautaire as a pre-condition of its pre-accession strategy. This requires accession
countries to adopt EU directives on policy, regulation and legislation. Other countries
are working towards adoption of the EU directives even though they have not yet signed
an Accession Document. EU provides significant technical assistance to help countries
adopt its directives via its Phare and Tacis programmes. A further factor is that a
number of countries have joined, or have applied to join, the World Trade Organisation
(WTO) which requires members to make commitments with regard to opening of
markets within specific timeframes.

Alignment of national legislation with the telecommunications acquis communautaire

and the WTO agreements and stricter enforcement are already prompting structural
changes in the Sector and driving significant preparatory work in legal and regulatory
reform. It is clear, however, that countries making these changes will require significant
external assistance in order to devise and implement the radical changes which will be
necessary both within the sector itself and for commercial legislation. Not surprisingly
the strategic objectives of the Bank are well aligned with those of the other institutions
and it is expected that the EU, the World Bank and EBRD will continue to play a major
role through co-ordination of their respective activities.

1.3 EBRD INVOLVEMENT IN THE SECTOR TO DATE

As of December 31, 1998, the EBRD had approved cumulative financing totalling euro
1.2 billion for 45 Telecommunications, Informatics and Media projects, with total
project costs of euro 6.4 billion, (Figure 2). In addition, a further 12 projects with
project total cost of euro 1.0 billion are under preparation where the EBRD funding
amounts to euro 312 million1.

Figure 2: Cumulative Signed Projects, mEuro

1400

1200
Private sector
Public sector
1000
million Euro

800

600

400

200

1992 1993 1994 1995 1996 1997 1998

1
Supplementary Information Section 1 provides a detailed overview of Bank financing committed to this Sector.

5
During the last seven years, the Bank has responded flexibly to changes in Sector
demand. In the early years, the majority of financing was committed to the public
sector but latterly, private sector projects have dominated. This reflects the change in
the Sector status in the more advance countries from a wholly state-owned monopolistic
incumbent operator to a more liberalised, competitive market allowing private sector
participation. Change in market demand is measured in the private:public sector
portfolio ratio which has changed from 33% in 1996 to 52% in 1998. Future projects
are expected to be predominantly in the private sector, or pre-privatisation financing
required to assist the transformation of the incumbent state operator towards the private
sector.

The telecommunications portfolio is particularly robust and there continues to be no

payment defaults or classified projects. Following the TPSA equity acquisition in 1998,
equity (including equity fund commitments), comprises 23% of the total portfolio
commitment. Approximately 75% of the equity commitment is in publicly quoted
companies, primarily Matav and TPSA.

Latterly, new operations have been concentrated in the more advanced countries –
consistent with their progress in Sector and regulatory reform – and in those countries
seeking EU accession where the demand for private sector financing has been growing.

6
 2. STATE OF THE SECTOR: ISSUES AND REQUIREMENTS

2.1 CURRENT POSITION

2.1.1 Regional variances in access availability, industry and market structure

The 1992 Telecommunications Operations Policy identified three fundamental

shortcomings and issues in the Region’s Telecommunications, Informatics and Media
Sector, namely:

• Severe imbalances between the demand and supply of Telecommunications,

Informatics and Media services;

• High operating inefficiencies and inadequate return on capital employed due, in

particular, to low tariffs; and

• Lack of commercial focus and basic management skills needed for successful
operations and sustainable growth for the Sector.

The significant progress made in some countries of operation, less so in others, has
resulted in wide variation in access availability and general sector development from
country to country. The Bank has made a significant contribution through its 45
signed operations. Access to service2 (see Figure 3) has increased in most countries,
with significant increases in individual countries, for example, Hungary 28% vs 10%
in 1990, Czech Republic 28% vs 16%, Estonia 30% vs 20%.

Figure 3: Penetration Ratio (1994-1996)

35
Main Telephone Lines per 100 Population

Source: ITU, EBRD

30
25
20
15 1994
1996
10
5
0
Central Baltic European Caucasus Central
Europe States CIS Asia

2
Access to service or penetration ratio is defined as number of main telephone lines per 100 population

7
For convenience the Bank’s countries of operation are grouped into five regional
areas (Caucasus3, Central Asia4, European CIS5, Baltic States6, and Central Europe7).
Access availability remains significantly below western European levels (EU average
52%), but generally higher than peers in the rest of the world with similar economic
performance (GDP) (see Figure 4). This figure depicts the Penetration:GDP
relationship for the Region versus the world average. However, the penetration is
particularly low in the rural areas where the investment costs are high and the
revenues very low.

Figure 4: Telecommunications and Wealth (1996)

Source: ITU, EBRD

70

60

50

40
Penetration

Region Average
World Average
30

20

10

0
$345 $765 $1937 $3035 $40630
GDP per Capita

The large investment programmes which have been undertaken in many countries
have resulted in significant progress regarding modernisation where obsolescent
analogue systems have been replaced with modern digital systems which are essential
for providing advanced services, including internet, see Figure 5.

3
Azerbaijan, Georgia and Armenia
4
Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan
5
Russia, Ukraine, Moldova and Belarus
6
Estonia, Latvia and Lithuania
7
Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, FYR Macedonia, Hungary, Poland, Romania, Slovak
Republic, Slovenia,

8
 Figure 5: Digitalisation Level (1994-1996)
Source ITU, EBRD

100
90
Digital Lines per 100 Main Lines

80
70 1994
60 1996
50
40
30
20
10
0
Western Central Baltic European Caucasus Central
Europe Europe States CIS Asia

Waiting lists have declined in many countries but it is estimated that the demand
exceeds more than 25 million across the Region, although it is difficult to be precise
because waiting lists inevitably do not always reflect true demand (see Figure 6). For
example, there are people who do not apply because the chance of success is slight or,
alternatively, those who indicate they would like to receive a telephone line
irrespective of their ability to pay. At an average investment requirement of typically
euro 900 per line, the total investment requirements of euro 22 billion cannot be
underestimated. However, to reach European fixed line penetration levels within the
next ten years, investments in excess of euro 100 billion would be required.

Figure 6: W aiting List / Main Lines (1994-1996)

18 40
1994 W aiting List
16 35
1996 W aiting List
14 1996 Ratio 30
Waiting list (millions)

12
25
10
20 %
8
15
6
4 10

2 5

0 0
Central Baltic States European Caucasus Central Asia
Europe CIS Source: ITU, EBRD

Significant progress has been made in the introduction of mobile telephone services
(Figure 7). This is an important market segment which lends itself to introduction of

9
competition as well as contributing to the overall availability of telephone service.
Although mobile penetration is generally low by European standards, Estonia already
has a similar penetration (14.3%) to France (14.3%) and Spain (14.2%) and higher
than Germany (13.5%), Belgium (13.3%) and Greece (12.7%). Single digit
penetration exists in other countries in the Region but is growing rapidly and the more
advanced countries are likely to achieve similar penetrations to western European
countries in the medium term. The Bank has been particularly effective in working
with foreign sponsors and local shareholders throughout the Region in developing
mobile telephone companies and this segment is seen as a significant contributor to
the transition process.

Figure 7: Analogue and Digital Cellular Penetration

16

14 Source: ITU, EBRD

12

10

% 8 1996
1998
6

0
Hungary

Macedonia
Lithuania

Romania
Bulgaria

Estonia

Slovakia

Slovenia
Croatia

Poland
Czech

Latvia

Cellular telephony is a market where competition has flourished in a number of

countries, notably Estonia and Poland with four networks, Ukraine (six), and Czech
Republic, Hungary, Lithuania and Romania with three each. Russia has seen strong
growth in metropolitan areas such as Moscow and St. Petersburg, but is somewhat
handicapped by the proliferation of national and regional technology standards.
Strong growth of mobile operators in some countries is challenging the traditional role
of the incumbent national operator and viable alternatives or substitutes to fixed
networks are emerging.

The legacy of the previous political regime has provided incumbent, monopolistic
dominant operators in the Region with operational efficiency significantly below
world standards due to inherited obsolescent design, ageing technologies and
equipment, and non-optimal operation. Staffing levels tend to be much higher than
those commonly found in competitive environments. The telecommunications market
remains dominated by basic voice services.

Modern telecommunications services support the development of new businesses, as

evidenced by the enormous growth throughout the world in recent years of cellular

10
and internet-based services8. In return, the growth of business activity and general
increase in economic activity drives the demand for additional telecommunications
services, thus forming a virtuous circle. Increasingly as business, especially private
sector business, develops in our countries of operation, there is a need within those
countries to address and develop the market for advanced telecommunications
services. One consequence is a strong support to the development and transition of
the economy as a whole.

Privatisation of the incumbent operator in the Region has generally involved a

strategic investor which is often a major operator in its own home country. This
brings the benefit of management know-how, advanced technology, contribution to
the globalisation of the industry, as well as financing to support the necessary
investment programmes normally required by the licence. The Bank strongly
supports this approach and has already participated in a number of such projects. It
further expects this model of privatisation to be used in a number of countries in the
Region where privatisation remains to be effected. Experience has shown that early
entry of a strategic investor can provide the necessary investment and management
control which can rapidly accelerate the development of access to the network, as
witnessed in Hungary (Matav) and the Czech Republic (SPT) (Figure 8).

Figure 8: Comparison of penetration trends

40.00

35.00
DT/ Ameritech raise
Matav stake to 37%
30.00

25.00 Voucher privatisation

Penetration %

Sale of 27%stake in
26% SPTTelecom stake
SPTTelecom to
20.00 SPT Telecom KPN/ Swiss PTT

15.00
Matav
10.00 Sale of 30%Matav to
TPSA Telekom/Ameritech
5.00

-
1991 1992 1993 1994 1995 1996 1997 1998

Most incumbent operators have already begun the transition from a government-
owned department to commercial independent entities, with the first stage usually in
the form of a joint stock company. Financial performance of such entities is generally
improving but remains weak. Revenues per line (see Figure 9), although improving
in some countries, notably the Baltics, are generally low leading to serious difficulties
in supporting large scale investment. In such cases, commercial development,
especially in the rural areas, may have to be complemented with support through

8
British Telecom estimates that 20% of its traffic is internet related.

11
universal access/service funds, access deficit charges, or innovative community
funding schemes.

