Disclaimer
: The objective of this paper is NOT to
give legal or financial advices.
This
article was NOT endorsed by the Firms
and Institutions which
helped me logistically. It just expresses
my views on this issue.
If
you were considering action you should
seek your own professional advice.
INDEX
Definition
Five
Main Characteristics of Project Finance
The
non-burdening of the balance Sheets?
Advantages
and Desadvantages of Project Finance
The
parties in presence in a Project
Finance Deal
Three
Different phases in Risk Coverage
and how to assess them.
1.
Pre-Completion
risk
Financial Design
of the Operation
1.
External Financing
2.
Equity Commitment
of the Sponsors
3.
The inherent conflict
between the sponsors and the external
financiers
References
DEFINITION
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Project
Finance is a technique, which can permit
enterprises (Project Finance for the private
sector), and governmental entities to
finance significant infrastructures that
require such large amounts of capital
that they would strain the ability of
these entities to raise sufficient equity.
The
lender will look primarily to the revenue
stream created by the project for repayment,
at least once operations have commenced,
and to the assets of the project (including
contracts for the supply of raw materials,
the sale of the finished product and a
host of other arrangements relating to
the continuing operation) as collateral
for the loan.
That
is not to say that project financing is
inherently risky for debt providers. Project
finance requires the parties to reconsider
the positions that they would typically
adopt in a financing transaction and give
detailed consideration to the overall
viability of the project itself. Debt
and equity providers need to ensure that
risks are identified and covered, and
any residual risks are properly allocated
so as to provide adequate incentives to
prevent opportunism and to ensure that
all parties are committed to the success
of the project.
It
should be noted in this era of privatization
and deregulation that PPP (i.e. public-private-partnership)
has become fashionable.
Another
objective of Project Finance would be
to obtain the needed infrastructure today,
without burdening the balance sheets.
I will comment this assumption below.
Five
Main Characteristics of Project Finance.
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- The
project is perfectly identifiable
and distinct from the other projects
and activities of the sponsors.
- Project
Finance is only, also in theory, financed
on the future cash flows stemming
from the project and without the guarantee
of the sponsors. It works, therefore
when the stream of future income is
sufficient to make the project profitable.
- In
theory the financing should be designed
according to the forecasted cash flows
and not according to the different
guarantees in place.
- Project
Finance deals with extremely high
level of indebtedness. Obviously leverage
is benefic but also increases the
financial risk.
- In
Spain it is used in long-term capital
intensive project: 2.000 millions
ESP (€ 12.500.000) seems to be
the bottom line due to the costs of
the legal and financial engineering.
The
non-burdening of the balance Sheets?
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The
non-burdening of the balance sheets is
very theoretical. The seventh council
directive of the European Union of 13
June 1983 based on the Article 54 (3)
(g) of the Treaty on consolidated accounts
(83/349/EEC) requires a consolidation
of all the activities independently from
their mode of financing.
Consolidated
accounts and a consolidated annual report
will be required if a parent undertaking:
- has
a majority of the shareholders' or
members' voting rights in another
undertaking (a subsidiary undertaking);
or
- has
the right to appoint or remove a majority
of the members of the administrative,
management or supervisory body of
another undertaking (a subsidiary
undertaking), and is at the same time
a shareholder in or member of that
undertaking; or
- has
the right to exercise a dominant influence
over an undertaking (a subsidiary
undertaking) of which it is a shareholder
or member, pursuant to a contract
entered into with that undertaking
or to a provision in its memorandum
or articles of association, where
the law governing that subsidiary
undertaking permits its being subject
to such contracts or provisions. A
Member State need not prescribe that
a parent undertaking must be a shareholder
in or member of its subsidiary undertaking.
Those Member States, the laws of which
do not provide for such contracts
or clauses shall not be required to
apply this provision; or
- is
a shareholder in or member of an undertaking
, and:
- a
majority of the members of the administrative,
management or supervisory bodies of
that undertaking (a subsidiary undertaking)
who have held office during the financial
year, during the preceding financial
year and up to the time when the consolidated
accounts are drawn up, have been appointed
solely as a result of the exercise
of its voting rights; or
- controls
alone, pursuant to an agreement with
other shareholders in or members of
that undertaking (a subsidiary undertaking),
a majority of shareholders' or members'
voting rights in that undertaking.
