Completion Report: Nepal: Corporate and Financial ...€¦ · Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to

Completion Report

Project Number: 28332 Loan Number: 1811 December 2010

Nepal: Corporate and Financial Governance Project

CURRENCY EQUIVALENTS

Currency Unit – Nepalese rupee/s (NRe/NRs)

At Appraisal At Project Completion 18 September 2000 20 December 2010

NRe1.00 = $0.01 $0.01 $1.00 = NRs72.20 NRs72.57

The Nepalese rupee is pegged to the Indian rupee (Re) at NRs1.60 to Re1.00. It is fully

convertible on all current account transactions.

ABBREVIATIONS ADB – Asian Development Bank ADBN – Agricultural Development Bank of Nepal CDS – central depository system CRO – Companies’ Registrar’s Office eFIT – electronic financial and information technology IT – information technology MIS – management information system MOF – Ministry of Finance NEPSE – Nepal Stock Exchange NJA – National Judicial Academy NRB – Nepal Rastra Bank PIT – project implementation team SDR – special drawing right SEBO – Securities and Exchange Board TA – technical assistance

NOTES

(i) The fiscal year (FY) of the government ends on 15 July. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2010 began on 16 July 2009 and ended on 15 July 2010.

(ii) In this report, "$" refers to US dollars.

Vice-President X. Zhao, Operations 1 Director General S. H. Rahman, South Asia Department (SARD) Director B. Carrasco, Financial Sector, Public Management and Trade Division,

SARD Team leader S. Shrestha, Senior Economist, SARD Team members A. Alipio, Associate Project Analyst, SARD S. Ruiz Brunschwig. Senior Economist, SARD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

I. PROJECT DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Project Outputs 3 C. Project Costs 6 D. Disbursements 6 E. Project Schedule 7 F. Implementation Arrangements 7 G. Conditions and Covenants 7 H. Related Technical Assistance 8 I. Recruitment and Performance of Consultants, Contractors, and Suppliers 8 J. Performance of the Borrower and the Executing Agency 8 K. Performance of the Asian Development Bank 9

III. EVALUATION OF PERFORMANCE 9 A. Relevance 9 B. Effectiveness and Efficiency in Achieving Outcome and Outputs 9 C. Preliminary Assessment of Sustainability 10 D. Impact 10

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 10 A. Overall Assessment 10 B. Lessons 10 C. Recommendations 11

APPENDIXES

1. Project Framework 12 2. Chronology of Key Political Events 22 3. Cost Estimates 23 4. Project Organization Chart 25 5. Compliance with Loan Covenants 26

BASIC DATA A. Loan Identification 1. Country 2. Loan number 3. Project title 4. Borrower 5. Executing agency 6. Amount of loan 7. Project completion report number

Kingdom of Nepal 1811 Corporate and Financial Governance Project Kingdom of Nepal Ministry of Finance SDR5,706,000 1211

B. Loan Data 1. Appraisal – Date started – Date completed 2. Loan negotiations – Date started – Date completed 3. Date of Board approval 4. Date of loan agreement 5. Date of loan effectiveness – In loan agreement – Actual – Number of extensions 6. Closing date – In loan agreement – Actual – Number of extensions 7. Terms of loan – Interest rate during grace period

– Interest rate during amortization – Maturity (number of years) – Grace Period (number of years)

4 September 2000 18 September 2000 13 November 2000 14 November 2000 14 December 2000 24 January 2001 24 April 2001 28 November 2001 3 (24 July 2001, 24 September 2001, 24 November 2001) 30 June 2005 15 June 2009 2 (30 June 2007, 30 November 2007) 1.0% 1.5% 32 8

8. Disbursements a. Dates

Initial Disbursement

15 Nov 2002

Final Disbursement

15 June 2009

Time Interval

79 months

Effective Date

28 Nov 2001

Original Closing Date

30 June 2005

Time Interval

43 months

ii

b. Amount Net ($ million)

Category or Subloan

Original Allocation

Partial Cancellations

Last Revised Allocation

Amount Disbursed

Civil works 1.173 1.173 0.000 0.000 Equipment 0.625 0.565 0.060 0.060 Training 0.207 0.207 0.000 0.000 Consulting 2.423 0.678 1.745 1.745 Onlending 0.782 0.782 0.000 0.000 Interest charge 0.078 0.048 0.030 0.030 Unallocated 0.418 0.418 0.000 0.000

Total SDR 5.706 3.871 1.835 1.835

Total $ 7.348 5.750 2.693 2.693

a b c c

a = $ equivalent per report and recommendation of the President. b = $ equivalent as of date of approval of cancellation. c = Actual $ equivalent. C. Project Data

1. Project cost ($ million)

Cost Appraisal Estimate Actual

Foreign exchange cost 5.064 2.478 Local currency cost 4.345 0.215 Total 9.409 2.693

2. Financing plan ($ million)

Cost Appraisal Estimate Actual Implementation costs Borrower financed 2.061 0.000 ADB financed 7.248 2.648 Other external financing 0.000 0.000

Total 9.309 2.648

IDC costs Borrower financed 0.000 0.000 ADB financed 0.100 0.045 Other external financing 0.000 0.000

Total 9.409 2.693

ADB = Asian Development Bank, IDC = interest during construction.

3. Cost breakdown by project component ($ million)

Component Appraisal Estimate Actual

Component 1: Strengthen Corporate Governance andCapital Markets

2.555 0.921

Component 2: Judicial Policies and Administration, NJA, Legal Information Center

5.017 1.727

Component 3: Start-up Funding for ICT 1.000 0.000 Interest Charges 0.100 0.045 Contingency 0.737 0.045

Total 9.409 2.693

iii

… = not available.

5. Project performance report ratings

Ratings Implementation Period

Development Objectives

Implementation Progress

From 31 Dec 2000 to 30 Jun 2001 Satisfactory Satisfactory From 30 June 2000 to 30 Nov 2001 Satisfactory Unsatisfactory From 31 Dec 2001 to 28 Feb 2004 Satisfactory Satisfactory From 31 Mar 2004 to 31 Aug 2004 Partially Satisfactory Satisfactory From 30 Sep to 31 Dec 2004 Partially Satisfactory Partially Satisfactory From 31 Jan 2005 to 30 Nov 2006 Partially Satisfactory Satisfactory From 31 Dec 2006 to 31 Dec 2009 Satisfactory Satisfactory

D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Fact-finding a 5–11 Apr 2000 Appraisal 4–18 Sep 2000 8 30 b, c, e, f, f, k, l,

m, Negotiations (held in ADB headquarters)

13–15 Nov 2000 6 18 b, b, c, c, d, j

Consultation 27 Mar–3 Apr 2001 2 11 b, c Inception 10–15 Dec 2001 4 48 a, b, c, d Review 19–29 Mar 2002 1 11 b Review 22–30 Oct 2002 5 45 a, b, c, e, h Review 16–18 Jan 2003 1 3 a Review 12–14 Feb 2003 3 9 a, c, g Review 27 Nov–2 Dec 2003 3 18 a, c, c Midterm review 23 Mar–1 Apr 2004 4 36 a, c, f, i Review b 18–25 Nov 2004 Review 16–21 Mar 2005 1 6 a Review 7–10 Jun 2005 1 4 a Review 14–16 Sep 2005 3 9 a, c, j Review 18–21 Apr 2006 3 12 a, a, b Review 25–31 Aug 2006 2 14 a, b Review 13–19 Dec 2006 2 14 a, i Review 5–8 Jun 2007 1 4 a a = financial specialist, b = financial economist, c = counsel, d = control officer, e = project analyst, f = consultant, g = resettlement specialist, h = secondee, i = investment officer, j = programs officer, k= project economist, l = trade economist, m = young economist. a Back-to-office report not on file. b Back-to-office report does not indicate mission members.