Management and corporate governance of incumbent national operators are generally

not up to industry standards and there is often lack of independence and transparency
in management due to Government interference. A key objective for the Sector must
be to liberalise and allow easy entry to the market for potential investors. Even in
countries where potential for competition exists, players frequently encounter barriers
to entry9.

Figure 9: Annual Revenues per Line (1994-1996)

1000

900

800

700
Source: ITU, EBRD
600
$U
S 1994
500
1996

400

300

200

100

Western Central Baltic States European Caucasus Central Asia

Europe Europe CIS

Development of the informatics and media market segments will be highly dependent
upon the availability of information technology within business and the home. Whilst
penetration of computers in businesses in the Region has increased considerably over
the last few years, it is still significantly below the levels found in developed
European economies, (Figure 10). Significant increase in penetration levels in
computers, especially in the home, and home entertainment consumer goods will be
geared to the wider macro-economic conditions existing in the country.
Notwithstanding this, there will be opportunities, especially for SMEs, to develop
niche businesses, especially in commerce oriented data and internet services.
Although there is a wide distribution of TV sets throughout the Region, there are very
few commercial broadcasting stations. Electronic publishing and related industries
are expected to be a growth area which will aid access to information.

9
PriceWaterhouseCoopers’ “Obstacles to Investment in Telecommunications in CEE Countries” (1998) identified a range of
obstacles associated with entry penetration such as licence acquisition, radio frequency acquisition, financial structuring, tariff
distortion (including interconnect charges), operations and network development and capital extension. Each investment phase
features obstacles and enablers which may be common to CEE countries or specific to an individual country.

12
 F ig u re 1 0 : In fo rm a tio n T e c h n o lo g y, 1 9 9 6
1 8 0 0 .0

1 6 0 0 .0

1 4 0 0 .0
per 10000 inhibitants

1 2 0 0 .0

1 0 0 0 .0
In te rn e t h o s ts
8 0 0 .0 N o o f P C 's

6 0 0 .0

4 0 0 .0
Source: ITU,
EBRD
2 0 0 .0

0 .0

C e n tra l E u ro p e B a ltic S ta te s W e s te rn E u ro p e

Figures 11 and 12 suggest the drivers which must be satisfied and the barriers which
must be overcome if the information age is to progress in the Region.

Figure 11: Drivers of Demand for the Information Age

Demand Drivers Supply Drivers

Macro-economic environment Established
Competitiveness Industry

Understanding and acceptance

Culture of the Industry
Willingness
and ability
Competitive pricing
to invest
and packaging STRONG STRONG
DEMAND SUPPLY
Access to skills Access to
skills

Access to advanced infrastructure

Role of the Government

Effective regulatory and legislative environment and government initiatives

Source: Spectrum

13
Bank strategy in the Sector will be to focus its operations on enhancing access to the
advanced infrastructure necessary to support the new services and by its willingness
and ability to invest in market segments critical to the transition, and provide support
and encouragement to others willing to enter this segment. Underpinning this, the
Bank will continue its work in assisting the authorities to create an effective
regulatory and legislative environment.

Figure 12: Barriers to the Progression of the Information Age

Low Skill Base Negative Attitudes

Information Age

High Prices Absence of Infrastructure

Source: Spectrum

2.1.2Regulatory framework; liberalisation and competition

Progress in privatisation of the incumbent national operator varies tremendously
throughout the Region from majority private ownership to full state ownership.
The majority of countries have introduced competition in mobile services, data
services and value added services but competition in fixed line services is rare.
This, however, should rapidly change over the next few years as countries begin to
meet their commitments made under EU Accession or WTO obligations.

In most transition countries, the regulatory framework is far from being acceptable
and based on the assumption that telecommunications services are to be provided
by a monopolist state-owned operator fulfilling the political objectives of the
government. As a result, even when some limited competition is permitted, there
are no regulatory instruments to facilitate the emergence of new services or to
assist new operators in penetrating the market.
The structure of the tariff policy of most national operators in the Region
constitutes a serious impediment to both liberalisation and privatisation. Tariffs
for local telecommunications services are often substantially below cost and need
therefore to be subsidised by income generated through the provision of

14
 international and long-distance services. Further cross-subsidisation may take
place from business to state-budget funded entities and residential customers
resulting in additional costs to commerce. Reform is required to introduce
transparent and robust mechanisms which enable the transition to cost-based tariff
structures.

Competitive procedures for awarding licences or concessions for developing

networks and/or providing services are not yet universally accepted and effective.
However, licences for major fixed line and mobile operators are normally awarded
through open competitive tendering.

2.2 Requirements: reforms and investment

2.2.1 Sector Reform

Traditionally telecommunications was regarded as a public utility where economies of

scale, political sensitivities and the need for a ubiquitous subscriber access network
resulted in a typical public service believed to be a natural monopoly. Technological
change and exponential increase in demand over the past decade has changed
economic thinking so that the sector is now viewed as a commercial market best
exploited by a profit-driven private sector. Throughout the developed world this has
resulted in liberalisation of the sector and recognition that there is no strategic reason
to keep the incumbent operator under state ownership. Indeed private sector
management of the incumbent is likely to greatly enhance the economic performance
of the company and improve the quality of service to customers. Furthermore such a
structure allows independent regulation of the sector. This approach has been
supported by the Bank as an essential prerequisite for the development of the sector
and, where appropriate, its investment operations have included conditionalities
targeted at meeting these objectives.

The Bank has strongly promoted the concept of privatisation of the incumbent
operator seeking, via transparent and competitive international tender, a strategic
investor with management control over the company. This has been successfully
achieved in a number of countries including Hungary, Czech Republic, Poland,
Lithuania, Estonia, Latvia, Armenia and Romania. Bulgaria will complete the first
stage of its privatisation shortly. Other countries including Ukraine, Albania, Croatia,
Belarus, Kazakhstan and Kyrgyzstan are currently in the earlier stages of preparation
for privatisation.

The Bank has facilitated through technical assistance the elaboration of a robust and
predictable Telecommunications Sector policy in the Region. Encouragement and
direct assistance to individual countries has been given for the adoption of a modern
telecommunications law providing safeguards of transparency, predictability, clarity
and creating regulatory instruments designed to facilitate the emergence of new
services and the penetration of new operators. The Bank has actively assisted in the
introduction of competition in all telecommunications markets and the adoption of
measures that will facilitate and enable telecommunications liberalisation. The
importance of establishing an independent regulatory body with no structural or

15
functional link with any of the telecommunications operators is well proven and has
formed a fundamental tenet of developing Sector policy for reform. This has been
accompanied by actively assisting in the efforts to rebalance tariffs.

2.2.2 Investment Priorities

Investment priorities within the Region are driven by the need to extend access to
basic telecommunications service, the introduction of advanced services such as data,
mobile and internet primarily to support business, and related market segments
oriented more to private users eg cable TV, media and publishing. These can be
broadly categorised as follows:
• Pre-privatisation financing where financing is required primarily to develop the
network. This provides an opportunity to influence the future development of the
company, and possibly the sector through restructuring and regulation, and provides a
strong demonstration effect.
• Participation in privatisation by directly financing the newly-privatised company
with equity or syndicated loans, including underwriting.
• Private sector operators in high growth service areas, (e.g. mobile telephone, value
added services, internet, data communication, information technology), which will
begin the process of stimulating competition and customer choice.
• Alternative or second operator financing as well as local telecommunication
operators, which will provide engines for change as the first real competition to the
dominant incumbent operator.
• Media and commercial broadcasting, which are progressively more important to
support the democratic process.
• New start-ups, small and medium size companies, in particular in technology
driven areas, through funds.

16
 3. BANK’S OBJECTIVES IN THE SECTOR

The EBRD’s objectives build on the progress made under the 1992
Telecommunications Operation Policy and reflect the developments in technology
which continue to be a driving force for change in available services, network
platforms and market structure within this sector. The key difference is that the
approach to project selection will now be highly dependent upon the stage in
transition which the specific country has reached, particularly the progress made in
the Sector. EBRD activities and investments in the Sector aim to make an important
contribution to the transition process through promoting private sector activity within
a well regulated environment. Recognising the operating principles of the EBRD
(transition impact, additionality and sound banking principles), the Bank will pursue
the following objectives through careful project selection and transaction structuring:
• promote sustainable network expansion, increase the density of telephones and
improve the quality of service
• foster emergence of innovative and advanced services crucial for overall
competitiveness of businesses within the country
• assist the incumbent operator and the government to accelerate privatisation
• develop appropriate regulatory and legal frameworks
• promote the development of the Sector beyond basic telephone services,
including media related, and which promote access to communications and
information.

The relative focus on these objectives will depend on the transition stage of any
particular country. The Bank's unique capability to cover the full private-public
spectrum of operations allows it to help the Sector throughout all stages of the
transition from state-owned monopolistic operator to liberalised competitive market-
led environment. This is achieved through a number of steps, for example,
establishing a regulatory framework, promoting sound corporate governance and
responsible market behaviour by Bank clients, promoting competition by encouraging
introduction of mobile operators, second operators and advanced service providers,
accompanied by efficiency improvements in the incumbent operator and, in many
cases, its privatisation. This evolution has led to a move from sovereign guaranteed to
corporate financing, thereby giving the EBRD the operational flexibility needed to
assist the public sector whilst maintaining its priority for private sector participation.

The Bank will primarily support the establishment and development of private
sector operators through equity and debt financing. The Bank can be highly
additional in mobilising private sector financing, particularly in the cellular and fixed
line market segments, but also in value-added and information services such as cable
TV, satellite communication services, publishing, and internet. Opportunities may
arise in any of the Bank’s countries of operation but are likely to be focussed in the
more advanced countries where sound regulatory frameworks exist. The Bank will
critically evaluate its additionality taking into account the transition stage in the
Sector of the individual country, the nature of the telecommunications or media
project, and the regulatory environment.

17
The Bank will assist in the transformation of the incumbent national
telecommunications operators into commercially-oriented, privatised companies.
The approach will include pre-privatisation financing through debt and quasi-equity,
privatisation participation and post-privatisation financing, including equity,
underwriting and syndicated loans. Technical assistance will be given through
institutional development programmes targeted on Sector legal reform and
establishment of an independent regulatory regime. Support will be targeted at those
countries where the Government has demonstrated greatest commitment to
implementing reforms as part of pre-privatisation preparation. In addition, the
beneficiary countries will be asked to establish a policy of progressive regulatory
reform and market liberalisation in order to secure the Bank’s financial support.
Opportunities are foreseen in Albania, Bulgaria, Slovak Republic, Central Asia,
Croatia and Ukraine.