In
other words Project Finance activities
might end up in the balance sheets of
the sponsors in function of their percentage
of participation in the capital and in
the management of the project.
Advantages
and Desadvantages of Project Finance.
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ADVANTAGES:
For
the sponsors:
- Avoids
having the project debt reflected
on their balance sheets (to be mitigated
as mentioned in the definition).
- Should
avoid covenants (highly unrealistic
before completion).
- Useful
when the sponsors creditworthiness
or borrowing capacity is less than
adequate.
- Useful
when the risk inherent to the project
overtakes the risk the shareholders
are ready to assume or when they
want to diversify the risk.
- It
is fine when clients exist and are
already satisfied with the project.
DESADVANTAGES:
Due
to its nature Project Finance is lawyer-intensive:
the financing of the project will be determined
essentially by the adequacy of the security
package (which also implies the participation
of external technical consultants).
The
security package means:
1. Availability of sufficient financial
support by or recourse to creditworthy
entities to:
- Guarantee
the timely completion of the project.
- Satisfy
stipulated performance guarantees.
- Cover
a reasonable return to the sponsors.
3.
Mechanism insuring the timely availability
and correct allocation of the project
revenue to service debt and cover operating
costs.
Two
big concerns are in presence: the revenue
stream and the currency risks. The revenue
stream risk exists especially in project
such as roads or bridges which don´t
lend themselves to user contracts and
a steady dependable revenue stream.
Details on the revenue stream and the
currency risks can be found in the Offtake
Section of this paper).
PARTIES
IN PRESENCE, BESIDES THE BANK, IN A PROJECT
FINANCE DEAL.
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1.
The sponsors may be either one company
or a consortium of parties interested
in the project, for example contractors,
suppliers or users of the product to
be produced by the project.
It
is likely that the project sponsors
will set up a Single Purpose Company
to build and operate the project in
order to isolate them from any project
risks additional to the capital they
have invested.
2.
The bankruptcy remote Single Purpose
Company created to frame the project.
Bankruptcy
Remoteness means that the entity will
have to be non-trading and liability-free.
Moreover, the Single Purpose Company´s
activities will be restricted only to
those essentials to the relevant project.
The
project sponsors own the shares of the
Single Purpose Company and it would
be this entity which would likely be
the borrower. The reason is that sponsors
do not want the funding of the project
to restrict their ordinary business
activities through ongoing recourse
post completion (which would have a
balance sheet impact as well as binding
the sponsors to ongoing obligations,
including restrictive covenants).
3.
The external consultants i.e. lawyers,
technical experts, public relations
firms, …
4.
Supranational, Governmental and Regional
Authorities acting in three different
ways:
- They
will deliver administrative authorizations.
- They
might be interested in project financing
public infrastructure (PPP) or in
becoming customer of an infrastructure.
- They
could bring in funds or give their
aval.
5.
Insurance companies since they evaluate
the risks and their extents.
6.
The constructors and operators.
The
different roles of the Bank and the degree
of sophistication involved will usually
be driven by the size of the project.
1.
Lender: the bank can loan money to the
sponsor or to the Single Purpose Company.
2.
Syndicator of loans to other lenders:
to spread the risks across a number
of lenders.
3.
Guarantor: it is an effective mechanism
to induce other commercial banks to
participate in the project funding.
4.
Underwriter agreement to indemnify parties
for a loss incurred by non-performance
of the project.
5.
Equity Investor: the bank invests risk
capital for which the Single Purpose
Company has no obligation of repayment
in terms of principal and interest.
It seems therefore fair to secure the
payment of preferred dividends.
6.
Financial and Investment Advisor acting
in three fields:
-
Economic
Viability Analysis i.e. definition
of the objectives and formalization
of the information into a structured
business plan.
- Financial
Engineering and Risk Coverage.
This
implies the design of an optimized
financial structure via the identification
of the different options of financing
and of their financial risks. The
proposal of contracts mitigating the
identified risks is obviously included
in the Financial Engineering task.
A
system of selection and control must
be implemented and applied with an
active advising role in the contract
negotiation processes.
Three
Different Phases in Risk Coverage and
how to assess them.
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1. Pre-Completion
Risk.
