Introduction and overview of

project finance

ESAMI

MutapaM
 OUTLINE 1
•  Definition of project finance
•  Project finance as opposed to financing of a project
•  Limited-recourse and non-recourse finance
•  Main features of project finance
•  Parties involved - interests and roles
•  Importance of cash flow
•  Documentation - what are the aims?
•  Project development process
•  Why choose project finance

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 OUTLINE 2 & 3
Project finance market
•  Origin and evolution of project finance

The main parties in a project finance

•  Parties involved - interests and roles
•  Project company/borrower
•  Sponsors/shareholders
•  Banks
•  Multilateral and export credit agencies
•  Insurers
•  Construction companies
•  Operator
•  Host government

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 Introduction
•  Project finance is a method of raising long-
term debt financing for major projects
through ‘financial engineering,’ based on
lending against the cash flow generated by
the project alone;
•  it depends on a detailed evaluation of a
project’s construction, operating and revenue
risks, and their allocation between investors,
l e n d e r s , a n d o t h e r p a r t i e s t h ro u g h
contractual and other arrangements.

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In 2012, at least $375 billion of investments
in projects around the world were financed
or refinanced using project-finance
techniques. In 2019 world bank DFI USD
49.6 billion.
A representation of 13% of 2012 as a base.
Estimated 2019 $423.75 billion.

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 Public Finance
Many governments, funded projects by using existing surplus funds or
issued debt (government bonds) to be repaid over a specific period.
However, governments have increasingly found this funding to be less
attractive, as it strained their own balance sheets and therefore limited their
ability to undertake other projects.
This concern has stimulated the search for alternative sources of funding.

A government borrows funds to finance an infrastructure project and gives a

sovereign guarantee to lenders to repay all funds. Government may
contribute its own equity in addition to the borrowed funds.
Lenders analyse Government’s total ability to raise funds through taxation
and general public enterprise revenues, including new tariff revenue from
the project.
The sovereign guarantee shows up as a liability on Government’s list of
financial obligations.

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 Construction contract
Private
Construction
Sovereign guarantee
Company
R loan
Lender Government
Repayment Construction
Taxes/tariffs

Users/ Treatment
taxpayers Plan
Water supply

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 Corporate Finance
The following chart illustrates the structure of a water treatment project
in which the private sector participant uses its own credit for raising the
funds due to its capacity and the limited size and nature of the project.
This option is often used for shorter, less capital-intensive projects that
do not warrant outside financing.
However, as with government financing, private companies avoid this
option, as it strains their balance sheets and capacity, and limits their
potential participation in future projects.
A private company borrows funds to construct a new treatment facility
and guarantees to repay lenders from its available operating income and
its base of assets.
The company may choose to contribute its own equity as well.
In performing credit analysis, lenders look at the company’s total income
from operations, its stock of assets, and its existing liabilities.
The loan shows up as a liability on the company’s balance sheet (“Mining
the Corporate Balance Sheet”)

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 n
Concessio Government

loan
R Private
Company
Lender
Repayment
Fees

Treatment
Users Plan
Service
s

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 Definition of project finance
Project Finance Not Project Finance
The creation and use of a legally
independent investment vehicle to finance a Involves recourse
single-purpose limited-life capital asset on a •  Secured debt
non-or-limited recourse basis. •  Sub debt
Project finance •  JVs
§  Off balance sheet •  Vendor debt
§  Limited or no recourse to the sponsor •  Leases
§  Heavily contracted (financially & legally) Financial asset holdings (not capital
ü  Attempts to optimally allocate project asset)
risks •  Asset backed securities
The special purpose vehicle (SPV) is •  Real estate investment trusts
created to No corporate sponsor
1)  remove, or mostly remove sponsor •  Private or municipal development
recourse in the event of default, •  Leveraged or management
2)  enable high leverage/significant tax buyouts
shields, and
3)  enable project cash flow-based lending

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Project finance as opposed to financing of a
project
Project finance’ is not the same thing as
‘financing projects,’ because projects may be
financed in many different ways.
Traditionally, large scale public-sector projects
in developed countries were financed by
public-sector debt;
Private-sector projects were financed by large
companies raising corporate loans.