4. Project schedule

Item Appraisal Estimate Actual

Date of contract with consultants UniQuest Jun 2002 30 Aug 2002 The Aries Group, Ltd. Jun 2002 1 Sep 2003 Yomari Incorporated Pvt. Ltd. Dec 2003 2 Feb 2007 COMDAQ Ltd. Dec 2003 5 Mar 2007 Reallocation of loan proceeds … 23 Nov 2006 Final cancellation Dec 2004 15 Jun 2009

I. PROJECT DESCRIPTION

1. On 22 November 2000, the Asian Development Bank (ADB) approved the Corporate and Financial Governance Project1 for SDR5,706,000 ($7.3 million equivalent) to the Kingdom of Nepal. The longer-term goal of the project was to promote sustainable growth and reduce poverty in Nepal. The project’s medium-term objective was to improve corporate governance and efficiency in the financial sector. To meet this objective, the project aimed to: (i) strengthen the capacity of key institutions, including the Securities Exchange Board (SEBO), the Nepal Stock Exchange (NEPSE), the Companies Registrar’s Office (CRO) in the Department of Industries, and the Central Depository System; (ii) improve legal enforcement capacity and infrastructure by establishing the National Judicial Academy (NJA), a legal information center and a secured transactions registry; and (iii) improve the payment and settlement infrastructure. The project became effective on 28 November 2001. The project framework is in Appendix 1. 2. A $3.3 million attached cluster technical assistance (TA) grant, 2 comprising six TA subprojects, aimed to: (i) develop key financial, corporate, and commercial legislation; 3 (ii) improve public sector accounting and auditing standards; (iii) strengthen rural finance regulation and supervision; (iv) develop an action plan for upgrading the payment system; (v) conduct financial and operational review of the Agricultural Development Bank of Nepal and the Nepal Industrial Development Corporation; and (vi) develop a legal and regulatory framework for insurance, pensions, and contractual savings. Together, the project and cluster TA were seen as the initial phase of a longer-term reform process to establish a robust and efficient financial system that supports growth and generates employment. 3. Political context. In evaluating the project, it is important to be aware of the political climate in Nepal during the implementation period. Soon after the loan became effective in November 2001, Nepal underwent a period of serious political turmoil, characterized by the Maoist insurgency, dissolution of Parliament, and rule by a series of caretaker governments. This seriously undermined the reform process—in particular the adoption of legislation needed for project activities and related capacity building initiatives to progress. In the absence of a Parliament, new laws took the form of ordinances that had to be renewed every 6 months, causing delays and creating considerable uncertainty. Instability and turnover in the senior leadership of key government agencies also contributed to the delays and unpredictability of the decision-making process. Moreover, security issues and frequent strikes made it difficult for ADB staff and consultants to travel to Nepal. A chronology of key political events is in Appendix 2.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

4. At the time of project design, Nepal’s financial sector was weak and inefficient and did not play a meaningful role in mobilizing savings for productive investments. The banking industry was characterized by considerable state control, limited competition, and poor governance. This resulted in distorted incentive structures, high borrowing costs, and misallocation of resources. Although the equity market attracted considerable interest from retail investors after its establishment in 1993, its size and maturity failed to keep pace with the 1 ADB. 2000. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical

Assistance Grant to the Kingdom of Nepal for the Corporate and Financial Governance Project. Manila. 2 ADB. 2000. Technical Assistance for Strengthening Corporate and Financial Governance. Manila. 3 Including a company law, an insolvency law, a secured transactions law, and a securities market law.

2

growth of the private sector. In 2000, 110 companies with a total market capitalization of about $650 million were listed on the stock exchange. Trading on the NEPSE was minimal, with the vast majority of shares illiquid. Individuals and institutions preferred to deposit their savings in banks at fixed interest rates, or even at very low to negative interest rates. This was partly the result of weak governance, including poor disclosure and accountability, and partly because of the absence of institutional investors. The project, which aimed to lay the foundation for a more resilient and broad-based financial sector, was relevant to the development of Nepal’s financial sector. 5. During project preparation, the government, ADB, and development partners agreed that the project would focus primarily on improving corporate governance and developing the capital market, while the World Bank would support banking reforms. 6. The project was in line with the objectives of the government's Ninth Five-Year Plan, FY1998–FY2002,4 which highlighted the important role that the financial sector would play in improving Nepal’s development prospects. The project was also consistent with the strategic priority of ADB’s country operational strategy5 of promoting the development of a market based economy, and was included in the country assistance plan, 2000–2002. The project built on past ADB assistance for financial sector development and corporate governance. 6 Project components and links to the cluster TA and other related TA are summarized in Table 1. 7. Although the overall goal of the project was relevant in Nepal’s development context, its design proved to be too complex given the weak capacity of the executing and implementing agencies and the lack of political commitment.

Table 1: Overview of ADB Assistance

Assistance Area Project Components Technical Assistance 1. Improving corporate and financial governance policies, regulatory and legal framework, and standards

TA 3371: Focal Point for Financial Sector Reform in the MOF TA 3461: Review of Company, Insolvency and Secured Transaction Legislation Cluster TA Subproject 1: Support for Streamlining of Selected Corporate and Financial Legislation and Strengthening of Law Reform Process Cluster TA Subproject 2: Improving Public Sector Accounting and Audit Standards

2. Capacity building for key financial institutions

Component 1: Securities Board of Nepal, Nepal Stock Exchange, Central Depository System,

TA 3356: Capacity Building for Accounting and Audit Profession

4 Government of Nepal. 1997. Ninth Plan (1997–2001). Kathmandu. 5 ADB. 1999. STS: NEP 99006: Country Operational Strategy Study, Nepal. Kathmandu (July). 6 ADB. 1999. Technical Assistance to the Kingdom of Nepal for Establishing a Focal Point for Financial Sector

Reforms. Manila; and ADB. 2000. Technical Assistance to the Kingdom of Nepal for Capacity Building of Accounting and Auditing Professions. Manila.

3

Assistance Area Project Components Technical Assistance Companies Registrar Office Cluster TA Subproject 3:

Strengthen Nepal Rastra Bank for Regulation and Supervision of NBFIs and Rural Finance

3. Improving legal enforcement capacity and infrastructure

Component 2: National Judicial Academy, legal information and secured transactions registry

4. Improving infrastructure for payments and financial service delivery

Component 3: Start-up funds for ICT

Cluster TA Subproject 4: Improvement in Payment System. TA 3571: Preparing the Information and Technology for Improved Financial Services Provision Project

5. Development of selected market participants

Cluster TA Subproject 5: Diagnostics and Options for ADBN and NIDC Cluster TA Subproject 6: Development of Insurance, Pensions and Contractual Savings

ADBN = Agricultural Development Bank of Nepal, ICT = information and communication technology, MOF = Ministry of Finance, NBFI = nonbank financial institutions, NIDC = Nepal Industrial Development Corporation, TA = technical assistance. Source: ADB. 2000. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant to the Kingdom of Nepal for the Corporate and Financial Governance Project. Manila B. Project Outputs

8. The project aimed to support the following outputs under the three broad components.

1. Component 1: Institutional Building for Improved Corporate and Financial Governance

a. Institutional Strengthening of the Securities Exchange Board

9. The project helped develop a corporate and financial plan to improve the operational and financial independence of the SEBO. The project also developed a comprehensive set of regulations—along with related implementation guidelines and manuals—pertaining to registration, trading and disclosure, and licensing of securities exchanges and securities business persons. In addition, the project supported the establishment of a basic information technology (IT)–management information system in SEBO. Although some on-the-job training to SEBO staff was provided, delays in the adoption of enabling legislation and regulations limited the formal training and other capacity building activities.

b. Privatization of the Nepal Stock Exchange

10. This subcomponent initially envisaged examining options for privatizing the NEPSE and helping it transform into a self-regulatory organization with efficient and transparent operational and governance structures. However, it was judged during implementation that this objective was premature, as the NEPSE’s management and financial performance would first have to be improved to generate private sector interest. Therefore, the government and ADB agreed to change the scope of this subcomponent to focus on the more immediate challenge of

4

strengthening the NEPSE’s operations under the existing ownership structure. Accordingly, the project helped prepare detailed recommendations on improving the NEPSE’s organizational structure and governance. The project helped develop membership rules for the stock exchange and rules related to clearing and settlement of securities. The project also supported the development of an electronic trading system, the NEPSE Automated Trading System. Launched in August 2007, the new screen-based system ended the open outcry system.

c. Establishment of a Central Depository System as a Separate Legal

Entity and With Full Automation

11. This subcomponent aimed to ensure safe custody and efficient settlement of securities through the establishment of a central depository system. Implementation was initially deferred because of the absence of the legal framework. In particular, establishing a central depository system required a depository law or a trust law, neither of which existed in Nepal. This subcomponent was subsequently dropped when it became clear that it was unlikely that a new law would be adopted within a reasonable time frame. The implementation of this subcomponent was not considered urgent as the existing settlement procedures operated by the NEPSE, though based on paper certificates, were adequate given the small volume of trading being undertaken at the time.

d. Upgrading the Companies’ Registrar’s Office

12. This subcomponent aimed to streamline and automate the operations of the CRO to enhance the reliability of company data and recordkeeping. The project helped develop a 5-year business plan for the CRO covering company administration, filing facilities, and human resource development. The project also supported the CRO’s business process reengineering with automation, and an electronic data management system.

