project finance south africa

project finance south africa

Project Finance in South Africa: Opportunities and Challenges

1. Introduction to Project Finance

Project finance is the financing of long-term infrastructure, industrial projects, and public services based upon a non-recourse or limited recourse financial structure where equity may also be pooled in a special purpose firm. The debt and equity are used to fund the project through a special purpose ‘off-balance-sheet’ project vehicle, despite specific contract and revenue structures that give a specific project a significant degree of independence from a general corporation’s financial position. Project finance is particularly attractive to the private sector because it offers strong potential for rendering profits and delivering attractive risk-return profiles, as well as other benefits including the diversification of portfolio and tax advantages. The role of project finance in infrastructure development in South Africa has been given added prominence since the government embarked on its R316 billion infrastructural development program, the Accelerated and Shared Growth Initiative for South Africa (ASGISA).

2. Key Players in Project Finance in South Africa

– Commercial banks. – Merchant banks. – Large investment banks.

2. Financial Institutions That Provide Traditional Banking Services to a Project but do Not Specialize in a Particular Type of Project:

– Land, housing, and property finance banks. – Development finance institutions. – Specialized export finance/insurance institutions. – Training and development initiatives accredited by the IFC. – Cooperative banks.

1. Financial Institutions That Lend Money for a Specific Type of Project or Project Phase:

The main providers of finance to projects are domestic and international banks, consortiums of banks, and South African financial institutions. The South African government is a further participant in the project financing sector and is part of a variety of legislation that is applicable to both them and the participants. In addition, there is a number of export credit agencies and multilateral financial institutions that provide financing facilities to projects located in South Africa.

3. Regulatory Environment and Legal Framework

Delegated effective responsibility for infrastructure development and management is exercised by Parliament and provincial legislatures as the parent entities and the three spheres of government and their intermediaries – a hierarchical array of departments, agencies, and state-owned enterprises – at the core of the delivery chain. At the end of the chain are the operators and users of the actual goods and services. The primary legislation governing infrastructure development in South Africa is the Legislative Framework Act of 1999 and the Petroleum Pipelines Act of 2003. Due to the complexity and sophistication of infrastructure projects in South Africa, secondary legislation tends to be deep and narrow rather than shallow and wide and commonly includes guidelines or directives which are issued under the regulations. These may be tailored to suit specific contracting projects such as the competitive tendering for air traffic services in Cape Town.

The stability of the regulatory environment and the soundness of the legal framework underpin any viable infrastructure project. In the absence of a good governance architecture, investments will be shunned. The capital flight to whence and where it currently is – real estate in first world countries rather than in local infrastructure projects – would continue, to South Africa and its sub-continental neighbors’ detriment. The South African legal framework is indeed sound and provides comprehensive and effective protection for local as well as international investors. South Africa is a constitutional democracy and this country’s highest law is the Constitution which was adopted in 1996. The supremacy of the Constitution is underscored by various judgments of the Constitutional Court, South Africa’s apex court.

4. Case Studies of Successful Project Finance Deals in South Africa

Lagis, Mobil and Eskom, the participants in South Africa’s largest project financing structure, the Mozal aluminium smelter, are building one of the lowest cost smelters in the world. They are committed to complete the project and have no other material distractions other than those under their control. They have entered into an appropriate series of core agreements at an appropriate time and all the stakeholders, including the market, have appeared comfortable with the project’s development timetable and the anticipated price environment for the products of the project. Note that, of the three of us, only Mobil brings any construction risk to the project. The risk profile is fairly evenly divided and is manageable. Since the negotiations of the project documents were commenced reasonably early, the project did not suffer undue interest during financial closing and Eskom’s tariff was affected to some extent and it appeared apparent that the EPA would be provided, the corporate credit ratings of the participants were not significantly or detrimentally affected, either.

Case studies of successful project finance deals in South Africa illustrate the critical success factors in project finance. Such factors include a strong and committed project sponsor, an appropriate and enforceable project capital structure, competitive cost and other advantages in a declining price environment, large-scale capacity and economies of scale, and comprehensive credit enhancement on a fairly limited underlying revenue stream. In other words, the application of project finance principles in a developing country should allow a risky project to be underwritten on the strength of the project itself and result in a project with a limited recourse to the project sponsor. More importantly, a simple and credible way should be found to provide competitive cost advantages, such as the Lagis deal’s gas indexing.

5. Challenges and Future Trends in Project Finance in South Africa

The debt markets play three crucial roles. Debt can be more easily geared than equity and is therefore the key to achieving the 70/30 equity-debt typical split in pet operation where debt-to-equity ratios of between 80/20 and 90/10 have been used. Although some areas have greater potential for the development of project search as a corporate bond market, structured finance with SPVs and guaranteed finance are already available. Thirdly, debt markets represent an enormous potential source of funding because they have the potential to keep financial costs down to a minimum. Their essential liquidity is a powerful tool when it comes to expensive foreign debt. However, the domestic market must be excessive reliance on foreign capital, which must be mirrored and examining all their implications of the benefits of liberalization, that is the effective fast forward to their share of projects done to date. The re-weighting process has begun to occur before the scale of benefits to be derived.

Many challenges face this fledgling project finance market in South Africa, but there are also many factors that will assist in the continued growth. The capital markets will play a crucial role. The market, both for equity and debt for PF projects, is being identified as a critical future source of finance. The future for the South African equity market looks good, where there are changes as the Calpers ruling opens up the market. The regulators effectively have turned around a 180-degree faster, enabling more portfolio managers to invest more of life companies, 45% into stocks. A big project which is appropriate for funding would be a key source of gearing up. The explosive potential is interesting. Once a number of companies in the province thinned out, few still remained and rating for risk should be an important effect.