project finance institute

project finance institute

The Role and Impact of Project Finance Institutes in Infrastructure Development

1. Introduction to Project Finance Institutes

Since it became a significant factor in their development, infrastructure project finance has been an evolving process rather than a coherent mobilization of resources and execution strategy. But to achieve real cost reductions, technological improvements, and private sector efficiencies, a number of overlapping factors must be present and operative – efficient processes and policies, economies of scale and scope, market competition, and effective risk allocation. Simply throwing money at infrastructure projects, particularly when public funds are used, is simply not a sufficient solution. Policymakers must make sure that the right amount of financing is available under the right conditions, assuming it is even possible to attract it. If the right projects are to be financed, institutional, as well as financial infrastructure, will be needed.

A project finance institute (PFI) is an entity, such as a think tank, that serves as an intellectual meeting ground for industry, academics, and governments concerned about the use of project finance in the development and construction of large infrastructure projects. The formal establishment of a PFI or similar type of institute to meet these expressed ends is, we believe, a concrete necessary step towards fostering the more reliable, efficient and economical development of infrastructure on a global basis. In this paper, we review why PFIs are necessary, discuss what functions such entities could serve, and make preliminary observations on their role, functions, and potential network architecture. Our conclusions highlight the desirability of planning and/or establishing such entities as quickly as possible, as well as further research into their full educational value to infrastructure development on a regional, national, and local basis.

2. Key Functions and Services Provided by Project Finance Institutes

While a PFI has no specialized purpose apart from spirit licensing and dedicated efforts to a focused activity, PFIs are typically established with a mandate to undertake a range of development tasks aimed at mitigating some of the imbalances market conditions causing weak project finance markets. These tasks include: gathering and promoting expertise, information and data, as well as codifying, analyzing and discussing project finance “best practice”; fine-tuning appropriate standardized legal documentation, and developing and disseminating model performance standards; creating promotion, educational and training materials and providing specialized training and technical advice; developing tools and rating systems for sponsoring states and utility creditworthiness; and offering arbitration facilities able to expedite contractual disputes. In order to develop the new skills for these tasks, PFIs maximize value by taking on complementary activities including promotion of new products or other innovations, underwriting and direct seeding of problem projects that are at early development stage while incorporating new practices, providing temporary ombudsman or locanter agent services, and benchmarking and performance measurement services, which can include credit ratings or ranking of efficiency or of other dimensions.

3. Case Studies: Successful Infrastructure Projects Financed by Project Finance Institutes

IFC approved loans totaling US$ 54 million and a $10 million equity investment for a series of three run-of-the-river hydropower projects located on the Se Don River in the Bolaven Plateau in southern Laos. Although Laos is a landlocked country, this project was provided by syndication loans from international commercial banks. This was the prototype of private sector participation in a hydropower project in Laos. Although no international financial organization was made an advisor of the project, the participating banks recognized IFC’s advice and financial support. Therefore, IFC took the leadership in forming the syndication for this project. Useful experiences were accumulated for the subsequent Nam Theum project.

3.2. The Bolaven Plateau Laos Hydropower Projects

The Banahin hydroelectric power plant is located in the Mountain Provinces of Northern Luzon, in the North Philippines, and came online as the first IPP hydroelectric project in the Philippines in July 1993. It is the largest foreign-financed IPP hydroelectric project in the Philippines. This project was developed on a BOO basis with an installed capacity of 60 MW. The company was capitalized by leading Japanese companies and financial institutions. The Overseas Economic Cooperation Fund (OECF) provided part of the company’s debt in yen, US dollars, and through a public offering.

3.1. Chico River Hydroelectric Project

4. Challenges and Opportunities for Project Finance Institutes

The operations of PFIs are eclectic and often idiosyncratic, and it is difficult to draw general lessons for emerging regions from the experiences of developed nations. The role of multilaterals and PFIs and the effectiveness of the default discipline exerted by PFIs derive primarily from their financial power. PFI-funded projects are often orders of magnitude larger than those financed solely by domestic banks, and the traditional reliance on collateral before lending makes no sense for infrastructure typically worth several times the value of the loan being used to finance it. These projects occupy a rather unique niche within the larger loan syndication market. Large projects are more difficult to monitor, but as the discipline provided by financial leverage becomes more important, the role of PFIs and multilateral institutions may become more critical.

The rapid growth of new project finance institutes since 1995 signals a growing consensus about the importance of international and local institutions in promoting long-term investment in developing regions. Poorly functioning or underdeveloped local institutions are frequently mentioned as a major cause of the lack of investment in infrastructure in emerging economies. While there is a general agreement about the desirable features of project finance, the empirical evidence is only beginning to be assembled. What is distinctive about project finance, and why is it appropriate for infrastructure investment? Does a better understanding of project finance tell us anything useful about how to spur investment in this sector? What do we know about the provision of project finance and the performance of institutions, including project finance institutes that have emerged to mediate among participants in the financial markets for infrastructure?

5. Future Trends and Innovations in Project Finance

A development that is already well advanced is the movement of project finance discussions further “upstream” in project design and planning cycles. While specialized financial and economic work of a general project preparatory nature can obviously be valuable in the absence of related project loans, the future might well see commercial (or even multilateral lenders) providing at least limited amounts of finance to pay for complex project design and structuring work. In fact, the advantages of spending (some) money to save (more) money or risk at a later stage can be used as strong arguments to justify this approach.

In terms of future trends and likely innovations in project finance, there are several areas where change and expansion are expected or demand is currently insufficient. Development can be expected to continue in the area of mezzanine finance. This form of finance is currently characterized by an essentially fill or kill, equity-like or debt-like negotiation process. It is often forced by the absence or at least scarcity of a market or institutional capacity for extending long-term finance. This genre of finance invariably contains somewhat less security and/or somewhat more flexibility than the straight equity or the senior debt tranches. There is some market interest in creating a standardized and perhaps ultimately even securitized tranche of mezzanine finance in size of up to 20 percent or 30 percent of an infrastructure project’s capital requirements.