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Pre-completion
risk means the risk stemming from the
project until completion. It is obvious,
and if not obvious at least safe, that
an external recourse (i.e. not only a
recourse limited to the project itself)
will have to be secured.
The
first step in allocating pre-completion
risk is to define what is meant by completion.
The
bank and the sponsors will have to agree
on the point at which the project is complete
and accordingly when money must start
being repaid. This will need to be a point
in time which can be judged from an objective
basis as the sponsors may be keen to delay
the point at which repayments must start,
while the lenders will be anxious that
this point occurs as early as possible
in the construction process to avoid the
loss of potential revenues.
Completion
is usually defined to include the project
producing at a minimum rate. That rate
will usually relate to the minimum level
of production required under take-or-pay
or similar contracts.
A
guarantee from third parties such as insurance
against physical damages, consequential
loss and third party and public liabilities
will have to be required from the sponsor.
The
pre-completion risk includes the sponsor
risk and also the risk for the sponsor
of not obtaining the necessary regulatory
approvals to begin the project.
It
is very important to assess it adequately
since in general it is associated with
completion risk.
Sponsor
risk can be broken down into two elements:
1.
Equity commitment.
It
seems to be normal for a bank to require
a contribution of anything from 15 to
50 % of the project cost to ensure the
sponsor´s continued commitment.
In
terms of risk sharing, the best interest
of the Bank is to see that entities
with direct experience of the business
are willing to risk their money in support
of the project as a worthwhile venture.
The same comment applies regarding the
participation of other financing entities.
The
subordinated debt guaranteed by the
shareholders as well as the subsidies
obtained by the project are considered
as equity commitment.
2.
Corporate strength and experience.
Regarding
corporate substance, it is obvious that
it is preferable to work with corporate
sponsors with substantial technical
expertise and financial depth.
In
order for the bank to assess the risks
connected with the implementation of
the project, the sponsor should be required
to describe the arrangements for implementation,
which includes a description of the
major components of the project.
The
description of the major components
includes a summary of the major features,
terms and conditions of the contracts
with the contractors in charge of implementation,
the name of the contractor in charge
of each component and the reasons for
selecting the particular contractor
and its relevant track record.
The
track record of the contractor is important
because it qualifies the contractor
in terms of its experience in work of
a similar kind (related with the technology
risk).
Dates
and types of contracts in which the
contractor was previously engaged would
be important.
It
is important for the bank to be protected
against the consequences of a project
breaching official consents and guidelines,
especially in the environmental field.
- The
Project Company must be authorized
to construct and operate the project
and must have any necessary concessions,
licenses and approvals.
This
sounds obvious and in practice it means
that full details of all consents and
approvals, planning, environmental,
generating license, etc.... (national,
regional and municipal), which are expected
to be required and the status of the
efforts being made to obtain such consents
will have to be presented to the bank.
Although
the lenders´security over the
project assets and contracts may give
them the ability to step in and take
control of the project in the event
of a default, any radical measures such
as the sale of the project company or
replacement of the management of the
project company may require governmental
approval. To apprehend this possibility,
an analysis of the ability of the project
to meet likely future constraints and
limits will also be provided to the
bank.
A
concern in addressing the political
risk is the possibility of a change
of government leading to a change in
law or in the regulatory regime that
could interfere with the project.
The
most extreme form of political risk
would be expropriation, which sounds
extremely remote in Spain.
-
Regarding
the environmental risk, due to
the increasingly demanding and restrictive
legislation controlling the impact
of industry on the environment, the
costs of failing to comply with such
legislation can be significant.
Environmental
liabilities will attach primarily to
the project operators but can also attach
to the project sponsors and lenders.
Since the liabilities for environmental
damages can be extensive and ruin a
project's profitability the Single Purpose
Company shall perform an environmental
assessment.
Moreover
the bank will seek to shield the borrowing
vehicle from such liabilities by ensuring
there is a responsible, creditworthy
independent operator who is responsible
for managing such risks.
2. Construction
Phase: period of the highest risk.
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Risk
of a total write-off
in
respect of a project that never produces
cash flow.
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The
risks exist in:
- Failure
to achieve stipulated performance
levels.
The
construction contractors and the sponsors
should assume those risks.
