global project finance

global project finance

The Dynamics of Global Project Finance: Strategies for Success

1. Introduction to Global Project Finance

The principal financial factors that distinguish project finance and investment under such circumstances are: (1) the identification and quantification of the risks and rewards attached to the project; and (2) the development of optimal financial vehicles to allocate and manage the financial assets. The project sponsors must be willing to pay for such costs as well as the opportunity costs attached to the real and financial opportunities foregone. The consequences of such opportunity costs can be measured in terms of an appropriate discount rate which not only incorporates the time and quantity value of the sponsors’ funds, but also the relative riskiness of the project income stream. It is vital, therefore, for those involved in making and evaluating project finance decisions to have a firm understanding of all risks and returns involved. Failure to do so could result in disastrous consequences, not only for the individual project itself, but also for its impact on the credit and credibility standing of the project sponsors.

Project finance is designed to enable a project to be developed as a separate legal entity and to be self-supporting while construction takes place and the demand for project outputs is proven. The equity required for the project can be raised from a variety of sources and institutional debt lenders, multilateral financial institutions, and export credit agencies are often willing to provide low cost, long-term funds to the project without recourse to the parent sponsors. As such, international project finance has been widely used by project sponsors to finance investments requiring high upfront costs, long gestation periods, and extreme exposure to various financial, political, and social risks. In addition, international project finance has often been used as a tool for horizontal and vertical financial disintermediation across sectors, countries, and institutional constraints. The rewards to project sponsors have likewise been substantial, both through taxes and through the accruing returns on equity invested.

2. Key Players and Stakeholders in Global Project Finance

Project finance is a particularly rewarding method of maintaining positive cash flow and securing non-recourse financing. It can be the lifeblood of the expansion of the global energy and mining industries. Since a higher percentage of project financings are held by institutional investors, including pensions and life insurance companies, private investors are the ultimate beneficiaries of these internally-generated funds. Managed funds invest on behalf of beneficiaries, namely individuals, employees, and beneficiaries of life insurance policies and pensions. Whether “managed money” is invested domestically or internationally, these individuals are well-represented around the world.

Project financings are large and complex, with each one being unique. However, there are several categories of key players and stakeholders that exist in most transactions. The focus of this work is on the roles of the borrowers, sponsors, project entities, banks, export credit agencies, and lenders in making each deal work. This will allow the readers to fully appreciate the dynamics of these interactions and ultimately enhance the value of their project financing experience.

3. Risk Management and Mitigation Strategies in Global Project Finance

Risk. General principles require risk to be carefully managed under a project finance structure because project promoters and organizers do not wish to find themselves in a position of financial obligation for project performance but, rather, seek to create the circumstance at the time of financial close where it is the project itself which has the ability to repay debt under stressed circumstances. It is this philosophy of risk management which distinguishes a project finance structure from some others, and it is this commitment to a risk transfer theme which motivates and leads financial arrangements throughout the procedures described in this book. It must be stated that the principal point of difference where project finance forms part of a total corporation financing portfolio is for there to be a clean separation of projects and their risks and obligations from other corporate activities. Whether this separation is made by corporate organization, physical segregation of assets, full economic or limited; all transportable rights to enterprise, or some other method of isolation, a clear break has to be made. It must be clear to the external money market and to the stakeholders in the enterprise that any lack of total commitment to the project by one or more participants up to the full amount of equity provided is not acceptable.

Chapter 3 discussed general principles of risk, with special emphasis on practitioner objectives in assessing and mitigating risk in project finance. We outlined the basic financial structuring of the project “vehicle” and discussed the allocation of risks. We identified the principal risks, classified them using broad headings and sub-categories, and attempted to rank the relative importance of categories of risks. There was a section on the commercial strategy “v(s)- Plan” reflecting the fundamental principles of success in global project finance. Finally, Chapter 3 described the primary “tools” available to practitioners for the assessment and mitigation of risk in global project finance.

4. Emerging Trends and Innovations in Global Project Finance

The energy, telecommunications, and transportation sectors, which are typically the focus of project finance activity, embody many of the most active markets involving multinational companies. The protection, financial performance, and market penetration strategies that underlie direct investment by multinationals in these sectors—the prudence of financial performance, government support, commercial ties, politics, and regulations—hold important lessons for long-term project finance success. Indeed, these lessons apply in different degrees to each of the four general groups of investors that participate in project finance—sponsor/developers, commercial banks, export credit agencies, and multilateral and international development institutions.

As competition in traditional markets for project finance loans grows, project sponsors are increasingly turning to an expanded universe of less-traditional providers of debt and equity project finance, including domestic private companies and foreign multinational corporations. This globalization of the project finance market, along with the pavement of direct investment in infrastructure by companies and multilateral development institutions, underscores the richness and complexity of project finance opportunities. It creates significant opportunities as well as risks for both corporate investors and their international advisors.