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 Cont’d
In developing countries, projects were financed
by the government borrowing from the
international banking market, development-
finance institutions such as the World Bank, or
through export credits.
These approaches have changed, however, as
privatization, deregulation, and the
introduction of private finance through public-
private partnerships

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 Cont’d
have changed the approach to financing
investment in major infrastructure projects,
transferring a significant share of the
financing burden to the private sector.

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 Project Finance
A team or consortium of private firms establish a new
project company to build, own and operate a specific
infrastructure project.
The new project company is capitalised with equity
contributions from each of the sponsors.
The project company borrows funds from lenders.
The lenders look to the projected future revenue stream
generated by the project and the project company’s assets
to repay all loans.
The host country government does not provide a
financial guarantee to lenders; sponsoring firms
provide limited guarantees. “Off-Balance-Sheet”
financing.
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 Sponsor
2 Sponsor
Sponsor 3
1

loan
R Concession
Project
contract
Company Government
Lender
(SPV)
Repayment Services
tariffs

Users

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 Toll Road Concession

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Project finance as opposed to financing
of a project
Advantages Disadvantages

Ø Non/limited recourse financing Ø Complexity of risk

Ø Off balance sheet debt and risks allocation
Ø High leverage and tax shields Ø Relatively high interest rates
Ø Enables a lower cost of capital and fees
Ø Risk diversification and risk Ø Increased lender risk
sharing Ø Increased lender reporting
Ø Collateral limited to project requirements
assets Ø Increased insurance
Ø Matches specific assets with coverage
liabilities Ø Encourages potentially
Ø Expands credit opportunities unacceptable risk taking

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 Limited-recourse and non-recourse
finance
Non-recourse finance is a type of commercial lending that
entitles the lender to repayment only from the profits of the
project the loan is funding and not from any other assets of the
borrower. Such loans are generally secured by collateral.

Recourse Debt Nonrecourse Debt

Borrower is… Personally Liable Not personally liable

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 Main features of project finance
Non-recourse Debt Equity Shareholders
Project Types Inter-creditor Agreements Board of Directors
•  Build-own-operate
•  Build-transfer-operate 70% 30%
•  Rehabilitate-own- Labor
Licenses
operate
•  Rehabilitate-operate-
transfer Fuel Supply SPV Company
contract Power output
•  Develop-operate- (Power Plant)
transfer
Equipment
•  Sale-leaseback contracts
•  Buy-build-operate EPC O&M
Contracts
•  Public and/or private– Contract

feel free to get creative

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 Importance of cash flow
•  Cash flow from investing activities refers to
cash inflow and outflow of cash from
investing in assets (including intangibles),
purchasing of assets like property, plant and
equipment, shares, debt and from sale
proceeds of assets or disposal of shares/debt
or redemption of investments like collection
from loans advanced or debt issued.

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 Project development process
Best-practice public procurement for PPPs usually involves formal
reviews and approvals (e.g. from the Ministry of Finance’s PPP unit)
at various stages of the project-development and procurement
processes, which provide a basis for moving forward to the next
stage.
Typical stages for review are:
Step 1 Initial Business Case.
Looks at the project from a high level to confirm that it fits into
government strategy, considers the various options for
achieving the project, and whether it is inherently suitable for
procurement as a PPP.
Typically fairly short and simple. If the Initial Business Case is
approved, the Contracting Authority normally engages external
advisors at this point.

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 Step 2 Outline Business Case.
Considers in detail the need for the project, based on a cost/benefit
analysis (which would apply to any major public-sector investment).
Based on this, the scope and estimated costs of a PPP Contract are
estimated in detail, and a financial model based on these estimates
(known as a ‘Shadow Bid Model’).
The Shadow Bid Model will take account of the estimated capital
(construction) costs and lifetime operating costs of the project, and
the likely structure and costs of private-sector project finance, thus
estimating the total costs of the project to the Contracting Authority
over its life.
This model will therefore enable the Contracting Authority to decide
whether the project is ‘affordable’, either within its own budget in the
case of a PFI Model or process-plant project, or for users in the case
of a Concession.