2. Component 2: Improving Legal Enforcement Capacity and Infrastructure 13. This component aimed to upgrade the skills of the judiciary and public sector lawyers and to enhance key legal infrastructure. Outputs envisioned included:

a. Establishment of the National Judicial Academy and Training of Judges and Lawyers

14. The National Judicial Academy Ordinance, which provided the legal basis for the NJA, was enacted in March 2004, and the government had provided land on which to construct the NJA building. However, construction was delayed because of procedural faults in the bidding process. Specifically, ADB’s procurement committee rejected the bid when it emerged that the government had tampered with the bidding documents to ensure the selection of a particular firm. Given this and given that an investigation into procurement under another ADB project—the Melamchi Water Supply Project—was ongoing, ADB advised the government to use its own premises for the NJA. Furthermore, the government and ADB disagreed about the NJA’s management and funding structure. While ADB recommended that recognized professionals be appointed to key positions such as CEO and auditor, the government preferred an ex-officio setup. The government also failed to allocate adequate budget resources for the NJA’s operations. As a result, this subcomponent was cancelled. 15. Several project-supported training programs were conducted at an interim facility housed at the Supreme Court. Approximately 500 judges, government attorneys and legal officers, and

5

private sector commercial lawyers participated in the training programs, which covered keys aspects of commercial law, case management, and ethics and code of conduct

b. Upgrading the Legal Information System to Improve Access of Legal Information

16. The project supported the development of organizational and financial plans for a legal information center. The project also supported the establishment of an internet-based IT system to disseminate timely updates on commercial cases and related information. The Supreme Court funded the procurement of IT equipment for the legal information center.

c. Establishment of a Special Commercial Bench With a Dispute

Resolution Mechanism

d. Establishment of Secured Transaction Registry to Facilitate Use of Movable Assets as Collateral

17. Significant delays in the adoption of enabling legislation prevented the establishment of a commercial bench and a secured transactions registry.7

3. Component 3: Improving Infrastructure for Payment and Financial Services Delivery

18. This component aimed to improve the timeliness and reliability of financial services delivery among financial institutions. The main output under this component was:

a. Establishment of the Electronic Financial and Information Technology Company8

19. To support this component, $1 million from the loan proceeds were earmarked to establish Electronic Financial and Information Technology (eFIT), a public–private information and communication technology company. The funds were to cover the immediate costs of setting up eFIT, including the costs of hiring personnel and carrying out training activities. However, a feasibility study conducted under the project preparatory TA concluded that although the proposed approach was technically sound, it was not financially viable due to the high cost of developing the required satellite infrastructure. Therefore, the funds initially earmarked for eFIT were reallocated to improve the clearing and settlement system by automating Nepal Rastra Bank's clearing house, establishing data communication between banks and Nepal Rastra Bank, and establishing a private intranet for the banking community. The new subcomponent would therefore complement cluster TA subproject 4, which supported the adoption of legislation and regulations to improve the clearing and settlement system and introduce remittance services in Nepal. To accommodate the change in scope, the loan closing date was extended from 20 June 2005 to 30 June 2007. However, this component was subsequently cancelled, as Nepal Rastra Bank and the Bankers’ Association failed to establish a private company to operate the clearing house, as agreed upon between the government and ADB.

7 Key enabling legislation included a companies act, a secured transactions act, an insolvency act, and Court of

Appeals rules. 8 ADB. 2000. Technical Assistance to Nepal for the Information and Communication Technology for Improved

Financial Services Provision. Manila

6

C. Project Costs

20. Project costs are summarized in Table 2. Detailed cost estimates are in Appendix 3.

Table 2: Project Costs Financed by ADB ($’000)

Note: Special drawing rights rate of 31 March 2004. ADB = Asian Development Bank, eFIT = Electronic Financial and Information Technology. Source: Loan Financial Information Services (LFIS) records

D. Disbursements 21. The government established the imprest account in November 2002. The first advance to the account of $24,183 was made in March 2005. Payments for consulting services and equipment purchases were made through direct payment procedures. It was projected that disbursements for components 1, 2, and 3 would be completed by September 2002, December 2004, and June 2002, respectively. However, actual disbursement was considerably slower. The imprest account was fully liquidated in June 2009. Actual annual disbursement by component is in Table 3.

Table 3: Disbursement by Year ($‘000)

Item 2002 2003 2004 2005 2006 2007 2008 2009 Total Component 1 152.8 257.5 172.8 331.6 6.4 921.1 Component 2 238.8 511.5 178.9 154.0 256.4 387.8 1,727.5 Interest charge

3.7 10.1 13.8 17.3 44.9

Imprest account

24.2 (23.0) (1.2) 0.0

238.8 668.0 470.7 167.8 446.5 696.4 6.4 1.2 2,693.5 () = negative.

Allocation and Withdrawal of Loan Proceeds At Approval At Closure

Item Amount Allocated Disbursed Civil works 1.500 0 Equipment 800 92 Component 1 600 92 Component 2 200 0

Component 3 0 Training and /or fellowships

2650

Consulting services 3,105 2,556 Component 1 829 Component 2 1,727 Part C: Onlending for start-up of eFIT

1,0000

Interest charge 100 45 Unallocated 578 0 Total 7,348 2,694

7

E. Project Schedule 22. The original project closing date was 30 June 2005. The actual closing date was 15 June 2009, following two extensions. The midterm review team on March 2004 requested that the closing date be extended to June 2007 because of slow implementation progress. The closing date was again extended, to 30 November 2007, to accommodate project expenses incurred after June 2007. The project was closed on 15 June 2009 after all claims had been settled and the Ministry of Finance (MOF), the executing agency, had refunded $1,171 to the imprest account for expenses that were ineligible for ADB financing. F. Implementation Arrangements 23. As the executing agency, MOF was responsible for overall coordination and project administration, including monitoring and reporting on the utilization of loan proceeds and on implementation progress. The SEBO, the NEPSE, and the CRO were the implementing agencies for component 1, and the Ministry of Law and Justice (MoLJ) and Supreme Court were the implementing agencies for component 2. Nepal Rastra Bank became the implementing agency for the revised component 3. A project implementation team comprising senior officials from the implementing agencies was formed for components 1 and 2. The project implementation teams were responsible for day-to-day implementation of their respective components, including consultant selection and supervision and preparation of implementation progress reports. A steering committee comprising senior government officials and the private sector9 was established to provide overall guidance to the implementing agencies. Detailed implementation arrangements are in Appendix 4. 24. Implementation arrangements were adequate in that the executing agencies and implementing agencies were appropriately selected and coordination mechanisms among the agencies were described in detail. However, despite the carefully designed and detailed implementation arrangements, project implementation faced several challenges, as described above in paras. 8–19. G. Conditions and Covenants 25. The loan became effective on 28 November 2001, upon meeting the two effectiveness conditions. The conditions included Cabinet approval of the tabling of the Securities Bill and the Chartered Accountants Bill to Parliament. The preparation of the draft Securities Bill was delayed as the initial drafts prepared by the government did not satisfy the criteria for administrative independence of the SEBO. Likewise, the preparation of the draft Chartered Accountants Bill experienced delays as the then-comptroller general of finance had reservations about provisions of the bill related to the process of nominating the comptroller general of finance. 26. Loan covenants were relevant and in line with the project requirements. However, several of the covenants were complied with after significant delays or not complied with. Once again, this occurred primarily because of political uncertainty and limited capacity to implement a complex project. The status of compliance with loan covenants is in Appendix 5.

9 MOF, MOI, MOLJ, the National Planning Commission, NRB, and SEBO from government, and FNCCI, ICAN,

RMDC, Nepal Bankers Association, Nepal Bar Association, and Supreme Court Bar Association from the private sector.