For
the construction contractors:
- Importance
of lump sum turnkey contracts with
guarantees of completion and performance
with damages payable if such guarantees
are not met. Clauses are inserted
in the contractors´s agreements
obliging them to complete the construction
and start-up of the project without
regard to any limitation on liability
under the construction contract, and
to pay liquidated damages up to 40
% of the contract price if the project
was not completed on time and to specified
performance levels.
- Back-stopping
devices (adequate insurance package,
surety bonds, bank guarantees or letter
of credit issued by reputable institutions)
in case of abandonment, default or
other similar occurrences threatening
the timely and successful completion
of the project. A cession of the benefits
of the different back-stopping devices
will be inserted in favor of the Single
Purpose Company or preferably directly
to the Bank.
For
the sponsors:
Since
no contractor will assume project risk
beyond those normally associated with
the construction activities under the
turnkey contract, the sponsor will be
expected to undertake all other pre-completion
risks. Nevertheless the risks are sometimes
shared between the sponsors and the lenders.
- Cost
overrun commitment to cover the possibility
of increased costs outside the contractor
´s scope of work (a description
and justification of any cost contingency
is expected).
Equity
and Debt Subscription: In the event
of a cost overrun or delay both the
financiers and the sponsors agree to
provide further funding. This may be
on a pro-rata basis or in alternative
tranches. The financiers may insist
on a cap on further funding which they
are committed to provide.
Stand-by
Facility: The parties may put in
place contingent underwriting type facilities
to cover overruns. These facilities
may be provided by the project sponsors
or related companies.
Overrun
Undertaking: The sponsors agree
to provide the overrun amounts above
the pre-agreed debt and equity amounts.
These may be required to be paid by
way of additional capital as cost occurrences
are identified during the construction
phase.
Insurance:
The project sponsor or the borrowing
entity may be required to take out insurance
against construction delays or cost
overruns.
-
In
case of delay, responsibility for
any costs necessary to insure the
completion of the project that is
not covered by the contract. This
can be materialized under the form
of a Completion Guarantee where
the project sponsors agree to repay
the loan either in full or on the
basis of an agreed repayment schedule
if the project is not completed on
time.
Completion
Undertaking is another method: the
sponsors agree to contribute any additional
moneys that are required in order to
ensure that the project reaches the
agreed completion stage.
If
the delay affects the overall long-term
economic viability of the project the
sponsor may remain liable under the
completion guarantee or may be required
to "top up" the cash flow if, or for
as long as, it proves insufficient to
cover debt service and operating costs.
- Letter
of Credit: the project sponsor may
be required to obtain a letter of
credit or guarantee from a bank.
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This
is normally seen as a sponsor risk. It
is important for the bank to be in presence
of a predictable process (particularly
with power plants); a study of feasibility
will be required and the opinion of an
independent technical consultant might
also be useful.
Detailed
examination demonstrating that:
- The
technology has a satisfactory track
record (a completion test is also
an option).
- The
contractors involved in the project
as well as the suppliers have experience
of the technology.
- The
guarantees and warranties are adequate.
- Maintenance
and component replacement are easy.
- The
availability and efficiency levels
predicted can be easily achieved.
3.
The Operation Phase.
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Operation
risk is the risk to the forecasted cash
flow arising from the failure of operations
of the project.
- The employment
by the sponsor of a third-party operations
and maintenance contractor is an element
of security due to the deeper reserves
of skills and personnel which this
can make available to a project and
also because the costs can be contractually
fixed. Operative leasing is a similar
option.
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The
operators will be chosen like all the
contractors. They should be experienced
and recognized in their field. The track
record is important since it qualifies
the operators in terms of experience
in work of a similar kind.
A
definition of the incentives and penalties
applicable to the achieved level and
quality of the operations should be
considered.
-
The distribution
of the revenue stream.
Analysis
of the market: Market description, location
and size.
The
survival and existence of a business
in a market economy is wholly dependent
on market demand. Thus a description
of the customers´need and profile
is expected as well as one of the market
environment (competitors).
Another
fundamental information is the one dealing
with the factors affecting the growth
of demand (financial position of the
buyers and substitutes).
Again
the quality of the operators will play
an important role since as far as possible
the bank will pass to third-party contractors
the risk of reduced prices chargeable
to the users.