The Bank will support smaller communications projects and seek diversification
through participation in equity funds specifically aimed at SMEs engaged in
media, publishing, internet, information technology and related businesses.

Apart from these objectives, the Bank will continue to play a special role in
supporting the Telecommunication Emergency Reconstruction Project in Bosnia and
Herzegovina and, potentially, Tajikistan. Special attention will be given to the
development of telecommunication services in the rural areas, particularly in the early
and intermediate transition stage countries. Through its projects and related technical
assistance and policy dialogue, it will support countries in their efforts to implement
the EU Acquis Communitaire and adhere to the WTO Telecommunication
Agreement.

The Bank’s capability to tailor its approach to the specific requirements of each case
across the full public-private sector spectrum gives a flexibility with which it can
complement the other IFIs and commercial financiers. The Bank has in-depth
capacity in banking and industry experience which can be combined with specific
regional experience. Its ability to complement its financial experience with its
regulatory institutional experience and resources increases the additionality the Bank
can bring to its operations.

As the Bank increasingly extends its activities into the media and informatics market
segments it may be necessary to supplement its in-house expertise by using the
services of external consultants for specific due diligence activities.

3.1 Promotion of Private Sector Involvement

Market forces and competition have been proved to be the major prerequisite for a
dynamic and efficient Telecommunications, Informatics and Media Sector. The
Bank's mandate to foster the transition towards market-oriented economies and to
promote private initiatives uniquely positions it to facilitate and optimise private
sector participation in the financing and provision of telecommunications
infrastructure and services in its countries of operations.

Historically, most countries throughout Europe have had a Telecommunications

Sector structured primarily on a monopoly basis, certainly so far as basic telephone

18
services were concerned. Indeed, telecommunications has often been described in the
past as a “natural monopoly” because of the very significant investment costs of the
local access network. During the last decade or more as cost effective alternative
access mechanisms have become available, this has been shown to be no longer the
case and most western European countries, and indeed some of the more advanced
transition countries, have progressively liberalised their telecommunications markets.
This process has been accelerated by the introduction of new services where free
competition is clearly necessary and desirable if the market is to progress, e.g.,
internet, data service provision, mobile telecommunication. Experience has proved
that the emergence of effective competition in the sector is often dependent on the
existence of a robust regulatory framework which will force the incumbent operator10
to provide access to its network on fair, reasonable and transparent terms, will provide
fair allocation of scarce resources such as numbering and radio frequencies, and
ensure a level playing field for all players in the market.

The primary goal of private sector involvement and increased competition is to

improve capital and operating efficiency. This is achieved by the private sector
assuming project risks relating to the design, construction, financing and operation of
an infrastructure or service asset. A key element of private sector involvement in
EBRD financed operations, therefore, is the genuine risk adoption by those parties
best able to manage them, thereby providing incentives for sustained effective
performance.

Bank operations in the Sector have to be designed to achieve efficiencies that most
naturally come from the private sector: stronger financial discipline in investment
appraisal; experience with a wider range of technological solutions; focus on least-
cost solutions; better integration of capital and operating costs; shorter design,
procurement and construction processes; innovation in the financing and operation of
services; and globalisation.

A further goal of private sector involvement in telecommunications infrastructure and

services is to increase the pool of available sources of investment funds. First-rate
sponsors, typically major telecommunications operators in their own country, will
have access to equity funds, foreign capital markets and loans that would not
otherwise be available. The Bank’s participation in a project can be highly additional
in securing the release of such funds, especially in those countries where the risk
through poor regulatory framework, is perceived to be unduly high.

The Bank will actively support new network operators (local, domestic long distance
and international) and mobile operators as the most direct route to achieve
competition. In parallel, the Bank will promote sound and transparent privatisation
strategies which will be actively supported by assisting the preparation for
privatisation, including pre-privatisation financing. The Bank will continue its policy
of looking for opportunities to participate in the privatisation itself through provision
of equity or long-term debt financing to the newly-privatised company.

The Bank will support opportunities to develop the Telecommunications, Informatics

and Media Sector beyond basic telecommunications services, e.g. information

10
The incumbent operator will normally have a de facto dominant position, i.e. the ability to behave independently of its
customers and suppliers.

19
technology, e-commerce (transactions using electronic methods), computer hardware
and software manufacturing, TV network distribution and broadcasting, publishing,
internet service provision, satellite communications, and media in general. As the
internet is still in its early stages, many electronic commerce opportunities are
available creating new business opportunities for SMEs who are taking advantage of a
global presence via their own online e-commerce services as customers are
progressively utilising more online sources to purchase products and services. New
technology via computer hardware/software and increasing speeds of computation
and magnitudes of memory coupled with decreasing prices of chips are enabling
businesses to embrace e-commerce and use it as a market differentiator to reach new
consumers. The marketing and sales potential of the internet in addition to the growth
of electronic business has prompted a strong expansion in the IT market. In some
cases, the most appropriate financing will be via Funds in which the Bank is
participating. With increasing convergence, there will be more opportunities in
related industries, including media and publishing where the Bank will support
service providers e.g. distribution. Media and publishing have proven to be the most
efficient tools in representing diverse opinions, choice, and democracy in general.
The Bank will support such a critical transition force in the Region whenever
possible. In addition, the Bank’s approach to these projects will be in accordance
with the Guidelines for Bank Involvement in Electronic Media and Broadcasting
Projects [SGS94-79 (Rev 1)].

The Bank will continue to be involved in mobile telephone projects where the newly
developed Universal Mobile Telecommunications System (UMTS) will provide the
wireless access networks for the new information society. UMTS will offer more
advanced services that will drive up penetration rate and usage, overcoming the
limitations in respect of voice and data services of current second generation
technology. UMTS will offer a range of mobile services that until now have only been
available on fixed line networks thus facilitating competition.

3.2 Commercialisation and long-term financial sustainability

A key objective pursued by the EBRD in its operations, especially important in the
early and medium transition countries, is the commercialisation of incumbent national
operators. Historically, in the Bank's countries of operations, the state-owned
telecommunications operator worked within, or as a department of, the Ministry of
Posts and Communications. Commercialisation usually begins by corporatisation and
during the last few years, many countries have begun this process by separating the
telecommunications operating activities from postal functions to form new
independent state entities, typically wholly Government-owned joint-stock companies
or similar structures. Nevertheless, the legacy of the past means that these new
entities are frequently characterised by inadequate accounting methods that under-
record the true cost of capital, deficient financial planning, programming and
budgeting practices, lack of cost control, and low levels of cost recovery. The
fundamental aims of reform in the public sector are to place these entities onto a
commercial footing, to improve their corporate governance and to take measures to
ensure long-term financial viability. This requires changes in the organisational status
of the entity, reform of tariff policies, accounting rules and administrative practices,
and the introduction of competition.

20
Corporatisation and commercialisation. An important first step in improving the
operational efficiency of incumbent telecommunications operators is to corporatise,
thus converting them into legally, managerially, financially and operationally
autonomous organisations separate from direct ministerial control. This will help to
insulate the utilities from political interference and enable them to operate in a more
transparent and accountable manner. By obtaining independent corporate status,
publicly-owned service providers become subject to standard commercial and tax law,
accounting criteria and competition rules. Corporatisation will compel them to adopt
commercial procedures and practices in accounting, revenue administration, and
financial planning and budgeting.

Tariffs and Cost Recovery. One of the legacies of central planning is that the tariffs
paid by consumers for the use of telecommunications services are typically set far
below operating and capital replacement costs. Tariff-setting procedures often lack
predictability and remain subject to political discretion. Also, except in the most
advanced countries, there is a high degree of (economically inefficient) cross-
subsidisation between classes of consumers — particularly from industry and
commerce to households. In many transition countries, most prominently in the CIS,
tariffs are largely determined by political and social considerations that may omit bad
debt provisions or rely on inadequate depreciation charges. In countries of the CIS,
including the Russian Federation, the difficulties caused by inadequate tariff regimes
are aggravated by poor revenue collection and low levels of cash receipts. As a result,
many incumbent operators, especially the smaller operators in the Russian Federation
and the less advanced countries, cannot generate sufficient cash surplus to fund or
borrow for capital improvement. Given the world-wide trend to base
telecommunications tariffs on cost-based systems, strongly supported by WTO, EU
and ITU, and the reciprocity between operators, especially on international routes,
major rebalancing of tariffs will be required over time throughout the Region.
Although the economic efficient system is to have cost-based tariffs, in practice, the
transition period through tariff rebalancing is long, even for western European
countries. A major consideration in this respect is the degree to which services in
certain subsectors can be financially self-sufficient without cross-subsidisation,
notably services provided to residential customers and having regard to the Universal
Service obligations of an incumbent operator.

Efficiency Incentives. Besides failing to cover the full economic cost of service
provision, the prevailing tariff policies are often economically inefficient. In (mostly
advanced transition) countries where the principle of economic pricing has been
accepted, tariffs are set on an increased cost basis, providing little incentive for
productivity gains and cost efficiency. In many countries, the level of operating
surplus is capped without consideration for investment needs.

The Bank has made, and continues to make, a significant contribution to the transition
towards commercialisation in these entities through conditionality whether in the
Borrower’s loan agreements or in the Government’s sovereign guarantee. Such
corporatised entities that receive Bank support are required to adopt international
accounting standards (IAS). They should be subject to general commercial law, to
accepted international accounting and auditing standards and to hard budgets. These
companies should be allowed to charge customers through a transparent tariff system
for the services they provide at levels that will enable them to be financially viable on

21
their own. An important focus of corporatisation is financial and operational
performance, which publicly-owned companies have to improve as a standard feature
of EBRD projects. The commercialisation and corporatisation of service and
infrastructure provision is generally the prerequisite for, and often the first step
towards, private sector involvement at a later stage.

3.3 Development of Regulatory Structures and Capacity

Telecommunications regulation is one of the five core areas being addressed by the
Bank in its Legal Transition Development Programme in liaison with other IFIs and
the EU. A key requisite to improving the quality and cost-efficiency of the
Telecommunications Sector is to have a proper regulatory structure and capacity in
place. Commercialisation of public utilities or the profit motive of private firms alone
does not suffice to assure high-quality services, improvements in efficiency or an
equitable sharing of gains. Telecommunications regulatory reform projects
11
undertaken by the Bank aim at promoting the emergence of competition within the
Sector and the elaboration of a modern regulatory framework likely to attract and
foster private investment.

