What is Project Finance?
Project Finance is the financing of, often long-term, industrial projects and increasingly those which provide public services or infrastructure. They are often based upon complex financial and contractual structures commonly involving many legal entities.
The cashflows from the project are usually the sole means of repayment of the borrowed funds, so the risk of the transaction is generally measured by the creditworthiness of the project itself rather than that of its owners (Sponsors).
Project Finance debt is often termed as “non-recourse.” The debt is typically secured by the project assets and the core project contracts.
Practically there are two main types of Project Financing:
- Greenfield – a fresh start
- Brownfield – expansion of an existing project
History of Project Finance
Project Finance has been recorded as being used by the Romans and Greeks as solutions to raise funds to export goods to other parts of the known world. It was also used for the development of the Panama Canal, but really gathered momentum in the 1980′s and 90′s when the ability to analyse complex cashflows increased in line with desktop computing power and availability.
During the 1990′s and 2000′s, governments grasped the opportunity to have the private sector assist in the development of assets and services under the PFI/PPP umbrella. In essence, there is little difference between Project Finance and PFI/PPP but the two approaches vary greatly when debt pricing, debt tenor, documentary and often transaction size and frequency are compared.
Project Finance is a core service of Developmental Banks and in them doing so often facilitates companies developing projects in transitional and emerging markets where traditional bank finance would be practically impossible.
The Risks
Project Financing is all about identifying risks, allocating them appropriately and ensuring that the responsible parties are adequately incentivised to manage their risks efficiently.
With often billions of dollars on the line, multiple parties involved, including sponsors, contractors, suppliers, host governments and global financiers, it is no surprise that from the inception of an idea to Financial Close, a Project Finance deal can take years to negotiate. Just some of the risks usually considered are:
- Construction time, costs & specification
- Operational cost, reliability
- Supply reliability, quality, cost
- Off-take volume, price
- Political environment, war, local hostility, currency inconvertibility
- Labour quality, availability
- Socio-environmental responsibilities
- Legal, documentary and tax risk
- Modelling and analytical risk
- Macroeconomic risks
Who is involved in a project financing?
A typical Greenfield Project Financing involves many different parties, including:
- Sponsors to ‘champion’ the construction of the asset
- Construction parties to build the asset
- Certifiers – to confirm it is built to specification
- Lead Arrangers / Underwriters – to provide primary debt funding
- Syndicated Lenders – to reduce the exposure of the lead banks
- Insurers – to cover many of the insurable risks
- Consultants – to provide expert opinions and services as needed
- Lawyers – to ensure the required contracts / agreements are in place
- Off-take parties – to secure the sale of the end product or service
The role of consultants in Project Finance is extensive and varies from project to project, but common to most transactions are experts in the following fields:
- The particular market of the product
- Financial Modelling (and Model Auditors)
- Environmental
- Engineering
- Process Design and Costing
- Insurance
- Economists
- Industrial Relations
- Government liaison experts and lobbyists
What are the drawbacks of using Project Finance?
Project Finance is a great solution to many funding requirements; however it does have several drawbacks, including:
- Generally only used for special projects rather than corporate finance
- Long transaction time
- High fixed transaction costs owing to number of parties
- Highly restrictive covenants and security constraints
- Robust financial analysis needs to be performed and validated
- Frequent monitoring of financial performance
- A payment default usually passes ownership / control to the lender(s)
Who provides it?
Project Finance Debt is provided in many forms by hundreds of companies around the world. It is traditionally sourced from:
- Investment Banks
- Commercial Banks
- Infrastructure Funds
- Government Export Credit Agencies
- Development Banks
- Multilateral Agencies
- Hedge Funds
Standard Bank, one of the largest banks in Africa by assets and earnings offers full spectrum of project finance products and leading capabilities in Africa.