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  General project finance fundamentals

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Project finance, or limited recourse financing, has features which render it quite different from ‘normal financings’ and these differences permeate throughout the structure.

  • Features of project finance:
    • Differences of project financing from corporate lending
    • Differences between infrastructure financing and other forms of project finance
    • The limitation of recourse
    • The due diligences required
    • The choice of project vehicle
    • Debt risk vs commercial risk
    • The role of contract
    • The role of security
  • What is gained by structuring on a limited recourse basis
   
 

Contracts and cross-border enforcement

 

Project financings involve a spider’s web of contracts. These contracts are pointless unless there is an ability to enforce rights under them. In cross-border context this is often not straightforward. Litigation is not the answer:

  • The laws governing the multiplicity of contracts, conflicts
  • The ‘problem’ with litigation
  • The administration of the contract
  • Expert mediation
  • International arbitration
   
 

PPP and other infrastructure projects

 

Because most PPPs and BOTs have a contractually-based revenue, their structure and characteristics are quite different from other project financings:

  • Infrastructure projects contrasted with industrial/extractive industry projects
  • The advantages and disadvantages of the PPP format
  • Public sector procurement
  • The structure of concessions
  • Termination clauses, compensation, step-in rights
   
 

  Case 1: Public private partnership infrastructure project

   
 

Pre-completion

 

Getting a project built and working as planned is the hardest and therefore the highest risk phase of most projects. Particular care is required in structuring the rights and obligations:

  • Standard form contracts – eg. FIDIC
  • Liquidated damages
  • Performance bonds and retentions
  • Fixed price, lump sum, liquidity
  • Variation and change orders
  • Turnkey EPC structures
  • Completion guarantees, refinancing risk
  • Technology, logistics and learning curve risks
   
 

Market and operating risks

 

Most projects have only one revenue source. The cash flow coming into the project needs careful structuring and due diligence:

  • Offtake agreements and the errors that often occur
  • Availability risk vs market risk
  • Take-or-pay features
  • Hidden recourse structures
  • Exclusions
  • Implications of market volatility
  • Currency exposures
  • Merchant power
   
 

  Case 2: Power project

   
 

Bond financing for Special Purpose Vehicles (SPVs)

 

An increasingly important financing option, but having very distinct disadvantages as well as advantages:

  • The history of bond finance of limited recourse SPVs
  • Cross-border bonds – prerequisites
  • Rule 144A – implications for emerging market projects
  • Rating agencies – approach to different sectors
  • Piercing the sovereign ceiling
  • The limited window for high yield bonds
  • Why use bond financing – advantages and disadvantages
   
 

  Case 3: Liquified Natural Gas (LNG) project

   
 

Export Credit Agencies (ECAs)

 

An explanation of how ECAs and their products work, and the pluses and minuses of getting them involved in the structure:

  • Buyer credits
  • Political and commercial risk cover
  • Concessional finance rates
  • Lines of credit
  • Advantages/disadvantages of ECA involvement
  • Multilateral agencies
 

Financier perspective

 

Total dependence on a single cash flow results in structures and covenants that are not found in other financings.

  • Risk – solvency risk vs volatility risk
  • Free cash flow – why is it fundamental to analyse
  • Cash management issues
  • Liquidity – creating ‘suspension’ for the special purpose vehicle
  • Why the financial covenants are different from conventional lending
  • Cash Available for Debt Service (CADS)
  • Loan life cover, project life cover, debt service cover (LLCR and ADSCR)
  • Surplus cash flows, lock-up, cash sweeps
  • Waterfall/cascade, reserve accounts
  • Contingency reserves
  • Designing structures to match cash flows
  • Dealing with default
  • Mortgage debentures/fixed and floating charges
  • Separating risk-taking and funding
   
 

  Case 4: An emerging market infrastructure project

   
 

Sponsor perspective

 

Sponsors need to have a disciplined approach to screen projects that are likely to deliver the benchmark IRR. There are number of potential pitfalls in the analytical approach.

  • The investment analysis without project finance
  • The difference in approach with a limited recourse structure
  • Project IRR contrasted with Equity/Sponsor IRR
  • The drivers of Sponsor IRR – and implications of negotiation of the financing term sheet
  • Evaluation of projects in emerging markets
   
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