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 Cont’d
These PPP cost estimates may be compared with the estimated costs
of a public-sector procurement of the same project, the latter being
known as a public-sector comparator (‘PSC’).
Clearly private finance is inherently more expensive than public
finance, so it might be expected that this comparison would rule out
a PPP.
However the cost of public finance does not take into account the
risks inherent in the project (which are absorbed by taxpayers)

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 Cont’d
Step 3 Readiness for Market.
The commonest error made by the public sector during the
procurement phase of a PPP project is lack of adequate preparation
before approaching the market—known as the ‘project preparation
gap’.
This may not be the fault of the project team: political pressure may
lead to a requirement to be seen to be ‘doing something’, and
behind the scenes preparation work is not conspicuous enough to
meet such political imperatives.
In fact, throughout a procurement there are likely to be conflicts
between a political timetable and a realistic and prudent approach.

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 The main parties in a project
finance

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 Parties involved - interests and roles
Sponsors may bring in other, more ‘passive’, investors such as
investment funds specializing in project-finance equity, especially in
the infrastructure sector (but such funds may themselves also act as
Sponsors);
● institutional investors, such as life-insurance companies and
pension funds, that are prepared to make direct equity investments
in projects, rather than via investment funds;
● shareholders in quoted equity issued by the Project Company on
a stock exchange;
● Contracting Authorities ;
● local partners, where the Sponsor is a foreign investor;
● DFIs, such as International Finance Corporation, who may invest
directly, or via investment funds;
● sovereign wealth funds, which have started to invest in this
sector, again directly or via investment funds.

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 Cont’d
The passive investors may prefer to come in at Financial Close, rather than
join the original Sponsors, in cases where the Sponsor group is bidding for
the project in a public procurement, because they do not want to take the
bid-cost risk, or the development-cost risk where the project is being
procured by a Contracting Authority
The investors who invest at Financial Close are known collectively as
‘primary investors’, as opposed to ‘secondary investors’— i.e. those who
come in at a later stage of the project by buying shares from the primary
investors

Lenders normally require the original Sponsors of the project to retain their
shareholdings at least until the construction of the project is complete and it
has been operating for a reasonable period of time; otherwise the perceived
benefits of the particular Sponsors being involved in the project would be
lost

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 Cont’d
Since Sponsors such as contractors and equipment suppliers may not
have an obvious long-term interest in the project, lenders will be more
comfortable in such cases if these Sponsors are in partnership with other
Sponsors who do have a long-term interest and can ensure that
contracts with the equipment supplier or contractor are set up and run
on an arm’s-length basis.

A Contracting Authority (or another public-sector entity) may be a

shareholder in a project in which it has an interest, i.e. a PPP
Contract or an Off take Contract where the Off taker is a public-
sector party. The motivations for such a shareholding may be:

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● To reduce the cost of the project by offsetting equity
revenues against the Contract Payments (but if this is the
motive, the public-sector analysis must take account of the
relatively uncertainty of receiving revenues compared to the
relative certainly of having to pay the Contract Payments—i.e.
the former should be discounted for risk);
● To share in any ‘windfall’ gains by the private-sector
investors from equity Sales.
● To ensure that the public sector is kept fully aware of
developments in the project.

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 Sponsors/shareholders
The project sponsors are those companies, agencies
or individuals who promote a project, and bring
together the various parties and obtain the
necessary permits and consents necessary to get the
project under way. As has been noted earlier, often
they (or one of their associated companies) are
involved in some particular aspect of the project.
This might be the construction, operation and
maintenance, purchase of the services output from
the project or ownership of land related to the
project.

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They are invariably investors in the equity of the
project company and may be debt providers or
guarantors of specific aspects of the project
company’s performance.
The support provided by project sponsors varies
from project to project and includes the giving of
comfort letters, cash injection commitments, both
pre- and post-completion, as well as the provision of
completion support through guarantees and the like.
Support is also likely to extend to providing
management and technical assistance to the project
company.

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 Third-Party Equity Investors
These are investors in a project who invest
alongside the sponsors.
Unlike the sponsors, however, these investors are
looking at the project purely in terms of a return on
their investments (ROI) for the benefit of their own
shareholders.
Apart from providing their equity, the investors
generally will not participate in the project in the
sense of providing services to the project or being
involved in the construction or operating activities.