The Bank considers that the performance of the Sector improves immensely when
there is effective competition between several privately-owned players. However,
telecommunications has hitherto long been considered as a public-service, the
provision of which could only be ensured if entrusted into the hands of a state-owned
monopolist. Transforming the Sector into a dynamic multi-operator environment is
quite challenging. Apart from the obvious need to change mentalities and remove
exclusive rights from the incumbent operator, one also needs to elaborate rules that
will facilitate the entry of new competitors into the market, provide new investors
with the necessary safeguards of transparency, objectivity and clarity and permit
competition to emerge.

Obliging the incumbent to interconnect on fair and reasonable terms with competitors
that threaten or encroach on its cosy monopoly is obviously a difficult task. The
problem can only be addressed by adopting a set of rules designed to force the
incumbent to provide new entrants with transparent, objective and non-discriminatory
access to its network and by creating strong and efficient institutions that will oversee
the market and ensure effective implementation of these rules.

3.3.1 The Policy

In accordance with its established policy and practice, the Bank provides technical
assistance to countries which have expressed a genuine interest in undertaking a major
reform of their telecommunications policy. Projects will only be launched if no other
law reform facilitator is providing adequate assistance and the project is directly
related to a specific Bank investment or potential investment or investment strategy in
general. In providing technical assistance, the Bank promotes:

11
Supplementary Information Section 2 provides further details of telecommunications regulatory projects carried out by the
Bank.

22
a) the gradual liberalisation of all telecommunications services; the Bank takes the view
that both the Telecommunications Sector and the overall economy of the country
concerned will benefit greatly from the rapid emergence of competition in all
telecommunications markets. The Bank, however, also recognises that in some cases,
the grant of a monopoly right to the incumbent operator for a well-defined
transitionary period in respect of basic fixed line switched voice service may be
justified in view of the size of the investment required for the fulfilment of its
Universal Service or similar obligations, the modernisation of the network and the
inherent risks of the relevant national economy. The Bank considers that these
transitory periods should be specifically defined and strictly limited, desirably
consistent with the WTO target of 2003 for the total liberalisation of basic
telecommunications service in its member countries.

b) the establishment of an independent regulator with no structural or functional links

with the incumbent telecommunications operator; the Bank considers that the
effective separation of the regulatory authority from the owner of the incumbent
operator is vital for the creation of a level playing field for new entrants. The Bank
therefore supports the efforts to create an independent regulator with the powers and
the means to sanction any anti-competitive behaviour of the incumbent operator and
to foster the emergence of competition in the Sector.

c) the progressive rebalancing of tariffs; the Bank considers that the structure of the
tariff policy of most dominant operators in the Region constitutes a serious
impediment for both liberalisation and privatisation. Tariffs for local
telecommunications services are often substantially below cost and need therefore to
be subsidised by income generated through the provision of international and long-
distance services. This has the following repercussions:
ƒ Unbalanced tariffs create an obvious opportunity for cream-skimming in
the event of competition, thus constituting a deterrent to liberalisation.
ƒ Unbalanced tariffs offer little incentive to provide local
telecommunications services, in particular to remote or sparsely
populated areas. Hence, the demand for telecommunications lines
exceeds that available and the Universal Service obligation of the
incumbent operator remains unfulfilled.
In order to compensate the likely adverse social effects of rapid tariff rebalancing, the
Bank supports all efforts to develop Universal Service and/or Universal Access
mechanisms which will permit less privileged customers to benefit from a direct
subsidy but which do not disrupt the development of the market by creating
competitive advantages or disadvantages.

d) the elaboration of a set of rules designed to facilitate the emergence of competition;

the main objective of these rules will be to enable new entrants to obtain access into
the dominant operator’s network on fair, objective and transparent terms. The Bank
takes the view that effective competition can only emerge if regulatory constraints
preclude predatory use of market dominance by the incumbent operator and unfair
practices versus its new competitors.

The policy advocated by the Bank is consistent with the WTO agreement on basic
telecommunications services and with the telecommunications policy and legislation

23
of the European Union. In the case of pre-accession countries, the Bank encourages
and supports the efforts of those countries to achieve full compliance with the acquis
communautaire.

3.4 Environmental Improvement and Energy Efficiency

A key objective for the Bank is to promote environmentally sound and sustainable
development by reducing environmental damage and securing improvements in
environmental quality and energy efficiency. Projects in the Telecommunications,
Informatics and Media Sector seldom give rise to significant environmental issues.
Indeed, telecommunications services can make an indirect contribution to the
environmental agenda by reducing the need for travel; it can save resources by
efficiently transferring information and can provide the knowledge to act on
environmental issues. The deployment of telecommunications infrastructure is
generally quicker than the building of roads and railways and can be a cost-effective
and environmentally-efficient way to modernise and regenerate less accessible areas
of the Region. The Sector can also act as a catalyst for developments in other sectors
which have a positive environmental application e.g. widespread use of solar energy
panels at remote communication stations, including roadside, where conventional
power provision may be costly or overly disruptive.

However, just because its services have the potential to provide environmental
benefits does not mean the telecommunications industry can ignore the environmental
impacts of its own operations. In fact, it places an additional burden on the industry
to pay attention to these issues. In the context of the Bank’s telecommunications
projects, environmental concerns are normally confined to the planning process where
the Bank requires clients to follow transparent consultative practices, eg when
deciding on sites for radio infrastructure or the laying of cables in public and private
property. Upstream processes will also be taken into account e.g. chemical treatments
of wooden poles which may present a toxic hazard to health. Disposal of surplus
equipment, especially where hazardous substances may be involved, are required to
follow national and European Union standards. Some of the Bank’s
telecommunications clients have already signed up to the European Public
Telecommunications Network Operators Association (ETNO) Environmental Charter
which is committed to continuous improvement through action in the areas of
awareness, regulatory compliance, research and development, procurement,
information and environmental management systems. Such initiatives will be
encouraged.

3.5 Project Evaluation and Lessons Learned

The Bank continues to post-evaluate a representative sample of its telecommunication

projects and to draw out the lessons learned. Projects are evaluated to assess their
performance in terms of transition impact and additionality, project business
performance (sound banking principles), profit contribution and overall success
rating. Lessons learned are disseminated within the Bank, and where appropriate, to
other IFIs, and have been taken into account in preparing this Operation Policy.

24
The key thematic lessons learned include:

• The Bank can play a useful role in assisting with the development of the legal and
regulatory framework. This will help to provide investors with confidence that the
“rules of the game” are transparent and sustainable and should promote competition
within the sector.

• Strong sponsors and their ability and willingness to work with local management
is a critical success factor.

• Turning around a formerly state-owned monopoly telecommunication operator to

meet the demand of service and perform in a competitive environment takes a long
time and cannot be achieved solely by the company’s existing management. The
changing force can be a) a new owner who contributes know-how and financing
and/or b) direct competition which forces the company to change to compete in the
new market environment.

• The Bank should seek equity-based investments in telecommunications,

informatics and media projects in order to improve the operation’s risk/return balance
and to maximise its additionality. The Bank can play a constructive role as “honest
broker” through being the bridge or balancing shareholder between state and private
interests.

• Where corporatisation and/or privatisation of an entity is a project objective, loan

disbursement should, to the extent possible, be linked with progress achieved.

• It is preferable, though seldom the case, that privatisation proceeds, or part

thereof, benefit the privatised entity.

25
 4. INVESTMENT PRIORITIES AND OPERATIONAL APPROACH

4.1 OPERATIONAL PRINCIPLES: STAYING AHEAD OF THE MARKET

4.1.1 Demand for EBRD investment financing

The demand for investment financing in the Sector has been rapid throughout the Region —
although geographically uneven. The most advanced transition economies, particularly the EU
accession countries, quickly recognised the need to improve their telecommunications, and have
made rapid strides in developing infrastructure and services. Nevertheless it is estimated that the
Region needs euro 12-15 billion per year to reach the current EU level of service within the next
10 years. A significant part of this financing will be needed to improve access in countries (or
rural areas) where the level of GDP is such that commercial financing is not possible.

Relative improvements in the regulatory and legal framework in these countries have increasingly
encouraged high quality investors to enter the market, especially where the incumbent operator
has been privatised and liberalised cellular telephone opportunities have been given.
Notwithstanding this, the Bank plays a vital role in providing complementary financing
instruments providing investors with reassurance and confidence.

The Bank ensures that its activities in the Sector are additional. The Bank has significant
experience in Telecommunications, Informatics and Media throughout the Region and its
potential role in the Sector's investment financing is well understood by the market. The Bank
assumes and manages transition-related risk that commercial banks are not willing to take and
provides financing with tenors/terms that match the specific needs of the Sector and which are
not otherwise available in the market. With its unique mandate, the Bank can intervene in the
Sector in ways that no other international or commercial financial institution can. The demand
for EBRD financing indicates that it is seen as a key player in the Sector, a position which has
been reinforced since the recent events of the emerging markets financial crisis and the contagion
to other countries in the Region.

The bankable part of this demand is concentrated in countries where regulatory frameworks have
become sufficiently stable and predictable, based on law, and where private sector investment is
facilitated by political and sustainable economic, financial and legal conditions. Such conditions
are currently experienced in the advanced transition economies including most of the EU
accession countries. Demand for financing in less advanced transition economies is more
dispersed and driven primarily by investment needs associated with network development of the
dominant fixed-line operator.

The EBRD intends to utilise fully the range and flexibility of its financing instruments in the
Sector, increasingly providing equity as part of its financial structuring and exploring means of
providing local currency funding, and, through continuous innovation and risk absorption, play a
leading role in rapidly developing markets, thereby paving the way for future commercial
financing.

26
4.1.2 Market selectivity
Given the sheer volume of investment needs and the Bank's limited capacity to meet these needs,
a selective approach is needed. Operations in the Sector will therefore focus on:

• private sector operations, and where the Bank’s particular Sector expertise and project
development capacity is most useful;

• projects with demonstration effect in early and intermediate transition economies where
Sector reform requirements are high and liberalisation and privatisation is an integral part of the
government’s economic reform programme;

• operations where EBRD funds can be leveraged with co-financing from other commercial
banks or international financial institutions;

• projects which make a major contribution to access to information, especially media and
publishing activities.