Analysis
of the revenue stream: the Discounted
Cash Flow Model.
Various
types of costs have to be taken into
consideration to screen adequately the
cash flow assumptions and forecasts.
Capital
costs can be viewed as the investment
from which long-term benefits are expected.
The capital costs reside in the business
for subsequent years with the view that
such items will make a positive contribution
for several years in the future.
Those
capital costs will be accounted as an
asset and depreciated over the subsequent
years.
They
include, not limitedly, maintenance,
materials, labor, service utilities,
storage, handling, etc.
The Input
and Supply Risks have
to be considered:
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It
includes the risks existing when the
project depends upon a reliable source
of supplies for its operation.
Sometimes
this is a hard thing to guarantee. An
example would be the availability of
wind energy for a wind power plant.
In cases like that, a completion test
might be valuable i.e. building one
unit in the projected location before
starting the construction of the entire
chain of wind power plant.
In
most case the supplies stem from human
suppliers and then it will be mandatory
to be in possession of a demonstration
of the security of the supply arrangements.
The
sponsor has to show that the assumptions
made relating to the quantities and
pricing are conservative and that even
on this basis the proposed debt can
be retired with a significant margin
of safety.
Different
scenarios are to be considered:
- Increase
of the raw material prices and/or
of the quantities necessary.
- Problem
in the availability of the adequate
quantity of raw material at the planned
price.
- The
quality of the raw material is also
important.
- Changes
in the demand of the service or product
and/or in the prices the customers
are willing to pay.
The
answers to those relatively common problems
can consist in long-term purchase agreements
and/or in use of derivatives.
Another
technique for minimizing supply risk
is the put-or-pay arrangement where
the supplier is committed to supply
a minimum quantity of raw material or
to pay a fixed level of compensation
to the project company.
Concession
Agreement: the governmental assurances
are particularly important.
In
a toll road project, the cash flow is
generated by the public use of the infrastructure
and there is no long-term contractual
arrangement with the users.
There
is however a long-term agreement of
exclusive right to collect tolls generated
by the use of the particular project
(and perhaps a degree of exclusivity)
between the government and the sponsor.
It
is important to provide for a periodic
adjustment to the stipulated toll rates
in order to reflect inflation. In some
cases the project sponsors assume the
traffic risk while in others the traffic
risk is assumed by the government.
Offtake
contracts have to be inserted in infrastructure
projects. They prevent the offtake risk
i.e. the risk that the project fails
to generate adequate income.
Components:
- Term
at least co-terminous with the term
of the loan agreement. A year or so
of cushion appears to be a common
practice.
- Committed
Contracts i.e. long-term sale contracts
for the service and product offered
and/or use of derivatives.
In
the case of a project such as a power
generation plant producing a commodity
for sale, the long-term contract with
a reliable party for the purchase of
the energy is called a "throughput
agreement".
That
contract will usually stipulate not
only a minimum quantity to be purchased
but also guarantee a minimum level of
revenue to the Project Company to enable
the Project Company to service its debt.
Projects
such as roads where payback is from
tolls cannot be protected to the same
extent
The
"take or pay" clause is also
an option, it implies that the buyer
agrees to buy or pay a product or service
in predetermined quantities and at a
predetermined date. In case of non-compliance
he will have to pay a penalty which
can reach the amount of the portion
of the contract.
-
Price
insuring coverage of debt service,
payment of operating costs and a reasonable
return to the investor.
The
linkage mechanism is another offtake
clause; it links the price of the service
or product offered to the different
costs involved and their evolution.
The price has to be adjustable to reflect
any increase in variable operating costs
and any decrease in the value of the
local currency.
A
clause allowing for a price revision
written or justified upon other terms
is also possible.
-
Swap
contracts and similar hedging arrangements
to reduce the Interest Rate and Foreign
Exchange Risks.
The
Interest Rate Risk arises frequently
where, for example, a project´s
income stream may depend upon an implied
fixed rate present value calculation
and the coupon on the notes is floating
rate. Additionally, the income stream
may be denominated in a different currency
from the Single Purpose Company´s
debt service obligations.
Clearly,
a swap will be required and the swap
counterparty will need to be appropriately
rated. The appropriate sovereign ceilings
will also need to be taken into account.