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 Banks
The sheer scale of many projects dictates that they cannot be
financed by a single lender and, therefore, syndicates of lenders
are formed in a great many of the cases for the purpose of
financing projects.
In a project with an international dimension, the group of
lenders may come from a wide variety of countries, perhaps
following their customers who are involved in some way in
the project.
It will almost certainly be the case that there will be banks
from the host country participating in the financing. This is as
much for the benefit of the foreign lenders as from a desire to
be involved on the part of the local lenders.
As with the involvement of local sponsors, the foreign lenders
will usually take some comfort from the involvement of local
lenders.
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As is usually the case in large syndicated loans, the project
loan will be arranged by a smaller group of arranging banks
(which may also underwrite all or a portion of the loan).
Often the arranging banks are the original signatories to the
loan agreement with the syndication of the loan taking place at
a later date.
In such cases the arranging banks implicitly take the risk that
they will be able to sell down the loan at a later stage.
However, participating in project financings is a very
specialised area of international finance and the actual
participants tend to be restricted to those banks that have the
capability of assessing and measuring project risks.
This is not to say that banks not having these skills do not
participate in project financings, but for these banks the risks
are greater as they must also rely on the judgement of the more
experienced banks
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 Facility Agent
As with most syndicated loans, one of the lenders will
be appointed facility agent for the purposes of
administering the loan on behalf of the syndicate.

This role tends to assume an even greater significance

in project financings as inevitably there are more
administration matters that need undertaking.

Usually, however, the role of the facility agent will be

limited to administrative and mechanical matters as
the facility agent will not want to assume legal
liabilities towards the lenders in connection with the
project.
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The documentation will, therefore, establish that the
facility agent will act in accordance with the
instructions of the appropriate majority (usually
66.66 per cent) of the syndicate who will vote and
approve the various decisions that need to be taken
throughout the life of a project.
The documentation, however, may reserve for the
facility agent some relatively minor discretions in
order to avoid delays for routine consents and
approvals

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 Technical Bank
In many project financings a distinction is drawn between the
facility agent (who deals with the more routine day-to-day tasks
under the loan agreement) and a bank appointed as technical bank,
which will deal with the more technical aspects of the project loan.

In such cases it would be the technical bank that would be

responsible for preparing (or perhaps reviewing) the banking cases
and calculating the cover ratios (CADS, DSCR, LSCR, PLSCR).

The technical bank would also be responsible for monitoring the

progress of the project generally on behalf of the lenders and liaising
with the external independent engineers or technical advisers
representing the lenders.

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•  It will almost always be the case that the
technical bank will be selected for its
special ability to understand and evaluate
the technical aspects of the project on
behalf of the syndicate.
•  As with the facility agent, the technical
bank will be concerned to ensure that it is
adequately protected in the documentation
and will be seeking to minimise any
individual responsibility to the syndicate
for its role as technical bank.

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 Insurance Bank/Account Bank
In some of the larger project financings additional roles
are often created for individual lenders, sometimes for no
other reason than to give each of the arranging banks a
meaningful individual role in the project financing.
Two of these additional roles are as insurance bank and
as account bank.
The insurance bank, as the title suggests, will be the
lender that will undertake the negotiations in connection
with the project insurances on behalf of the lenders.
It will liaise with an insurance adviser representing the
lenders and its job will be to ensure that the project
insurances are completed and documented in a
satisfactory manner and that the lenders’ interests are
observed.
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•  The account bank will be the lender through
which all the project cash flows flow.
•  There will usually be a disbursement account to
monitor disbursements to the borrower and a
proceeds account into which all project receipts
will be paid.
•  Frequently, however, there will be a number
of other project accounts to deal with specific
categories of project receipts (e.g. insurances,
liquidated damages, shareholder payments,
maintenance reserves, debt service reserves)

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 Multilateral and Export Credit Agencies
Many projects are co-financed by the World Bank or its private
sector lending arm, the International Finance Corporation
(IFC), or by regional development agencies, for instance the
European Bank for Reconstruction and Development (EBRD),
the African Development Bank or the Asian Development
Bank.
These multilateral agencies are able to enhance the bankability
of a project by providing international commercial banks with a
degree of protection against a variety of political risks.
Such risks include the failure of host governments to make agreed
payments or to provide foreign exchange and failure of the host
government to grant necessary regulatory approvals or to ensure
the performance of certain participants in a project.