A key aspect of Bank selectivity is the need for the EBRD to maintain its additionality, the
capacity and willingness to assume ever changing transition-related risk, and stay ahead of the
market. This has already been demonstrated by a quantitative change in the Sector’s product mix
away from public sector, sovereign guaranteed loans, towards private sector equity investments
and debt project financing.

4.1.3 Investment priorities

The Bank considers telecommunications as a key element of basic infrastructure which is vital for
business development and economic growth and will continue to support development in this
area.

EBRD operations in the Sector fall into four broad categories (Table 1) which can be directly
related to the stage of transition of any specific country. This is turn determines the type of
financing instrument and transaction structure appropriate for the Bank to provide.

To date, the majority of the Bank's activities in the Sector has been concentrated in advanced
transition economies and EU accession countries. Increasingly, the EBRD is working in medium
or early transition countries with a reliable foreign sponsor on private sector projects or
participating in privatisation activities. It will use its capacity to manage transition-related risk to
mobilise support from private investors and commercial banks for investments in the Sector. In
countries where the economic transition process is less advanced and where macroeconomic
conditions and uncertainty over fiscal capacity adversely affect the credit quality of public sector
borrowers, the EBRD may need to secure its loans through sovereign guarantees. In such difficult
circumstances, the Bank will continue to leverage its activities by close co-ordination with other
IFIs in order to better address the related macro-economic issues. The Bank's operations in these
countries will generally be selective, transition-oriented and of a strategic nature; in any event,
such operations would be accompanied by conditionality to promote Sector reform and would
require a clear undertaking by the Government to pursue the path to liberalisation of the Sector
through appropriate regulation and de-regulation.

27
 NATIONAL FIXED LINE TELECOMS MOBILE, SECOND OPERATORS,
Table 1 OPERATOR VALUE ADDED SERVICES, MEDIA
AND FUNDS

BEFORE PRIVATISATION PRE-PRIVATISATION PRIVATISATION AND POST- PRIVATE SECTOR

PRIVATISATION

Typical • sovereign guaranteed long-
Instruments term/convertible debt
• technical co-operation
Operational • prepare ground for private sector
Objectives and involvement
Benefits • support Government efforts to reform
Sector through regulatory framework
development with TC
• immediate access to capital for
restructuring and development
Challenges • political acceptance of direction towards
private sector involvement
• evolving legal/regulatory framework for
commercialisation/privatisation
• operation preparation/appraisal time
• procurement issues
• non-sovereign guaranteed quasi-equity/long
term debt
• pre-privatisation equity warehousing
• convertible debt
• Increase valuation of company by injecting
funds for investments
• provide political comfort to potential investors
• syndicated loan to commercial banks
• mobilise commercial funds for company
• prepare company for privatisation within 12-24
months
• provide company with “anchor” investor
• long development time
• political acceptance of direction towards private
sector involvement
• evolving legal/regulatory framework for
commercialisation/privatisation
• operation preparation/appraisal time
• procurement issues
• pricing and syndication challenge
• foster corporate governance
• privatisation equity • corporate (convertible) loan, syndicated
• privatisation quasi-equity/long term debt loans
and syndicated loans • local currency instruments
• underwriting of IPO • (quasi) equity
• capital market instruments
• political risk carve-out (to sponsors)
• guarantees and underwritings
• Acquisition of new equity ensures receipt • mobilisation of domestic and foreign capital
of privatisation proceeds • involvement of commercial banks, other IFIs,
• Government realises proceeds if the IPO and ECAs for strong co-financing
size exceeds market demand • foster private sector
• provide political comfort to investors • encourage competition
• mobilise commercial funds • strengthen transition impact by affording
• attract best strategic partner customers more choice
• provide support for uncertain or
insufficient commercial underwriting
• “plug” demand for large size of offering or
capital needs
• acceptability of EBRD pricing and • acceptability of EBRD pricing and
conditionality in view of growing conditionality in view of growing competition
competition • overall timing issue
• overall timing issue
• desire by sell-side investment banks to
sever relationship to not encumber
process
• harmonisation between privatisation and
liberalisation

EBRD • Romtelecom • MATAV II (1993) • MATAV III (1997) • Netia, Poland

Benchmark • Kyrgyztelecom • Romtelecom, Romania • MATAV Bond (1998) • NW GSM & Moscow GSM, Russia
Transactions • MATAV I (1991), Hungary
• Bulgaria Telephone Co. • Armentel, Armenia • TPSA IPO, Poland • MobiFon, Romania
• Macedonia Telecom • Baring Communications Equity (Emerging
Europe) BCEE Fund
• TV2, Hungary

28
Investments in the incumbent or in entities with significant state ownership will be
accompanied by a commitment to regulatory reform. In practice, this means:

• Countries which are candidates for EU accession will be encouraged to move

towards the adoption and implementation of the Acquis Communautaire in good time
for accession.

• Countries which have signed the WTO Agreement will be encouraged to make
progress towards the adoption and implementation of the principles contained within
the relevant Agreement.

• Countries which have not yet signed the WTO Agreement will be encouraged to
progress towards the adoption of the principles contained within the WTO Reference
Paper on Telecommunications Services, in particular, the adoption of a regulatory
framework, the establishment of an independent regulator, the adoption of cost-based
tariffs and the phasing of liberalisation in preparation for WTO accession.

EBRD Benchmark Transactions included in the table demonstrate how different

countries are at different stages of transition. Notably it shows how two countries the
Bank has been particularly involved with, Hungary and Romania, have progressed
within the transition spectrum. Equally it has been more difficult in some countries,
e.g. Russia, where the regulatory and legal framework is such that, so far, it has only
been possible for the Bank to participate in a limited number of private sector mobile
operator projects.

Today the relative positions of the Bank’s countries of operation vis-à-vis regulatory
and legal development can be more easily determined and choice of future operations
will tend to be determined on geographical lines. In the EU accession countries, (and
eventually other countries as they make the transition to advanced economy), the
EBRD will provide equity and long term debt financing primarily to private sector
operations or soon-to-be privatised companies. It will typically assume risk that
commercial banks or capital markets may not be willing to take, and will seek to
leverage its participation by bringing in commercial banks under its security umbrella
in syndicated loans. In countries where the economic transition process is less
advanced and where macroeconomic conditions and uncertainty over revenues
adversely affect the market, the EBRD will continue to play a greater role through its
financing and security structures, supported by regulatory development technical co-
operation projects. While in these countries investment needs in the Sector are
pressing and vast, the EBRD's financing opportunities may be restricted by risk
constraints. Hence, for Russia and Ukraine which represent over 50% of the Region’s
population, macro- and micro-economic conditions will demand the co-ordination of
IFIs, such as the World Bank and the IFC, and the EU, as financing requirements and
regulatory improvements are simply overwhelming. Specifically, the Bank will have
to seek a balance between risk and return including acceptable regulatory
environment, tariff rebalancing and enhanced security to reflect the changed
operational environment. Bank operations are likely to have major impact on the
following areas:

29
Private Sector

The Bank will develop operations in the private sector whenever the opportunity
arises as the prime instrument for promoting competition in the Sector. Given the
need for predictable and stable legal, commercial and regulatory environments, such
operations are more likely to be undertaken in the EU accession countries. Where the
market segment is regulated through a limited number of licences, e.g. cellular
mobile, the Bank will normally expect the project company to have been granted the
licence through competitive bidding. The Bank will look to work with project
companies which have sponsors with adequate financial and management resources
and experience of similar operations in the sector. Projects are likely to be in the
following market segments:

• Mobile operators which is a prime market segment for private sector companies
and which can bring early benefits through competition to the incumbent and
customer choice. These mobile operators could be second, third, or even fourth
entrants in the market depending upon the availability of disposable income to support
such number of players. This segment of the Sector has been characterised by several
successful transactions for the Bank and consequently, a certain industry expertise has
been built upon which can be replicated in other countries in the Region.

• Second operators and local telecommunication companies, which are increasingly

becoming financially viable in the more advanced countries as the regulatory
framework develops to support opening of markets as part of EU accession
agreements or WTO commitments. Such second operators, which would be
competing against the incumbent operator, require a regulated market environment
relying heavily upon the concept of fair access to the local network with fair
interconnection agreements. The Bank can play a pivotal role in supporting such
companies and ensuring the introduction of competition on a phased basis. Equally
the timing of such introduction and the manner in which it is brought about is vital to
the incumbent player which should be strong enough to withstand competition
without jeopardising its existing obligations such as providing universal service. It is
notable that the concept of second local operators is only now being tested in
western Europe where severe price-cutting measures are being deployed to add
customers to the new networks, but thereby reducing profitability drastically.

• Value added services, including data transmission, electronic mail and internet, as
well as satellite communications. Such services will grow in importance as it has
been demonstrated in western Europe. The traffic demands on the networks will be
heavy and investments will be required to support the additional traffic.

• IT and software development which is an increasingly global activity where a

number of countries in the Region, in particular Russia, are seen to have a competitive
advantage. In order to be able to bring about the current IT surge worldwide, several
opportunities will exist to tap into a highly-educated pool of resources in the Region.

• Informatics and Media, including publishing and broadcasting, which can play a
major role in furthering the democratic process. The relationship between the
regulatory licensing bodies and the entities vying for such opportunities will be a
critical area for the Bank to assist in. In addition, such transactions will clearly foster

30
and promote the transition process in countries where government-owned facilities are
the only available choice to-date.

In the years to come some of the manufacturing companies will move to the Region to
develop local production and the Bank will consider providing financing for these
operations.

SME or specialised funds will be used for smaller projects or those in niche markets.
Although these are targeted at the more advanced countries, limited opportunities may
also arise in Central Asia, Caucasus and the Balkan countries.

PRIVATISATION AND POST-PRIVATISATION

The Bank will continue to support privatisation of incumbent operators. In many

cases this support provides significant leverage for the introduction of liberalisation
and regulatory regimes. This will include financing, through equity and long term
debt, companies which have been privatised with a strategic investor through a
transparent and competitive international bidding process. The overall objective is for
the Bank to provide comfort to the potential investors and introduce the privatised
company to alternative means of financing via the international capital markets. The
Bank will also support second (and subsequent) tranche privatisations by participation
in IPO (Initial Public Offering) and other capital market instruments, as it has already
done in Hungary (MATAV) and Poland (TPSA), as well as introducing the newly
privatised entity to the international syndicated loan market. Opportunities are
foreseen in Lithuania, Poland, Armenia and Kazakhstan.