Additionally,
all funds belonging to the Single Purpose
Company will need to be segregated and
held with appropriately rated banks.
There
will need to be put in place a fairly
substantial and sophisticated cash management
regime to ensure that all payments are
made by or on behalf of the Single Purpose
Company on a timely basis (for details
see point 7 below).
-
Back-stopping
package: adequate insurance including
business interruption coverage and
loss of potential income, monoline
insurance guarantying the Single Purpose
Company´s ability in meeting
its obligations
Factoring
the receivables is a form of insurance
as well as over-collateralization i.e.
when a larger portion of the assets
over-collateralize a lesser amount.
Certain
standby financial commitments of the
sponsors in the form of equity or quasi-equity
contributions are also common. It would
be also advisable to limit the distribution
of dividends by the sponsors as well
as limiting the transferability of the
shares they own in the Single Purpose
Company.
-
Sovereign
guarantee of the offtaker´s
performance when the offtaker is a
government-owned entity.
-
Escrow
or Trust Accounts to ensure that the
revenue generated by the project is
properly collected and timely allocated
to relevant items of cost and debt
service, including debt service reserve
accounts for future debt service payments.
More
specifically, the aim is to prevent
the liquidity and reinvestment risks.
The
liquidity risk equates to the risk
not that amounts are not received at
all, but that they are received late
such that the Single Purpose Company
cannot pay in a timely fashion on a
coupon date.
This
risk can be addressed by the provision
of a liquidity facility by an appropriately
rated third party, or by building into
the cash flows a spread/debt reserve
account to be credited and replenished
(where necessary) over time so as to
ensure that a coupon payment can always
be made.
The
reinvestment risk can be categorized
as the inverse of liquidity risk. It
occurs in the situation where, for example,
the payments in respect of project income
are received early such that the Single
Purpose Company might have insufficient
moneys to pay on the coupon date.
The
solution to this problem is to ensure
that the Single Purpose Company has
available to it eligible investment
criteria and/or a guaranteed investment
contract under which it can invest funds
for a guaranteed return. This may also
be the solution to stage payment related
issues where a note issue is launched
to finance the project´s construction.
In
Toll highways, there is a problem in
the cession of the right to collect
the tolls since this is a cash flow
that is not determined or determinable
as required by the Spanish Civil Code
for the cession of financial claims.
A solution for the bank is to mortgage
the highway.
Financial design
of the operation.
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1.
External Financing.
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The
external financing of the project varies
from 50 % to 85 % obtained under different
forms:
- Senior
Debt i.e. debt that has priority of
claims ahead of other obligations.
The syndication procedures might apply.
- Normal
Debt i.e. its position for eventual
repayment in the event of bankruptcy
follows that of senior debt, but precedes
any repayment to the shareholders.
- Leasing
and/or Bonds but they are not very
common since they are not compatible
with the Senior Debt.
Besides
that, bonds are complicated to use during
the construction period of a turnkey
project. A turnkey project will require
advances of funding on a number of "milestone"
dates. Therefore, it will be necessary
to allow the issuance of bonds on this
number of dates throughout construction
(a cash collateral arrangement where
the unutilized portion of the original
issuance proceeds are deposited in a
blocked account until required to be
advanced would be easier).
2.
Equity Commitment
of the Sponsors.
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It
finances what is not covered by external
financing i.e. from 15 % to 50 %.
It
consists in purchase of stocks in the
Single Purpose Company. It must be pointed
out that the subordinated debt guaranteed
by the shareholders is considered as
equity commitment.
3.
The inherent
conflict between the sponsors AND the
external financiers.
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Typically,
the debt provider is viewed as having
a fixed or certain claim on a borrower's
assets while the equity provider has a
residual claim. Lenders will receive interest
and principal payments in priority to
equity distributions and will have priority
in the event of liquidation. However,
the lenders will have no voting rights
and no right to participate in profits.
In
project financing however, the financiers'
claim may appear to be as residual as
that of the project sponsor. This is emphasized
by the high gearing and long-term commitment
expected from project financiers. Examples
of areas that create conflicts for sponsors
and financiers in a project financing
are the level of return on debt funding
and the extent of security taken.
Return.