8

H. Related Technical Assistance 27. Cluster TA comprising six TA subprojects for a total amount of $3.3 million was approved together with the project (Table 1). The cluster TA aimed to (i) support project implementation by preparing legislation and regulations on securities markets and payments systems, and providing related capacity building (cluster TA subprojects 1 and 4), and (ii) support capacity building for reforms in other areas, including accounting and auditing standards, rural finance, the Agricultural Development Bank of Nepal and the Nepal Industrial Development Corporation, insurance, pensions, and contractual savings. In December 2004, the government and ADB agreed to prepare two additional TA subprojects utilizing savings from the other TA subprojects within the cluster. These included cluster TA subproject 7: Coordination of Financial Sector and Legislative Reform; and cluster TA subproject 8: Developing Commercial Small and Medium Enterprise Finance. The TA completion report, completed in June 2008, rated the cluster TA as “partly successful” (footnote 4). I. Recruitment and Performance of Consultants, Contractors, and Suppliers 28. Consultant performance is rated satisfactory. After the firm initially engaged for component 1—PricewaterhouseCoopers (PwC/IBM)—defaulted, the government terminated the contract and engaged the second-ranked firm, Aries Group. The quality of Aries Group's outputs was satisfactory. The two main vendors for component 1 were Yomari, which installed an electronic data management system in the CRO; and Comdaq Ltd. (COMDAQ), which established the electronic trading system in the NEPSE. Yomari delivered its output broadly in line with the time frame and specifications in the contract. COMDAQ was not fully able to meet the hardware and software deadlines. This was in part due to “scope creep”—i.e., the NEPSE added requirements that were beyond the deliverables specified in the contract. The consulting firm UniQuest was engaged for component 2. Although UniQuest’s performance was initially hampered by the significant change in scope and related uncertainly, it performed satisfactorily in implementing the revised scope of component 2. J. Performance of the Borrower and the Executing Agency 29. The government and the MOF’s performance are rated unsatisfactory. One of the factors that undermined the government’s performance was the difficult political climate in Nepal during the project period (para. 3). This was exacerbated by the weak capacity of the MOF and the implementing agencies to implement a complex and multidimensional project. The government exhibited poor implementation capability, weak ownership, and insufficient project supervision. The steering committee never met, which exacerbated delays in addressing implementation bottlenecks and led to a lack of oversight of the implementing agencies and consultants. The MOF was late in submitting the audited project accounts and did not prepare the quarterly progress reports and the project completion report, as required. The government demonstrated its weak ownership by failing to comply with several loan covenants and failing to make budget funds available for the NJA and the SEBO, two of the main institutions supported by the project. 30. As noted in para. 14, the project implementation team for component 2 tampered with the bid for the construction of the NJA building, which led ADB to reject the bid. The government was particularly slow in responding to requests by ADB and consulting firms to settle the firms' outstanding claims, despite deliverables having been met. This created an environment of tension and mistrust, to the detriment of the project. In June 2005, UniQuest wrote to the ADB President requesting intervention in the matter. These claims were eventually settled, albeit with significant delays.

9

K. Performance of the Asian Development Bank 31. ADB’s performance was partly satisfactory. Following loan effectiveness, ADB fielded 15 missions for a total of 233 person-days. The review missions were effective in providing technical inputs, monitoring implementation progress, and coordinating with other development partners. Given that the project included a substantial legal aspect, staff from ADB’s Office of the General Counsel were closely involved in implementation and regularly participated in review missions. Likewise, staff from the Nepal Resident Mission provided valuable assistance in facilitating policy dialogue, evaluating bid documents, and assessing potential safeguard issues pertaining to the proposed construction of the NJA. Despite resistance from the government, ADB took a firm stance in ensuring strict adherence to ADB’s procurement and resettlement policies. ADB also helped settle the outstanding claims of the consulting firms and played an important role in mediating other disagreements between the government and consultants. 32. ADB continued to pursue certain subcomponents even after it became clear that they would not succeed because of technical reasons, capacity constraints, or a lack of government ownership. Although the project scope was revised on several occasions, it was not always done in a timely or systematic manner. Project outcomes would likely have been enhanced had ADB better anticipated implementation difficulties and worked with the government early on to introduce components that better reflected government priorities and implementation capacities.

III. EVALUATION OF PERFORMANCE A. Relevance 33. The project is rated partly relevant. The overall thrust of the project—financial sector development through improved governance, regulatory and enforcement capacity, and IT infrastructure—was relevant. It was also closely aligned with the government’s development objectives and ADB’s medium-term operations strategy for Nepal. However, the project was highly complex and ambitious given the weak capacity of the implementing agencies and the government's weak commitment to reform. Several of the activities envisaged under components 1 and 2 had to be cancelled, while component 3 was dropped altogether. This significantly reduced the scope and ultimately the achievements of the project. B. Effectiveness and Efficiency in Achieving Outcome and Outputs 34. The project was partly effective in achieving its outcome and outputs. The project had three main achievements. The project helped strengthen the institutional capacity of the NEPSE by improving its organizational and governance structure. The introduction of an electronic trading system was an important milestone in the modernization of the exchange. Another important achievement was the business process reengineering and automation of the CRO. Another important output was the legal information center in the Supreme Court, which helped improve transparency regarding legal cases and judgments and helped increase public awareness of the legal system. 35. However, the outcome and outputs fell short of those envisaged during appraisal. As highlighted above, the project experienced numerous setbacks that led to the project scope being reduced and caused approximately 63% of the original loan amount of $7.3 million equivalent to be canceled. In many instances, project components or subcomponents were cancelled after consultants, counterpart staff, and ADB staff had already invested considerable

10

time and energy. Moreover, despite the reduction in scope, the project implementation period had to be extended by almost 4 years. The project was therefore inefficient in achieving its outcome and outputs. C. Preliminary Assessment of Sustainability 36. The sustainability of project outcomes is rated less likely without further assistance. Progress is being made in two specific project areas. With support from Indian firm Central Depository Services, NEPSE has recently initiated the establishment of a central depository system for Nepal's bond and equity markets. This will reduce transactions costs, facilitate Nepal's transition from a T+3 trading system to a T+1 system, and improve the reliability and security of custodial services. Nepal has also received considerable external support to further strengthen the NJA, including support from the United States Agency for International Development, the German government through GTZ, the United Nations Development Fund for Women, the United Nations Development Programme (UNDP), the World Bank, and the Department for International Development of the United Kingdom (DFID). Consequently, the NJA has established itself as an effective institution for judicial training and research. 37. Despite these achievements, Nepal’s capital market remains underdeveloped and continues to lag behind banks in its financial intermediation role. Development of the bond market, which plays a crucial role in mobilizing long-term funds for productive investment, has been particularly slow because of remaining regulatory and institutional weaknesses. Although the authorities have expressed strong commitment to further reforming the capital market, weak capacity of key institutions, in particular the MOF and the SEBO, means that further assistance will be needed to ensure sustainability. D. Impact 38. The potential impact of the project was undermined as a result of the significant reduction in project scope.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS A. Overall Assessment 39. The project is rated unsuccessful.10 Project design was only partly relevant, and it was not effective or efficient in achieving its outcome and outputs because of weak design, capacity constraints, political uncertainties, and limited government ownership. Sustainability is less likely in the absence of further assistance from development partners. B. Lessons 40. Proper sequencing and project readiness. Proper sequencing of project activities is essential for project success. The project had strong policy, legal, and regulatory content, some of which were addressed through conditions for loan effectiveness and disbursement. However, several more policy, legal, and regulatory reforms were to be supported through the cluster TA that was approved with the project. Fact-finding for cluster TA was conducted only after project approval. In the absence of an enabling policy and regulatory environment, several project activities were either delayed or had to be cancelled altogether. There were also gaps in terms

10 Overall assessment is in accordance with the definition and guidelines of ADB's Independent Evaluation

Department: http://www.adb.org/Documents/Guidelines/Evaluation/PPER-PSO/default.asp

11

of project readiness. For instance, the project preparatory TA for assessing the feasibility of component 3 was only approved after project approval. When the project preparatory TA concluded that this component was not financially viable, it had to be cancelled. 41. Capacity constraints and project complexity. Overly ambitious and complex projects are less likely to be successful. The project, which attempted to tackle a wide range of issues in several subsectors within a short time frame, was too complex given the capacity constraints of the MOF and the implementing agencies. Although the MOF had effectively executed ADB projects before, those projects were considerably less complex. Several implementing agencies had little or no previous experience in development-partner-funded projects. C. Recommendations

1. Project Related 42. Additional assistance. Given the importance of the financial sector in promoting economic growth and reducing poverty, ADB should continue its engagement in the sector. At the government’s request, ADB is preparing a project that will support bond market development. The proposed project will help Nepal (i) develop an effective debt management and issuance strategy, (ii) establish a professionally managed public debt management office, (iii) improve the primary dealership system by introducing licensing requirements and a code of conduct, and (iv) improve the autonomy and enforcement capacity of the SEBO. Furthermore, at the request of the South Asian Association for Regional Cooperation Secretariat, ADB is supporting studies and activities that will facilitate cross-learning among member countries, and will help member countries initiate the process of harmonization of rules and regulations and corporate governance standards.11

43. Timing of the project performance evaluation report. Project activities were largely completed by 2007, and no issues are outstanding. Preparation of the project performance evaluation report can start at any time.