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Export credit agencies also play a very important role in
the financing of infrastructure and other projects in
emerging markets.
As their name suggests, the role of the agencies is to
assist exporters by providing subsidised finance either to
the exporter direct or to importers (through buyer
credits)

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 Construction Company
In an infrastructure project the contractor will,
during the construction period at least be one of
The key project parties.
Commonly it will be employed directly by the
project company to design, procure, construct and
commission the project facility assuming full
responsibility for the on-time completion of the
project facilities usually referred to as the “turnkey”
model

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 Operator
In most infrastructure projects, where the project vehicle
itself is not operating (or maintaining) the project facility, a
separate company will be appointed as operator once the
project facility has achieved completion.
This company will be responsible for ensuring that the day-
to-day operation and maintenance (O&M) of the project is
undertaken in accordance with pre-agreed parameters and
guidelines.
It will usually be a company with experience in facilities
management (depending upon the particular project) and
may be a company based in the host country.
Sometimes one of the sponsors will be the operator as this
will often be the principal reason why that sponsor was
prepared to invest in the project.
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•  As with the contractor, the lenders will be
concerned as to the selection of the operator.
They will want to ensure that the operator not
only has a strong balance sheet but also has a
track record of operating similar types of
projects successfully.
•  The contractor and operator are not usually the
same company as very different skills are
involved.
•  However, both play a key role in ensuring the
success of a project.

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 Experts
These are the expert consultancies and professional firms
appointed by the lenders to advise them on certain technical
aspects of the project.
(The sponsors will frequently also have their own
consultants/professionals to advise them.)
The areas where lenders typically seek external specialist
advice are on the technical/engineering aspects of projects as
well as insurances and environmental matters.
Lenders will also frequently turn to advisers to assist them in
assessing market/demand risk in connection with the project.
Each of these consultancies/professional firms will be chosen
for its expertise in the particular area and will be retained to
provide an initial assessment prior to financial close and,
thereafter, on a periodic basis.

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•  An important point to note is that these
consultancies/professional firms are appointed
by (and therefore answerable to) the lenders and
not the borrower or the sponsors.
•  However, the cost of these consultants/
professional firms will be a cost for the project
company to assume and this can be a cause of
friction.
•  It is usual, therefore, for a fairly detailed work
scope to be agreed in advance between the
lenders, the expert and the sponsors.

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 Host Government
As the name suggests this is the government in whose country the
project is being undertaken.
The role of the host government in any particular project will vary
from project to project and in some developing countries the host
government may be required to enter into a government support
agreement.
At a minimum, the host government is likely to be involved in the
issuance of consents and permits both at the outset of the project
and on a periodic basis throughout the duration of the project.
In other cases, the host government (or an agency of the host
government) may actually be the purchaser or off-taker of products
produced by the project and in some cases a shareholder in the
project company (although not usually directly but through
government agencies or government controlled companies).

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•  It is usually the case that the host government will be
expected to play a greater role in project financing
(whether in providing support, services or otherwise) in
the lesser developed and emerging countries.
•  Whatever the actual level of involvement the host
government of a particular country plays in project
financings, its general attitude and approach towards
foreign financed projects will be crucial in attracting
foreign investment.
•  If there has been any history of less than even-handed
treatment of foreign investors or generally of changing
the rules, this may act as a serious block on the ability to
finance projects in that country on limited recourse terms.

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 Insurers
Insurers play a crucial role in most projects. If there is a
major catastrophe or casualty affecting the project then both
the sponsors and the lenders will be looking to the insurers
to cover them against loss.
In a great many cases, if there was no insurance cover on a
total loss of a facility then the sponsors and lenders would
lose everything.
Lenders in particular, pay close attention not only to the
cover provided but also to who is providing that cover.
Most lenders will want to see cover provided by large
international insurance companies and will be reluctant to
accept local insurance companies from emerging market
countries.

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•  In some industries (e.g. the oil industry)
some of the very large companies have set
up their own offshore captive insurance
companies, either for their own account or
on a syndicate basis with other large
companies.
•  This is, in effect, a form of self-insurance
and lenders will want to scrutinise such
arrangements carefully to ensure that they
are not exposed to any hidden risks.

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 Discussion Question
Discuss and demonstrate the difference
between public, corporate and project
funding, using an example of your choice for
a project (SPV).

MutapaM 52
 Thank you
Mpafya Mutapa, BSc, MBA, CTFP, FCMA, FCGMA, FZICA
Contacts:
Email: [email protected]
Skype Id: mpafya.mutapa
Cell: +255-684-164-019
Whatsapp:+260-977-619-535

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