PRE-PRIVATISATION

The Bank will continue to focus on pre-privatisation financing where the Bank’s
involvement will be highly dependent upon government commitment to reform and
improvements in the legal and regulatory framework. EBRD will co-ordinate with
other IFIs and the EU to ensure synergy between independent initiatives and
optimisation of resources. The Bank will leverage its participation to influence the
government towards liberalisation of the market and creation of a level playing field,
thus facilitating the private sector and boosting investor confidence that the market is
safe for business. Projects will be structured taking into account the country’s legal
obligations to EU and WTO. Bank involvement will be conditional upon the
government appointing privatisation advisors and the privatisation being undertaken
through a transparent process within a certain time period. EBRD anticipates that
privatisation of the remaining incumbent operators in the Region will involve a
strategic investor. The Bank would require such an investor to be appointed by
international competitive tender and to be given management control, irrespective of
the degree of ownership of the company. Privatisations are slated to occur during the
next two years in Slovak Republic, Bulgaria, Georgia, Ukraine and Belarus. The
Bank will continue to work closely with the World Bank to assist the privatisations in
Kyrgyzstan, Albania and Moldova.

BEFORE PRIVATISATION

The Bank will use its mandate to work with those countries which are still at the
beginning of the transition process in the Sector.

31
In Russia where the Sector is extremely fragmented and still in need of severe
regulatory reforms, the Bank will work closely with other ifis. As the scope of
investments would be prohibitive for a single ifi and as structural reforms would be
required as well, improvements in the legal, commercial and regulatory framework
will demand several IFI participation. In the meantime, opportunities may arise for
financing Regional telephone companies who commit to privatisation and have the
ability to rebalance their tariffs.

The Bank will continue its special role in the Bosnia and Herzegovina
Telecommunication Emergency Reconstruction project, and potentially Tajikistan
where sovereign-guaranteed financing may be necessary. The Bank will explore
opportunities to finance basic service development in the rural areas, in particular, in
the early transition stage countries.
4.1.4 Adaptability to Changing Market Conditions
As the legal and regulatory environments improve, and commercial investors become
more willing to work in these countries, the Bank will need to continuously develop
and innovate its financing instruments in order to satisfy the requirements of the
market. To complement growing availability of investment financing from
commercial banks and capital markets, the EBRD will need to adapt its instruments
whilst at the same time maintaining its additionality, ensuring the acceptability of its
pricing and conditionalities and improving its ability to respond rapidly and flexibly
to financing needs.

The Bank recognises that not all projects can contribute equally to meeting its goals of
helping the transition, sound banking principles and additionality. It will critically
review its potential operations to ensure they meet minimum threshold standards for
each goal whilst maximising contribution to the overall performance of the Bank.
This will provide the Bank with flexibility to tailor its approach taking into account
the conditions existing in the country and the nature of the project.

4.1.5 Financing
The EBRD's approach to addressing the investment needs in the Sector vary
according to differences in economic and regulatory frameworks in each country.
The EBRD can offer a wide range of financing approaches, essentially depending on
the public or private nature of the borrower, the size of the proposed investment
programme, and a country's stage in the transition process. The EBRD can apply this
flexibility both across and within its countries of operations.

The EBRD's singular capability to cover the full private–public spectrum of

operations allows it to help the erstwhile state-owned incumbent to graduate from one
transition stage to another over the life of an investment, for example moving from
sovereign to private financing (see following text box on Matav and RomTelecom).

A key factor in the demand for EBRD financing is its capability to assume risks that
commercial banks and investors are not willing to take at this stage in the transition
process and to provide financing on terms that are currently not available in the
market. Specifically, the Bank can take transition-related risks, such as those related

32
to the regulatory and licensing framework, which may have a fundamental impact on
investment economics.

4.1.5.1 Loans
The majority of the EBRD's financing in the Sector will continue to be provided in the
form of senior loans with maturities typically below 10 years. Debt is the preferred
instrument in certain cases, in particular because of the possibilities to link
disbursement with commercialisation and creditworthiness covenants. Loan
financing will be applied in countries in all stages of transition, and to all kinds of
borrower. However, depending on the specific risk characteristic of the country or the
project, the EBRD will provide loans in the form of subordinated debt, where needed
to facilitate commercial bank co-financing.

The EBRD will continue to mobilise external financing through syndicated A/B loan
structures and will offer standby commitments to enhance commercial banks’ terms
under the B-loan (such as, refinancing guarantees to extend the B-loan maturity).

Graduation from sovereign to non-sovereign borrowing

Among the first EBRD loans in the Telecommunications Sector were those for the Hungarian
Telecommunications Project in 1991 and RomTelecom Project in 1992. At that early stage in the transition
process, the credit risk of these telecommunications operators which were just established as independent
entities was such that non-sovereign financing could not be considered. Among the operations' main stated
objectives were the corporatisation of operators and the improvement of their operational and financial
performance. As part of its loan conditionality, the Bank required the borrowers to adopt modern accounting
systems and to implement corporate development programmes. Loan covenants included tariff reform
requirements and other specific measures aimed at financial and operational performance improvement.
Implementation of these EBRD requirements by companies and Governments led to significant improvements
in the companies' performance.

Matav. The Bank extended to Matav a DEM 185 million loan backed by sovereign guarantee in 1991. Matav
was able to attract strategic investor already in 1993 when Deutsche Telekom and Ameritech jointly acquired
30.2 % of the company. Just before the privatisation, the Bank provided the company with USD 60 million
pre-privatisation convertible debt that was converted into equity at the time of privatisation. EBRD pre-
privatisation financing helped fund additional development at a time when the strategic investors' investment
was going to the Government, and also demonstrated commitment to privatisation in a difficult political
context. Furthermore, EBRD provided syndicated loan of USD 300 million in 1995 at the time when the
strategic investors acquired additional 37.2% stake in the company from the Hungarian Government.

RomTelecom. In 1992 EBRD provided an ECU 142 million senior loan backed by a sovereign guarantee to
RomTelecom. This financing enabled the company to construct a modern overlay network and expand network
capacity. In early 1998, with the aim to facilitate RomTelecom's privatisation and continuation of its
investment programme, the Bank extended to the company unsecured long-term pre-privatisation corporate
loan of US$ 100 million as a private sector transaction. RomTelecom was successfully privatised in November
1998 when OTE of Greece obtained 35% stake in the company along with management rights.

The project companies will be able to mitigate potential foreign currency risk through
local currency denominated financing. Such loans coupled with back-to-back EBRD
bond issued in the local currency, will allow the companies to tap the demand in
markets where their own credit rating would not allow them to access. The Bank will
also arrange various hedging facilities to mitigate interest and cross currency risks in
conjunction with any of its financing.

33
4.1.5.2 Strategic role of Sovereign Operations
The Bank has become increasingly selective in its development of sovereign
operations, which are likely to be used only in extremely difficult situations, eg as in
Bosnia-Herzegovina and, potentially Tajikistan, as well as rural projects in early stage
transition countries. Sovereign operations will, in general, only be pursued in order
to:
• establish an early market presence in strategic countries where potential
exists for future non-sovereign operations; or
• selectively address "hot spots" where the Bank's operations can achieve
transition impact.

Strategic markets. The Bank will selectively develop operations on a sovereign basis
in early or intermediate transition economies that are of strategic importance to the
development of a market-oriented sector. In certain early transition countries where
current conditions do not allow financing on a non-sovereign basis, the Bank's
strategic objective is to assist the transition towards non-sovereign and commercial
financing.

This approach was adopted by the Bank in the early days of its operations in many of
the countries of operation and has worked well, eg in Hungary, Lithuania, Romania,
Czech and Slovak Republics. In these countries, the EBRD established an early
presence and has had successful projects which have made a major transition impact.
This has enabled it to influence regulatory and policy development in the Sector and
pursue a strategy of gradually progressing from sovereign to non-sovereign public and
private lending.

"Hot spots". The EBRD will continue to play its part within the international
community to address specific emergency and reconstruction programmes, as it is
doing in Bosnia and Herzegovina. The Bank may be called upon to do this in
Tajikistan and, in view of the current conflict in the Balkans, in Albania and
neighbouring countries in the Region. In these cases, the primary operational
objective is stabilisation and reconstruction while observing the EBRD’s principles of
additionality, transition impact and sound banking principles. The EBRD’s
participation will normally be part of a wider financing package including grant and
concessionary funds provided by other IFIs and donor agencies.

4.1.5.3 Equity and Equity Related Instruments

Equity is expected to provide an increasing component of the EBRD's financing in the
Sector. Bank equity investments in the Sector may be driven by any of the following
rationales:
• to find an appropriate balance in the financing package taking into consideration
the frequent limitations of the client’s gearing capabilities;
• to enable privatisation and ease political resistance to private sector involvement;
• the Bank may be asked to take a pre-privatisation equity position that will
encourage other investors during a private placement or stock market flotation;
• where there is upside potential, e.g., in cellular companies.

34
The EBRD's role as impartial investor is reinforced by its capacity to participate in the
equity capital of the project companies whose investments it finances. Both
Government authorities and private investors expect the Bank to play a balancing role
in private operations. Its presence in investment structuring and equity financing is
expected to ensure that contractual arrangements provide appropriate economic and
financial incentives for efficiency improvements and that the interests of Government
authorities, consumers and private sector parties are fairly balanced.

The EBRD will offer convertible bonds or A/B syndicated convertible loans in the
context of privatisation of state-owned telecommunications operators. Such financing
would be offered at pre-privatisation stage and would be convertible into equity at the
time of privatisation, whether this occurs by public flotation or by sale of shares to a
strategic investor. Such pre-privatisation financing is a way of moving forward with
relatively low political risk while the necessary regulatory reforms are undertaken.

The EBRD will continue to offer equity warehousing approach in privatisation of

telecommunications companies. Under this structure, prior to privatisation, the Bank
would invest in special convertible preference shares with accruing but unpaid
preference dividend. If the privatisation does not occur within a certain pre-agreed
number of years (e.g., 2-3 years) or under certain events of default, the shares could
be put to the company itself. In certain cases, the EBRD could also underwrite shares
to sell in the public offering with the ability to hold the shares for the medium term if
the demand is weak.