2. General 44. The project was beset by implementation difficulties that undermined its effectiveness. To a large extent, this was attributable to the challenging political environment that prevailed during much of the project implementation period. Nonetheless, the project would have been more effective had ADB paid closer attention to the sequencing of project components, project readiness, and the capacity constraints of the executing agency and implementing agencies. The lessons highlighted above should be taken into account in the design and implementation of future projects. 45. ADB should consider adopting a program loan modality or sector development program modality for projects that involve substantive policy and legal reforms. These modalities are typically more effective in leveraging difficult reforms, especially in instances where government ownership and commitment are weak. 46. Given the bottlenecks and irregularities encountered during this project, ADB should provide counterpart staff involved in project implementation with thorough training on ADB policies and procedures related to safeguards, consultant selection, procurement, disbursement, and anticorruption.

11 ADB. 2008. Technical Assistance to Nepal for Promoting South Asian Economic Cooperation II. Manila

12 Appendix 1

PROJECT FRAMEWORK

Design Summary Performance

Indicators/Targets Monitoring

Mechanisms Assumptions and

Risks Goal Deepen and broaden financial sector and increase efficiency of financial intermediation for growth and equity

Increase the domestic investment (credit volume) and monetized savings (deposits) rate Increase in liquidity of financial instruments, including capital markets Improve domestic credit/deposits ratio and incremental capital output ratio (ICOR)

Nepal Rastra Bank (NRB) statistics for monitoring domestic investment, savings, credit creation and stock, deposits, liquidity, spreads and interest rates in the formal finance system Securities Board (SEBO) statistics on capital market activities Nongovernment organization (NGO)/private sector feedback

Continued political commitment to reform Adequate human resources and institutional capacity Timely and accurate statistics

Purpose/Objectives 1. Increased competition for improved financial resources mobilization and intermediation

Adequate regulatory and supervisory framework to ensure and safeguard orderly market entry/exit mechanisms for finance institutions; includes Bankruptcy Act, Companies Act, Secured Transaction Act, Securities Exchange Commission (SEC) Act, e-Commerce Act, and other financial and corporate laws as agreed upon with His Majesty’s Government of Nepal During project implementation Equal opportunities in the nonbank financial institutions and rural subsector to stimulate more competitive market; includes rationalization of interest rates and branch licensing policies and elimination of directed credit sector lending requirements

Asian Development bank (ADB) review missions and regular project progress reports Coordination with the World Bank Annual report by SEBO and NRB

Strong political will and policy consistency during transition period Effective restructuring of commercial bank (with World Bank assistance) Domestic players see foreign participation as opportunity for know-how and business

Appendix 1 13




Risks Improved rural savings mobilization Improved allocation of financial resources in capital markets

2. Reduced information and transaction costs to increase the effectiveness of financial intermediation

Rationalized incentive structure for key market players to comply with information disclosure requirements

Simplified laws, regulations, directives, and procedures

Clear bankruptcy law, arbitration, and enforcement

ADB review missions and regular project progress reports

Cost and time required for funds transfer

Spreads applied by financial intermediaries

Increase in transactions with secure property rights

Increase in number of successful cases of creditor rehabilitation, or bankruptcy/collateral enforcement

Adequate analysis of incentive structure of key financial sector players

Improved legal and institutional capacities and human resources

3. Improved transparency and disclosure as basis for sound financial sector risk

Development of market infrastructure: (i) institutions; (ii) human resources; (iii) application and enforcement of international financial, auditing, and accounting standards

ADB review missions and regular project progress reports Issue of new standards by the independent accounting and auditing standards boards

Continued Government support and commitment in pursuing reforms without reversal Buildup of trust between government and market participants to encourage reliable and timely revelation of information

Professional support and institutional capabilities needed for moving improved standards, their application and enforcement

4. Improved corporate and sector governance with effective enforcement and dispute resolution

Clear institutional framework and roles of NRB, SEBO, and Companies Registrars Office for financial

ADB review missions and regular project progress reports Institutional structure

Emerging consensus of key players: International Monetary Fund (IMF), World Bank, and ADB.

14 Appendix 1




Risks mechanism sector regulation and

supervision explicitly defined Finance and commerce dispute resolutions mechanism outside of court system

Clearly defined rules and procedures for arbitration for corporate matters

Effective legal enforcement by strengthening regulatory and judicial structure, and processes and procedures in the finance and commerce sectors

of regulators setup, defined roles of regulators

Outputs Area 1 – Improved corporate and financial governance (CFG) policy, regulatory and legal framework, and standards 1.1 Consistent legal

framework for financial and corporate sector (Sub-TA 1)

1.2 Convergence of

public and private accounting and auditing standards towards international level (Sub- TA 2)

Consolidation of laws with qualitative improvement

Number of people trained in international accounting and auditing standards

ADB review missions and regular project progress reports Number of laws reviewed and drafting activities under Legal Reform Coordination Committee

Asian Development Bank review missions and regular project progress reports

Adequate drafting capacity and understanding of key issues Broad stakeholder support Political commitment to elimination of special privileges and reduction of direct intervention in the running of affairs of financial institutions

Appendix 1 15




Risks Area 2 – Institution building for key CFG for regulation and supervision

– Improving corporate and capital markets (loan component A)

Asian Development Bank review missions

2.1.1 – SEBO strengthened 2.1.2 Nepal Stock Exchange (NEPSE) privatized 2.1.3 Central depository system (CDS) established 2.1.4 Companies Registrars Office (CRO) upgraded

Corporate and governance plan prepared and implemented; staff trained; management information system (MIS) installed; rules and regulations for securities market operation issued NEPSE to develop rules and regulation and move toward effective self-regulation A fully automated CDS established as a separate legal entity and licensed to performing clearing and settlement operations. Business and governance plan prepare and implemented; rules and guidelines to ensure CDS developed; staff trained Legal status of CRO clarified; corporate and financial plan prepared and implemented; new database designed to allow link with tax administration and

Track development on SEC legislation, corporate and governance plans SEBO/consulting team to furnish regular progress reports SEBO to furnish ADB with its annual reports Review of NEPSE to provide a report to SEBO on the strategy of privatization, and improvements in corporate governance and trading SEBO and consulting team to furnish regular progress reports CDS and consulting team to furnish regular progress reports CRO and consulting team to furnish regular progress reports

Delay in promulgation of the SEC legislation Delay in adoption of recommendations of the consultants on institutional strengthening of SEBO. Support from Government and members for stock exchange reforms Private sector interest in bidding for the license to operate CDS Sufficient financial and human resources to maintain the database, if possible through outsourcing Compliance of

16 Appendix 1




Risks 2.2. Strengthened capacity of NRB for supervision of rural finance activities (Sub-TA 3)

credit information bureau; registration of existing companies data updated Development of rules and procedures for reporting by financial institutions; implementation of MIS; specialist staff trained for effective assessment of reports

Asian Development Bank review missions NRB and consulting team to furnish regular progress reports on development of rules, regulations, MIS implementation, and training conducted

registered companies in submitting required information NRB Act reviewed to redefine role and mandate of NRB Responsibilities within NRB clarified and streamlined, specialist wing established in NRB to deal with nonbank rural finance

Area 3: Improving legal enforcement capacity and infrastructure 3.1 Loan component B: Improving legal enforcement capacity and infrastructure 3.1.1 A commercial bench and dispute resolution established

Compilation of judicial statistics Strategic and operations plan for development of judiciary and administration Review and Arbitration Act Development of scheme for establishment of commercial courts of specialized benches tithing existing system