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Despite
the risks that a project financier takes,
the return that it receives (while higher
than on a full recourse loan) is likely
to still reflect the assumption of debt
rather than equity risks. Aside from
the risks the financier will also want
to reflect in its return the substantial
time required to analyze, negotiate
and administer this type of funding.
If
the financier demands returns equivalent
to an equity provider the project sponsor
may prefer to find equity investors
instead. The project sponsor may perceive
equity investment as an advantage once
returns demanded exceed a certain level
as debt providers are often seen as
less likely to share an entrepreneurial
attitude providing a greater level of
restrictions on the flexibility of the
project.
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Granting
security has a cost to the borrower. In
addition to transactional costs there
is the impact of the security on the credit
of the borrower and, potentially, the
project sponsor if security is required
from it during the full recourse phase.
On
the other hand, particularly in a situation
where the borrower may be a shell company
and the lender's recourse is limited to
the assets of the project, security over
and restrictions on the use of those assets,
including the contractual arrangements
on which it is relying for its cash flow,
will be seen as important to the lender.
Security
not only allows the lender to more readily
control, operate or realize assets on
default and to have a claim in priority
to other creditors, but constrains the
borrower's ability to dispose of assets,
assume more debt and to terminate or alter
any contractual arrangements on which
the borrower (and the lenders) may be
relying for cash flow or protection.
However,
the reality of security in a project finance
is that it is often primarily defensive
as the most likely circumstance in which
a default under a project financing occurs
(for example a failure of the technology
being utilized) may mean that a realization
of the secured assets is not possible.
The
tension arises between the financiers'
desire to protect itself against all eventualities
by restricting the borrower and the sponsor
's desire for flexibility to deal with
unforeseen events.
4. Allocating
risk between the project sponsors AND
the financiers.
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It
is essential to identify all conceivable
risks in relation to the project from
the outset, to provide protection against
such of these risks as it is feasible
to obtain protection and to allocate responsibility
for any residual risk.
The
way in which the risks of a project are
allocated amongst the parties to the project
will impact on the total project cost.
Project
cost benefits can be realized when risk
allocation is tailored to the circumstances
of an individual project. Owners who routinely
force maximum assumption of risk on the
contractor are likely to incur higher
project costs. Contract preparation that
allocates risk with a balanced input from
all parties will be the most cost effective.
The
tension arises between the external financiers'
desire to ensure that any residual risk
to them is minimized by ensuring every
conceivable event is identified and to
the greatest extent possible, covered,
including by contractual obligations (such
as insurance), and the sponsor's desire
to minimize the cost of the project.
This
may mean that the more remote risks may
be left uncovered (for instance where
the cost of insuring a particular event
is substantial and that event is wholly
or partly "self insured" by the borrower)
with the consequence that either of the
financiers or, in certain cases, the sponsors
bear that risk.
Arguably,
the most effective method of allocating
risk will be to ensure that the party
best equipped to manage and minimize a
particular risk is the party to whom that
risk is allocated. By properly allocating
risks the parties should reduce the overall
costs of those risks and should promote
a better working relationship between
themselves.
REFERENCES.
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- Risks
in Projects; Instituto Tecnológico
Autónomo de México (ITAM),
Mexico, 1998.
- Project
Finance - Identifying and Allocating
Risks; Russell McVeagh McKenzie Bartleet
& Co, Wellington, New Zealand,
1998.
- Problems
and Solutions to Energy Efficiency
Investment in Central Europe; EBRD
, London, 1998.
- Securitization
in the Project Finance Sector; Norton
Rose, London, 1997.
- Today´s
Business: Project Finance; Price Waterhouse,
Toronto, 1997.
- Guide
to Energy Efficiency Bankable Proposals;
European Commission, Directorate General
for Energy, Brussels, 1997.
- Los
por qué y para qué de
un Project Finance; Instituto de Empresa,
Colegio de Dirección, Madrid,
1996.
- Why
Project Finance can make sense; Kelley
Drye & Warren LLP, Los Angeles,
1996.
- International
Project Finance, Private Infrastructure
Projects in Emerging Nations; Kelley
Drye & Warren LLP, Los Angeles,
1994.
- LBO
Market Presentation; Banca Commerciale
Italiana, New York, 1989.
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