In cases where there is an upside potential, the nature of the EBRD's equity
participation will be full risk bearing. In cases where for reasons of risk management,
the EBRD's presence is desired by the private sponsor, the EBRD's participation will
take the form of portage equity with a put option at predetermined return ('floor') to
the private sponsor.

4.1.5.4 Guarantees and Credit Enhancement

Guarantees have considerable potential and can form an important complement to
Bank loans and equity. Guarantees are well suited to mobilising private sector
financing from both commercial banks and investor-operators. In the Sector, they
would be targeted to mitigate political, regulatory and performance risks that the
private sector may not be in a position to absorb or manage. Guarantees would also
be used to extend terms on commercial bank loans to meet the need for long
maturities in the Sector.

Partial risk guarantees. In private, limited-recourse projects in the Sector, investors

are provided with undertakings regarding regulation, actions or payments that are
under their control. In addition, to facilitate private sector financing, additional
financial support can be given against risks that cannot be insured at reasonable cost.
The Bank would provide guarantees not only to give credibility to these contractual
undertakings but also to lower investors' risk perception and consequent risk
premium.

Partial credit guarantees. At this stage in the economic transition process,

commercial lenders may not be able or willing to provide loans at the required long

35
maturities. The Bank can provide guarantees that will allow commercial lenders to
provide loans with a balloon payment, possibly under an A/B loan structure. Other
ways in which the guarantee instrument can be used to extend commercial loan terms
include: liquidity guarantees in the form of take-out financing or put options; or
rolling guarantees that cover a fixed number of scheduled payments.

4.1.5.5 Revenue and General Obligation Bonds

In cases where bond financing may be a suitable alternative to EBRD loan financing,
the Bank may facilitate access by companies to capital markets, for example, by
providing guarantees, or co-arranging or partially underwriting General Obligation
bond issues or Eurobond issues.

As international capital markets become more accessible and domestic capital markets
develop, there will be considerable potential for project-based revenue bonds where
the cash flow generated by an investment project secures the bond (securitisation of
revenue streams or receivables). The Bank should be able to play a key role in
introducing project-based revenue bonds and facilitate their issuance through the
provision of partial risk guarantees such as those related to the unilateral termination
of service contracts by the authorities, or their refusal to pay the project company
contractually agreed service fees or compensation or to set the tariffs at required and
agreed levels.

4.1.5.6 Wholesale Instruments

In certain cases, the scope for Bank financing in the Sector may be limited by the
small size of investments making it uneconomic to undertake and finance projects on
a stand-alone basis. Nevertheless, for strategic reasons relating to a specific
subsector, country or investment type, the Bank will want to become involved in such
investments. Such investment opportunities will be pursued broadly via two types of
instruments:

Equity Funds:

The primary objective of equity funds will be long-term capital appreciation through
equity and equity-related investments in a diversified portfolio of primarily unlisted
companies that are well positioned to take advantage of the high growth potential of
the media and communications industry within the EBRD’s countries of operations.

Through its equity investment, the EBRD will assist funds to facilitate the
development of small and medium-sized operators and service providers in the
Telecommunications, Informatics and Media Sector in order to increase the
competition in the sector, thus, increasing the choice and range of offered services.

Holding Companies:

The Bank will make equity investments into holding companies that invest further
into small and medium size local companies in the Region. The main feature of the
regional holding company is that a private sponsor with the relevant Sector experience

36
and expertise will be the strategic investor/partner in the company, provide a part of
equity financing and assume most management responsibilities. The Bank's
participation as an equity partner would provide the project sponsor with comfort
relating to political risks associated with such investments.

Other Financing Instruments:

In addition to these two instruments, SME’s in the sector will be catered for through
other non-sector specific financing facilities employed by the Bank, including country
or regional credit lines set up with intermediary banks.

4.2 Technical Co-operation

Technical co-operation has played a significant role in developing and supporting

telecommunications projects. To date, euro 14.6 million has been committed to 95
projects in 21 different countries (Figures 13 and 14). The need for technical co-
operation projects has significantly declined commensurate with the shift from project
to corporate financing and in the future is likely to be limited to regulatory reform
programmes, assistance to the Government in preparation for privatisation, or special
circumstances such as the Emergency Reconstruction Programme in Bosnia and
Herzegovina. Bank technical co-operation funds are not used to support private
sector projects.

F ig u re 1 3 : T e c h n ic a l C o o p e ra tio n F u n d s
5 .0 P ro g ra m m e (T C F P )
R e g u la to ry R e fo rm
4 .5
4 .0 S e c to r R e fo rm

3 .5 C o rp o ra te B u ild in g

3 .0 P ro je c t Im p lem e n ta tio n

2 .5 P ro je c t P re p a ra tio n
2 .0
EURO mln

1 .5
1 .0
0 .5
0 .0
1991 1992 1993 1994 1995 1996 1997 1998

In the future technical co-operation projects will be limited to countries where the
government has demonstrated commitment to reform and where transactions are
foreseeable. Close co-operation will be maintained with other IFIs and the EC to
ensure synergy between project and optimisation of available resources.

37
 Figure 14: T echnical C ooperation Fund
Program m e
C um ulative C om m itm ents as of D ec-98 Euro ( m ln)

9.07 C en tral E uro pe

0.26
B altic S tates

E uro pean C IS

C en tral A sia &

2.22 C aucasus
R egio nal

1.76
1.19

4.3 Co-Financing Sources

4.3.1 International Financial Institutions (IFIs)

The EBRD has already co-financed a number of telecommunications operations with
other international financial institutions (IFIs): the World Bank (IBRD/IFC) and the
European Investment Bank (EIB). The Bank's approach complements that of other
IFIs operating in the Sector. The EBRD is the only IFI with a full range of financing
instruments, enabling it to work across the full public-private spectrum, and to offer
new instruments to its clients as they move along this spectrum. See Figure 15 which
depicts total EBRD financing which attracted co-financing (IFIs and commercial
banks).

Figure 15: Projects Involving Cofinancing

ECU 561m ECU 935 m ECU 4,819 m

EBRD financing Cofinancing1 Total project

costs
Note 1. Cofinancing comprises IFIs (ECU366m), Governments (ECU100m) and Commercial Banks (ECU469m)

The Bank will work with the IBRD/IFC on projects, mainly in early and in some
intermediate transition economies, where reform requirements are particularly
pressing and the combined weight of two IFIs can contribute to bring about changes

38
in policies and in the legislative and regulatory framework of the Sector. In co-
operating with the IBRD, the EBRD will build on its comparative advantage, which
lies in its local presence and its wider and deeper experience in the Region, especially
in the Telecommunications, Informatics and Media Sector. The IBRD/IFC would
tend to capitalise on its broader Sector-policy development expertise and its capacity
to influence Sector policies at national levels of Government. The Bank will also
work with IFC in private sector projects that have significant transition impact and
demonstration effect in difficult economic conditions such as exist currently in Russia
and Ukraine.

The EIB has played a major role in telecommunications in the Region contributing
more than ecu1.2 billion in Central and Eastern European countries since 1990. The
Bank will continue to look for opportunities to work with the EIB within the EU
accession countries. Whilst the EIB can lend to organisations within the EU
accession countries, unlike the EBRD, it normally does so with a sovereign or
commercial bank guarantee.

In their co-operation, each institution will bring to bear its comparative advantage.
The EBRD has a strong project development, finance appraisal and financing
structuring capacity in the Sector. The EIB, for its part, can provide loan financing at
longer maturities and usually on more advantageous terms than the EBRD. In its co-
operation with other IFIs, the Bank may face a challenge in reconciling its specific
transition objectives with the operational and policy goals of the co-financing
institution. Especially in the advanced transition economies, the opportunities for the
Bank to implement its transition objectives can be affected by the possibility of
funding from other IFIs (and commercial banks) that do not have a similar mandate.
The process of co-operation and resolution of differences in such situations will,
however, be assisted by a common interest in robust financial conditionality. The
EBRD, other IFI’s and the EC share common objectives in the Region and will co-
ordinate with each other to pursue those objectives through individual agendas
determined by their respective institutional priorities.

4.3.2 Commercial banks, ECAs, and private equity

Commercial banks are becoming increasingly active in the Telecommunications,
Informatics and Media Sector, especially in the advanced transition economies.
However, apart from the most advanced companies, they generally seek to work with
the EBRD in the Sector as they recognise the benefits of the Bank’s active participation
in mitigating political and project risk. The Bank seeks to co-finance with
commercial banks by extending its preferred creditor status through syndication under
the A/B loan structure, through providing guarantees for the longer maturities not
typically taken by commercial banks and by offering partial guarantees.

Export Credit Agencies (ECAs) are starting to become more involved in the countries
of the Region as sponsors tend to use foreign-based technology which will seek ECA
coverage to complement what the Bank offers. Such co-financing will add desired
effect of bringing multiple sources of financial tools which will ultimately benefit the
country.

39
Private equity co-financing is brought about by the participation of strategic investors
via equity funds who become silent partners and add to the exposure by the company
to the international capital markets. Such equity funds will usually participate in
smaller tranches; also, such funds could basically plug financing needs which cannot
be covered by other sources.

4.4 Projected Level and Composition of EBRD Financing

The annual total of EBRD financing commitments to Telecommunications,

Informatics and Media projects has been relatively stable during the period 1993 to
1998 in the range euro 100 to euro 200 million. In 1998, the Bank committed over
euro 181 million to the Sector.

Based on current trends in the growth and composition of the pipeline of projects
under preparation (Figure 16), it is expected that annual volumes will remain in this
window although the number of projects will probably increase due to the
predominance of smaller private sector projects with no counterbalancing large public
sector investments. Activity is expected to be predominantly in countries in early and
intermediate stages of transition with attention focussed on the Caucasus, Central
Asia, Balkans, Ukraine and Russia.

Figure 16: Pipeline Portfolio, mEuro

Regional 8.8
Central Europe
Caucasus 22.0
Central Asia 70.4
79.2

European CIS
172.6

A key aspect of the structural and geographical changes in pipeline composition is

that Telecommunications, Informatics and Media operations are becoming more
complex in their legal and financial structure, while the average size of EBRD-
financed operations in the Sector decreases. The predominance of private sector
financings creates a sharp increase in project development risk, which may lead to
higher (pre-signing) project pipeline erosion than hitherto. Over time, potential

40
projects have become more vulnerable to market developments as commercial banks
have been increasingly willing to accept risk in advanced transition economies,
though this situation has reversed somewhat since the emerging market crisis in
August 1998 and the resultant contagion. See Figures 17 and 18 for evolution of
portfolio.