Regular progress reports, review missions Stakeholder workshops

Support for collection and availability of required statistical data

3.1.2 National Judicial Academy (NJA) established

Governance structure of NJA agreed upon and key personnel selected; development of organizational, business, and financial plan; development of curriculum; pilot training courses conducted; training facilities and MIS installed; key staff trained; design of annual report

Regular progress reports, review missions Stakeholder workshops

Agreement on operational independence of NJA Adequate budgetary provisions

Appendix 1 17




Risks 3.1.3 Legal information System improved 3.1.4 Secured Transaction Center (STC) established

Development of financial and operational and plan MIS and internet infrastructure in place; legislation translated; development of case filing and indexing system; public relation campaign; training of key staff for translation and updating of system Legal status of STC clarified, license to operate STC awarded, business plan prepared, MIS system installed, operations manual and guidelines prepared, staff trained

Regular progress reports, review missions Regular progress reports, review missions

Full support from the Government, judiciary, and legal profession Adequate budgetary provisions of fee structure for financial sustainability Acceptance of LIC output as reliable and recognized in court system Private sector interest in bidding for the license to operate STC Sufficient financial and human resources to sustain information system

Area 4 – Improving infrastructure for payment and financial services delivery 4.1 Nepal Payments Association established and functioning electronic interbank settlement service (Sub-TA4) 4.1.1 Electronic finance and information technology (eFIT) established (Loan Component C)

Organizational, governance, and business plan prepared and implemented; key staff trained; information and communication technology infrastructure installed; rules, procedures and reporting to NRB developed Support of eFIT start-up operations, key staff recruited; eFIT incorporated; and organizational, governance, and business plan prepared and implemented

Regular progress reports, review missions Stakeholders workshops Number and volume of financial transactions passed through the system Regular progress reports, review missions

Participating banks and financial institutions will be able to integrate electronic operations with their overall management and operations Interest of international technology partner and financial viability of eFIT Financial community, Government and international and domestic IT providers work together in establishing eFIT

18 Appendix 1




Risks Area 5 – Development of selected market participants 5.1 Detailed operational and financial diagnosis and recommendations for restructuring of ADBN and NIDC (Sub-TA5) 5.2. Recommendations for development of insurance industry and contractual savings (Sub TA 6)

Detailed operational and financial audit report

Report of regulatory framework for insurance industry, pension, and contractual savings Report on operations of National Insurance Company (NIC) and plans for restructuring and investment developed Report on operations of Employees Provident Fund (EPF) and private pension funds Provision of training programs

Regular progress reports; review missions Stakeholder workshops

Regular progress reports, review missions stakeholder workshops

Operational autonomy and improved governance of ADBN/NIDC Cooperation of ADBN/NIDC management and availability of required information, and acceptance of possibly negative findings

Government support for streamlining of legal, regulatory, and policy environment Cooperation of NIC and EPF management and availability of required information

Inputs and Activities Loan Components

Regular progress reports, review missions

Adequate and timely provision of counterpart funds, skilled, staff, and facilities Project ownership by Government and stakeholders Successful consensus building and consistent political support Timely recruitment of consultant

Appendix 1 19




Risks Loan Component A $2,500,000 (loan): Consulting services: 40 person-months International and national IT equipment Loan Component B $3,800,000 (loan): Consulting services: 46 person-months International and 72 national IT equipment Loan Component C $1,000,000 (loan) for nonlending to eFIT

Develop operational plans (governance, legal, organization, business, and financial) and support in drafting of rules, regulations, and procedures for activities of SEBO, NEPSE, CDS, and CRO Procurement and installation of IT systems Training of key staff Organization of stakeholder workshops

Support to Ministry of Law and Justice and Supreme Court in review of commercial arbitration and dispute resolution mechanisms and formulate recommendations Develop and implement operational plan (governance, organization, administration, business, and financial) for establishment of NJA Training of key staff Development of curriculum for training judges and pilot testing Establish LIC Establish STC Procurement and installation of IT systems Consultation with key stakeholders

Provision of start-up financing needs of e-FIT including key personnel, operational and

Regular progress reports submitted under the PPTA on ICT for improved financial

Strong commitment by HMGN to the initiative to encourage the private sector to come forward

20 Appendix 1




Risks Inputs and Activities TA Cluster I. Sub-TA1 $250,000 Consulting services: 6 person-months International and 15 national II. Sub-TA2

$250,000 Consulting services: 6 person-months International and 10 national III. Sub-TA3 $800,000 Consulting services : 20 person-months international and 20 national IT Equipment

organizational development, training and marketing, and human resource development

Support to Legal Reform Coordination Committee in reviewing and drafting legislation Support interview and formulation of regulatory and policy framework for NBFIs Organization of stakeholder workshops

Support to public sector to move toward improved accounting and auditing standards Design and conduct training programs for key staff from the auditor general’s office and other key public entities

Support to NRB interview of organizational setup and drafting of policies, rules, regulations, and procedures for

service delivery Regular progress reports, review missions

Private sector’s willingness to contribute equity share to eFIT

Adequate and timely provision of counterpart funds, skilled staff, and facilities Project ownership by Government and stakeholders Successful consensus building and consistent political support Timely recruitment of consultants

Appendix 1 21




Risks

IV. Sub-TA4 $400,000 Consulting services: 9 person-months International and 11 national V. Sub-TA5 $850,000 Consulting services: 20 person-months international and 30 national VI. Sub-TA6 $750,000 Consulting services: 18 person-months international and 27 national

regulation and supervision of rural and microfinance activities Procurement and installation of IT systems Training of key staff Organization of stakeholder workshops

Review of legal policy and institutional framework of current financial service delivery system and recommend an appropriate institutional environment for improvement Design an implementation plan for upgrading the system Training of key staff

Operational and financial audit of ADBN and NIDC Review of regulatory framework for insurance, industry, pension, and contractual savings Review of operation of NIC, EPF, etc.

ADB = Asian Development Bank, CDS = central depository system, CFG = corporate and financial governance, CRO = Companies Registrars Office, eFIT = electronic finance and information technology, EPF = Employees Provident Fund, IMF = International Monetary Fund, MIS = management information system, NEPSE = Nepal Stock Exchange, NGO = nongovernment organization, NIC = National Insurance Company, NJA = National Judicial Academy, NRB = Nepal Rastra Bank, SEBO = Securities Board, SEC = Securities Exchange Commission, STC = Secured Transaction Center.

22 Appendix 2

CHRONOLOGY OF KEY POLITICAL EVENTS

2003 May-June – Prime Minister Chand resigns; King Gyanendra appoints his own nominee Surya Bahadur Thapa as new premier. 2003 August – Rebels pull out of peace talks with government and end seven-month truce. The following months see resurgence of violence and frequent clashes between students/activities and police. 2004 May – Royalist Prime Minister Surya Bahadur Thapa resigns following weeks of street protests by opposition groups. 2004 June – King Gyanendra reappoints Sher Bahadur Deuba as prime minister with the task of holding elections. 2005 1 February – King Gyanendra dismisses Prime Minister Deuba and his government, declares a state of emergency and assumes direct power, citing the need to defeat Maoist rebels. 2005 30 April – King lifts the state of emergency amid international pressure. 2005 November – Maoist rebels and main opposition parties agree on a program intended to restore democracy. 2006 April – King Gyanendra agrees to reinstate parliament following weeks of violent strikes and protests against direct royal rule. GP Koirala is appointed as Prime Minister Maoist rebels call a three-month ceasefire. 2006 May – Parliament votes unanimously to curtail the king’s political powers. The government and Maoist rebels begin peace talks, the first in nearly 3 years. 2006 16 June – Rebel leader Prachanda and PM Koirala hold talks – the first such meeting between the two sides – and agree that the Maoists should be brought into an interim government 2006 November – The government and Maoist sign a peace accord, declaring a formal end to a 10-year rebel insurgency. The rebels are to join a transitional government and their weapons will be placed under UN supervision. 2007 January – Maoist leaders enter parliament under the terms of a temporary constitution. Violent ethnic protests erupt in the south-east; demonstrators demand autonomy for the region. 2007 April – Former Maoist rebels join interim government, a move that tales them into the political mainstream. 2007 May – Elections for a constituent assembly pushed back to November. 2007 September – Maoists quit interim government to press demand for monarchy to be scrapped. This forces the postponement of November’s constituent assembly elections.

A

ppendix 3

23

COST ESTIMATES

Item FC LC Total Cost % of

FC % of

Baseline Area 1: Improving CFG Policy, Regulatory and Legal Framework, and Standards A. Streamlining of financial, corporate and commercial legislation (TA1)

181,500 88,000 269,500 67.3 2.2

B. Improving accounting and auditing standard in the public sector (TA2)

186,500 88,000 274,500 67.9 2.3

Subtotal 368,000 176,000 544,000 67.6 4.5 Area 2: Institution Building for key CGF for Regulation and Supervision A. Loan component A: Strengthen corporate governance and capital markets

1. Strengthening of SEBO 693,000 229,000 922,000 75.2 7.7 2. Strengthening of NEPSE 575,500 152,000 727,500 79.1 6.0 3. Establishment of CDS 427,250 122,000 549,250 77.8 4.6 4. Strengthening of CRO 229,000 128,000 357,000 64.1 3.0B. Capacity Building in Rural Finance for NRB (TA3) 656,500 207,000 863,500 76.0 7.2 Subtotal 2,581,250 838,000 3,419,250 75.5 28.4 Area 3: Improving Legal Enforcement Capacity and Infrastructure A. Loan component B 1. Improvement of judicial policies and administration 123,000 94,000 217,000 56.7 1.8 2. Establishment of NJA 1,071,000 2,992,000 4,063,000 26.4 33.7 3. Establishment of legal information center 165,000 139,000 304,500 54.4 2.5 4. Establishment of STC 335,500 97,000 432,500 77.6 3.6 1,695,000 3,322,000 5,017,000 33.8 41.7

24 A

ppendix 3

Item FC LC Total Cost % of

FC% of

BaselineArea 4: Improving Infrastructure for Payments and Financial Services Delivery A. Development of Nepal’s payment system (TA4) 317,000 95,000 412,000 76.9 3.4B. Loan component C: Start-up funding fro ICT 1,000,000 0 1,000,000 100.0 8.3 Subtotal 1,317,000 95,000 1,412,000 93.3 11.7 Area 5: Development of Selected Market Participants A. Financial and operational review of ADBN and NIDC (TA5) 621,000 239,000 860,000 72.2 7.1B. Development of insurance, pension, and contractual savings (TA6) 567,500 221,000 788,500 72.0 6.5 Subtotal 1,188.500 460,000 1,648,500 72.1 13.7 Subtotal Baseline cost 7,149,750 4,891,000 12,040,750 59.4 100.0 Price Contingencies 539,000 361,000 900,000 59.9 Physical Contingencies 100,000 175,000 275,000 36.4 TOTAL PROJECT COST 7,788,750 5,427,000 13,215,750 58.9 Interest Charges 100,000 0 100,000 1.0 TOTAL COST TO BE FINANCED 7,888,750 5,427,000 13,315,750 59.2 % of TOTAL 59.2 40.8 100

ADBN = Agricultural Development Bank of Nepal, CDS = Central Depository System, CFG = Corporate and Financial Governance, CRO = Company Registrars Office, ICT = information and communication technology, NEPSE = Nepal Stock Exchange, NIDC = Nepal Industrial Development Corporation, NJA = National Judicial Academy, NRB = Nepal Rastra Bank, STC = Secured Transaction Center.

Appendix 4 25

PROJECT ORGANIZATION CHART

Public- Private ICT Company

MoLJ Supreme Court

Public Sector MoFinance (Chair) MOIndustries MoLaw&Justice NPC NRB SEBO

Private Sector FNCCI ICAN RMDC Nepal Bankers Association Nepal Bar Association Supreme Court Bar Association

CFG Steering Committee

Policy Issues: Subcommittees Operational implementation

Issues: Project Implementation Teams (PITs)

PCMU >> MOF

Accounting & Auditing

Corp. Governance & Capital Market Regulation

Specialized Financial Institution & Rural

Finance

Legal Reforms and Drafting

PIT for Component A:

Corp. Governance & Capital Markets

PIT for Component B:

Legal Strengthening

Component C:

Onlending IT

TA Implementation: TA1: Auditor General TA2: MoLJ TA3, 4 : NRB TA5 : ADBN/NIDC TA6 : MOF

SEBO NEPSE Mol/CR

Overall Supervision through CFG Steering Committee with public sector representation, chaired by MOF as Executing Agency

Implementation through Project Implementation Teams comprising IAs concerned. Coordination and monitoring through MOF

* To be established under PPTA

Role of steering Committee: Oversight and accountability Role of EA/PCMU: Coordination and monitoring Role of IAs/PITs: Selection and direct interfacing with consultants, preparation of reports administrative documents

ADBN = Agricultural Development Bank of Nepal, ICAN = Institute of Chartered Accountants of Nepal, NEPSE = Nepal Stock Exchange, NIDC = Nepal Industrial Development Corporation, NPC = National Planning Commission, NRB = Nepal Rastra Bank, PCMU = Project Coordination and Monitoring Unit, RMDC = Rural Microfinance Development Center, SEBO = Securities Board.

26 Appendix 5

COMPLIANCE WITH LOAN COVENANTS

Covenant

Reference in Loan

Agreement Status of Compliance 1. The Borrower shall make available, as promptly as needed, the funds, facilities, services, land and other resources which are required, in addition to the proceeds of the Loan, for the carrying out of the Project and for the operation and maintenance of the Project facilities.

Section 4.02 Partly complied. The MOF did not provide adequate budget for NJA.

2. (a) In carrying out the Project, the Borrower shall cause competent consultants and contractors, to be employed to an extent and upon terms and conditions satisfactory to the Borrower and the Bank. (b) The Borrower shall cause the Project to be carried out in accordance with plans, design standards, work schedules and construction methods acceptable to the Bank. The Borrower shall furnish, or cause to be furnished, to the Banj, promptly after their preparation, such plans, design standards, specifications and work schedules, and any material modifications subsequently make therein, in such detail as the Bank shall reasonably request.

Section 4.03 Partly complied. The procurement process for the construction of NJA was flawed, and was rejected by the Procurement Committee in ADB. Serious delays were also encountered in the settlement of consultant firms’ clams.

3. The Borrower shall ensure that the activities of its departments and agencies are coordinated in accordance with sound administrative policies and procedures.

Section 4.04 Partly complied. Coordination among relevant agencies was not adequate, despite detailed implementation arrangements.

4. (a) The Borrower shall make arrangements satisfactory to the Bank for insurance of Project Facilities to such extent and against such risks and in such amounts as shall be consistent with sound practice. (b) Without limiting the generality of the foregoing, the Borrower undertakes to insure, or cause to be insured, the goods to be imported for the Project and to finance out of the proceeds of the Loan against hazards incident to the acquisition, transportation and delivery thereof to the place of use or installation, and for such insurance and indemnity shall be payable in a currency freely usable to repair such good,

Section 4.05

Complied.

5. (a) The Borrower shall maintain, or cause to be maintained, records and accounts adequate to identify the goods and services and other items of expenditure financed out of the proceeds of the Loan, to disclose the use thereof in the Project, to record the progress of the Project (including the cost thereof) and to reflect, in accordance with consistently maintained sound accounting principles, the operations and

Section 4.06 Partly complied. Audited documents were prepared for FY2003, FY2004, and FY2005

Appendix 5 27

Covenant

Reference in Loan

Agreement Status of Compliance financial condition of the agencies of the Borrower responsible for the carrying out of the Project and operation of the Project facilities, or any part thereof.

(b) The Borrower shall maintain (i) maintain, or cause to be maintained, separate accounts for the project; (ii) have such accounts and related financial statements audited annually, in accordance with appropriate auditing standards consistently applied, by independent auditors whose qualifications, experience and terms of reference are acceptable to the Bank; (iii) furnish to the Bank, as soon as available but in any event not later than 12 months after the end of each related fiscal year, certified copies of such audited accounts and financial statements and the report of the auditors relating thereto, all in English language; and (iv) furnish to the Bank such other information concerning such accounts and financial statements and the audit thereof as the Bank shall from time to time reasonably request.