Figure 17: Signed EBRD Financing at the end of 1995

Central Asia
European CIS 1% Baltics
5% 6%

Central Europe
88%

Figure 18: Signed EBRD Financing at the end of 1998

Central
Asia
European 1% Baltics
CIS 15% 4%

Central 80%
Europe

4.5 Procurement

All projects financed by EBRD are required to follow the Bank’s Procurement
Policies and Rules (the “Rules”). Much of the equipment and services required to

41
build Telecommunications infrastructure are specified by international bodies, such as
European Telecommunications Standards Institute (ETSI), American National
Standard Institute (ANSI) or International Telecommunications Union (ITU) and are
widely standardised. The supply chain is extensive and highly competitive, and
competitive tendering to standard specifications is the industry norm.

The Bank’s public sector operations are required to follow public sector procurement
via open tendering except in specific circumstances. The tendering method to be
followed is specified in the procurement plan for the project and incorporated in the
Loan Agreements between the Borrower and the Bank. A high percentage of
contracts (in value terms) awarded for telecommunications projects have been
procured through open tendering.

It should be noted, however, that with the increasing complexity of the latest
generations of telecommunications equipment, especially digital switching and
transmission systems which rely extensively on common software management and
control, Borrowers are increasingly likely to have standardised on their preferred
suppliers of such equipment via previous open tendering12. Thus it may be necessary
to employ Selective or Single Tendering as provided for under the Rules in order to
procure equipment which is fully compatible with that already deployed in their
network. It will therefore be important to evaluate procurement plans for public
sector projects taking this into account.

Private sector enterprises where the Bank holds equity or debt, are encouraged, but
not obliged, to use international tenders to obtain goods and services economically.
In practice, the procurement methods of the enterprise are fully evaluated during the
due diligence stage to ensure that sound selection methods are used to procure goods
and services at fair market prices. Particular attention is paid to all cases where the
sponsor, or major shareholders, are also suppliers of goods and services to the project
enterprise.

12
This is analogous to the position with IT systems where an early strategic decision on choice of
computer operating platform limits future vendor selection.

42
 Annex 1

TRANSITION IMPACT OF PROJECTS IN THE

TELECOMMUNICATIONS, INFORMATICS AND MEDIA SECTOR

The restructuring of infrastructure provision and services is central to the process of

transition in the EBRD countries of operation. Historically, telecommunications
infrastructure provision was decided under a central planning system, generally
supply-led, and did not reflect economic planning principles. Furthermore, tariff
structures were artificially low resulting in distorted usage patterns.
Following the collapse of the previous political regime, transition economies faced
major reconstruction and development programmes, limited finance for investment
and significant demand increases, especially for advanced information services
critical to well functioning businesses. Hence, reforming infrastructure in a way that
promoted efficient performance became an urgent priority.
The requirements for fostering the transition in infrastructure, as set out in the 1996
Transition Report, include entry liberalisation, commercialisation, the introduction of
competitive pressures and services that respond to demand, the move to cost-based
prices, the establishment of regulatory institutions and the reduction of environmental
costs. With, perhaps, the exception of the last criterion, all of these are directly
relevant to operations in the Telecommunications, Informatics and Media Sector and
contribution to improvements to these transition factors are primary criteria in
selection and evaluation of projects.
In order to quantify the progress in transition, the 1998 Transition Report introduced
Infrastructure Transition indicators which included telecommunications. These are
reproduced below. Transition in telecommunications is largely measured by the
degree and quality of regulation, the degree of liberalisation and competition, and the
barriers to market entry. For the future the Bank will extend the scope of these
indicators to embrace informatics and media. Although similar criteria will apply, we
expect that political and social factors will be given a larger weighting, especially
with regards to media where political involvement and cross-ownership limitations
become more important. We will take into account that regulation in the sector is
constantly evolving, even in western Europe, which will require similar progress from
such institutions in the Bank’s countries of operations.

Telecommunications Indicators
The telecommunications transition indicators are designed to measure progress in
reform across all EBRD countries of operation. The key dimensions used for the rating
(see the box) are commercialisation and regulation. Under the first category are
included initial steps made for legal corporatisation of the dominant operator, the
gradual reduction of political interference in the management which should ultimately
lead to its successful privatisation and widen the extent of private ownership. Under
regulation is encompassed tariff reforms, degree of liberalisation in the market
(focusing particularly on those segments of the market which are believed to justify
no economic restriction to entry in segments such as cellular and other value added
services) and institutional design (separation of telecommunications from postal
services, degree of independence of the regulator). There are five transition stages
which are defined as follows:

Transition
Rating Characterised by:
Little progress in commercialisation and regulation. That is, minimal
degree of private sector involvement; strong political interference in the
1 management decisions; lack of cost effective tariff setting principles
and extensive cross-subsidisation. Few other institutional reforms to
encourage liberalisation envisaged even for mobile phones and value
added services.

Modest progress in commercialisation. That is, corporatisation of the

dominant operator and some separation of operation from public sector
2 governance, but tariffs still politically set.
Substantial progress in commercialisation and regulation. Full
separation of telecommunications from postal services with reduction
3 in the extent of cross subsidisation. Some liberalisation in the mobile
segment and in value added services.

Complete commercialisation (including the privatisation of the

dominant operator) and comprehensive regulatory and institutional
4 reforms. Extensive liberalisation of entry.

Implementation of an effective regulation (including the operation of an

independent regulator) with a coherent regulatory and institutional
4+ framework to deal with tariffs, interconnection rules, licensing,
concession fees and spectrum allocation. Existence of a consumer
ombudsman function.
 TRANSITION PROGRESS
Key:
Little or no progress
Under preparation
Completed

Country Privatisation of New Telecoms Separation of Post Independent Private Competition in

Dominant Operator Law and Telecoms Regulator Cellular Value Added
(Percentage of (Year of Services
private ownership ) enactment)

Early Stage:
Turkmenistan
Albania 1998
Azerbaijan
Belarus
Bosnia/ Herzegovina 1998
Tajikistan
Kazakhstan 50%
Kyrgyzstan 10% 1998
Uzbekistan
FYR Macedonia 1996
Georgia
Country Privatisation of New Telecoms Law Separation of Independent Private Competition in
Dominant Operator (Year of Post and Regulator Cellular Value Added
(Percentage of enactment) Telecoms Services
private ownership)

Medium Stage:
Armenia 90%
Croatia
Moldova 1996
Slovak Republic
Slovenia 13% 1997
Ukraine
Bulgaria 1998
Romania 35% 1996
Russian Federation 25%
Latvia 49%

Advanced Stage:
Lithuania 60% 1998
Poland 15%
Czech Republic 49%
Estonia 73%
Hungary 94%
 Bank projects in the Sector can contribute to the transition in a number of ways which are largely determined by the stage of transition extent in the
specific country, the commitment of the Government to reform and the speed with which change can take place. The table below identifies the Bank’s
transition objectives in the sector and provides illustrations of the Bank approach. Transition impact and Bank approach will be specific to each
individual project.

Transition Impact Bank’s Objectives Bank’s Response

1. More intense competition in the project sector
• Number of operators
• Intensity of price and quality competition
• Move towards cost-reflective tariff
structures and higher standards of
quality
• Increase customer choice through
provision of new services by
incumbent operator and introduction
of new players in the market.
(illustrative)
Early reform stages
• Elimination of cross-subsidies
More advanced reform stages
• Strengthen competition in cellular and value added
services (supporting private sector providers)
• Support companies in related market segments

All stages
• Promote competition among suppliers through the
application of EBRD Procurement Policies and Rules

2. Market expansion in other sectors
• Cost and reliability of access to the service
• Provide low-cost and high quality
services for downstream business
users
• Increase general network accessibility
Early reform stages
• Network upgrading and expansion
More advanced stages
• Introduction of value added services
 Transition Impact Bank’s Objectives
3. Private ownership • Maximise private sector involvement
and reduction of transaction costs
• Ownership reforms
throughout the economy
• Entrepreneurship
4. Frameworks for markets • Develop a sound regulatory
framework to support competition
• Tariff reforms
(through clear and transparent rules
• Liberalisation in the market related to licensing, pricing rules –
• Institutional design including interconnection- and
• Adequate legal and commercial frameworks spectrum auction allocation)
• Develop legal and commercial
frameworks
Bank’s Response
(illustrative)
Early reform stages
• Corporatisation (of incumbent operator)
• Pre-privatisation
• Post-privatisation
More advanced reform stages
• Investment in funds specifically aimed at SME engaged
in media and information technology
All stages
• Financing companies, especially those with a foreign
strategic investor, where majority ownership and /or
management control rests with the private sector.
Early reform stages
• Ensure government commitment to regulatory reforms
• Provide education and support institutional building
• Prepare for tariff reform
More advanced reform stages
• Establish an independent regulator, reduce length and
breadth of exclusivity terms, introduce cost-oriented
and fair interconnection rules
• Tariff reform, including rebalancing
• Support governments in their efforts for EU accession
and WTO membership
 Transition Impact
5. Transfer of technology and skills
• Upgrade technical and managerial skills
6. Demonstration effects
• Innovative financing structure
• Successful restructuring
7. Enhancing standards for corporate governance
and business conduct
• Protection of minority shareholders
• Improvement of business conduct rules
Bank’s Objectives
• Maximise the impact of the transfer of
technology and know-how throughout
the economy
• Create replicable practices that
transfer the transition impact from the
project level at an economy-wide
level
• Foster improvement in corporate
governance arrangements at the
enterprise level
Bank’s Response
(illustrative)
Early Reform Stages
• Develop appropriate training programmes
More advanced reform stages
• Ensure the best technological options are introduced as
early as possible
Early reform stages
• Restructuring the dominant operator (through
horizontal and vertical break-up, where appropriate)
More advanced reform stages
• IPO, Local currency funding for local services
• Entering into new sector related industries eg
media publishing, information technology and
software.
Early reform stages
• Adoption of commercial methods and management
techniques
More advanced reform stages
• Set up effective incentive and monitoring systems to
improve performance