(c) The Borrower shall enable the Bank, upon the Bank’s request, to discuss the Borrowers financial statements for the Project and its financial affairs related to the Project from time to time with the Borrower’s auditors, and shall authorize and require any representative of such auditors to participate in any such discussions requested by the Bank, provided that any such discussion shall be conducted only in the presence of an authorized officer of the Borrower unless the Borrower shall otherwise agree. 6. (a) The Borrower shall furnish, or cause to be furnished, to the Bank all such reports and information as the Bank shall reasonably request concerning (i) the Loan, and the expenditure of the proceeds and maintenance of the service thereof; (ii) the goods and services and other items or expenditure financed out of the proceeds of the Loan; (iii) the Project; (iv) the administration, operations and financial condition of the agencies of the Borrower responsible for the carrying out of the Project and operation of the Project facilities, or any part thereof; (v) financial and economic conditions in the territory of the Borrower and the international balance -of-payments position of the Borrower; and (vi) any matters relating to the purposes of the Loan;

Section 4.07

Not complied. Quarterly reports were not prepared.

28 Appendix 5

Covenant

Reference in Loan

Agreement Status of Compliance (b) Without limiting the generality of the

foregoing, the Borrower shall furnish, or cause to be furnished, to the Bank quarterly reports on the carrying out of the Project and on the operation and management of the Project facilities. Such reports shall be submitted in such form and such detail and within such a period as the Bank shall reasonably request, and shall indicate, among other things, progress made and problems encountered during the quarter under review , steps taken or proposed to be taken to remedy these problems, and proposed program activities and expected progress during the following quarter. (c) Promptly after physical completion of the Project, but in any event not later than three month thereafter or such later date as may be agreed for this purpose between the Borrower and the Bank, the Borrower shall prepare and furnish to the Bank a report, in such form and in such detail as the Bank shall reasonably request, on the execution and initial operation of the Project, including its cost, the performance by the Borrower of its obligations under this Loan Agreement and the accomplishment of the purposes of the Loan.

7. The Borrower shall enable the Bank’s representatives to inspect the Project, the goods financed out of the proceeds of the Loan and any relevant records and documents.

Section 4.08

Complied.

8. The Borrower shall ensure that the Project facilities are operated, maintained and repaired in accordance with sound administrative, financial, engineering, environmental, and maintenance and operational practices.

Section 4.09

Complied.

9. The following are specified as additional events for suspension of the right of the Borrower to make withdrawals from the Loan Account:

(a) the legislation concerned or any provision thereof shall have been repealed, suspended, or amended in any manner which in the reasonable opinion of the Bank will or may adversely affect the carrying out of the Project or the operation of the Project facilities;

(b) The securities Bill, the NJA Bill and a Bill for amend the Nepal Chartered Accountants Act shall not have been passed by Parliament in the forms acceptable to the Bank by 31 July 2001; and

Section 5.01 (a) This was complied with after a significant delay (November 2005). (b) The Government did not provide adequate budgetary support for the operation of NJA. This subcomponent was subsequently cancelled.

Appendix 5 29

Covenant

Reference in Loan

Agreement Status of Compliance (c) The Borrower shall have failed to

provide adequate budgetary support to the Accounting Standards Board and the Auditing Standards Board, or SEBO, or the NJA. 10. MOF shall execute the Project with the assistance of the IAs and establish the PMCU in MOF and staff it in a manner and to a level acceptable to the Bank. MOF will convene meetings of the CFG Steering Committee and the IAs to coordinate all Project activities.

Schedule 6, para 1.

Partly complied. While the PCMU and Steering Committee were established, they did not meet regularly as required and did not fulfill their roles satisfactorily.

11. One PIT each shall be established for Parts A and B of the Project. Each PIT shall be responsible for (i) leading the consultant selection process; (ii) supervising the consulting teams; (iii) monitoring resources inputs, including verification of consultant time sheets and withdrawals from the imprest account for eligible Project activities; and (iv) preparing progress implementation reports for submission to PCMU.

Schedule 6, para 2.

Partly complied. PIT2 was responsible for the flawed procurement process including proposed adjudication of contract to a bidding with tampered bidding documents.

12. (a) By 30 June 2001, the Borrower shall submit to Parliament the following bills:

(i) Securities Bill; (ii) Companies Bill; (iii) Insolvency Bill; (iv) Secured Transactions Bill; (v) A bill to amend the Nepal Chartered Accountants Act; and (vi) NJA bill each in a form acceptable to the Bank.

Schedule 6. para 3.

Complied with significant delays.

(b) By 31 December 2001, the Borrower shall submit to Parliament the following bills:

(i) NRB Bill; (ii) Financial Institutions Bill; and (iii) E-commerce Bill.

13. The Borrower shall establish NJA and staff its organization. Ensure adequate budgetary support to the NJA, gradually increase budgetary allocation for the judiciary.

Schedule 6, para 4.

Not complied, Inadequate budget provided for NJA. This subcomponent was cancelled

14. By 30 June 2001, the Borrower shall issue a gazette notification to bring to force the Judicial Fund Act 1986 to ensure adequate development budget for the judiciary.

Schedule 6. para 5.

ADB and Government agreed that notification of the Judicial Fund Act 1986 in the existing form did not support NJA or development of the judiciary.

15. The Borrower shall review and decide upon and take action to rationalize institutional and organizational arrangements for regulation of companies and merge or reorganize SEBO, CRO, and CLB.

Schedule 6, para 6.

Complied.

16. By 31 December 2002, the Borrower shall transfer ownership and control over NEPSE to the private sector upon terms and conditions acceptable to the Bank.

Schedule 6, para 7.

ADB and Government agreed not to pursue NEPSE privatization under the Project.

30 Appendix 5

Covenant

Reference in Loan

Agreement Status of Compliance 17. By 30 June 2001, the Borrower shall rationalize setting of interest rates and licensing of branches in the banking sector.

Schedule 6, para 8.

Complied. The Government applies no interest rate regulations except for targeted programs funded by the Government. Under ADBN, RBB, and NBL restructuring bank branches are being rationalized.1

18. By 30 June 2001, the Borrower shall review its policies concerning directed credit to different sectors of the economy.

Schedule 6, para. 9.

Complied.

19. The Borrower shall establish a new payment system for the banking sector and for this purpose, create electronic funds transfer, and clearing and settlement under the supervision of NRB.


Not complied. NRB and Bankers Association did not take appropriate initiative to implement their commitment as agreed.

20. By 31 December 2002, the Borrower shall examine and finalize a fair tax treatment scheme that gives minimal discretionary powers to income tax officials, and creates rebuttable presumption of correctness in favor of accounts of companies that are audited by a chartered accountant who is a member of ICAN in accordance with higher disclosure requirements prescribed by SEBO


Complied.

21. The Borrower shall ensure protection of the requisite radio frequency spectrum band for electronic transmission of information through the financial VSAT communication network.


This covenant became irrelevant following the cancellation of this subcomponent.

22. Subject to a feasibility study to be carried out for this purpose, the Borrower shall support establishment of eFit for the establishment, operation and maintenance of ICT network and services for the financial sector.


The feasibility study confirmed that the proposed eFIT was not financially viable.

23. The Borrower, through the PCMU to establish a benefit and monitoring evaluation system that shall: (a) establish performance parameters for the IAs; (b) involve civil society users of services; (c) independently monitor progress at the end of each year; (d) in relation to judges, develop a performance management system as part of a merit-based judicial appointment system, in consultation with the Borrower’s Judicial Council; (e) in relation to government lawyers, develop a performance management consultation with the Borrower’s Judicial Service Commission; and (f) in relation to private lawyers, develop a performance management system in consultation with the Nepal Bar Council.


Not complied. PCMU did not establish the system.

24. The Borrower and the Bank shall jointly conduct review missions at least twice a year,

Schedule 6. para. 15.

The mid-term review took place approximately 28 months after

1 ADB. 2008. Project Performance Report. Manila

Appendix 5 31

Covenant

Reference in Loan

Agreement Status of Compliance and comprehensive midterm review 18 months after the Effective Date. The mid-term review will focus on (a) performance of consultants; (c) progress in disbursement of the loan and adequacy of implementation arrangements; (d) policy constraints in Project implementation; and (e) initial Project impacts.

Effective Date due to the slow implementation progress.

25. The Borrower shall hold stakeholder consultation workshops. The Borrower shall, in addition, hold regular meetings of the CFG Steering Committee.


Partly complied. No Steering Committee meetings were held. However, consultative meetings among some of the stakeholders were frequently held.

26. The Borrower shall set up a system for measuring the performance of SEBO, NEPSE, CDS, CRO, and NJA. Performance measurement will focus on the development impact, particularly capacity building and skills transfer. The monitoring shall be carried our on an annual basis.


Not complied.

27. The Project shall be carried out in accordance with the Bank’s policies on environment and resettlement.


Following change in Project scope, no construction was involved.