Project Finance for Public-Private Partnership Continuum
The Project Finance is to financing of Long-term Infrastructure, Industrial projects or Public Services based on Non-Recourse or Limited Recourse structure, where debt and equity are used to fund establishment and paid back from the cash flow generated by the same project.
One of the most common – and often most efficient – financing arrangements for PPP projects is “Project Financing”, also known as “limited recourse” or “non-recourse” financing. Project financing normally takes the form of limited recourse lending to a specially created project vehicle (special purpose vehicle or “SPV”) which has the right to carry out the construction and operation of the project. It is typically used in a new build or extensive refurbishment situation and so the SPV has no existing business. The SPV will be dependent on revenue streams from the contractual arrangements and/or from tariffs from end users which will only commence once construction has been completed and the project is in operation. It is therefore a risky enterprise and before they agree to provide financing to the project the lenders would ask to carry out an extensive due diligence on the potential viability of the project and a detailed review of whether the project risk allocation protects the project company sufficiently. This is known commonly as verifying the project’s “Bankability”.
The project is unlikely to generate revenue until the operations period and so it is going to be key to lenders and other investors that the revenue stream is certain and that forecasts of revenues are accurate. Future forecasts of demand, cost and regulation of the sector in any relevant site country will be important to private sector investors considering the revenue prospects of the project. The Project Participants must ensure that the project has received all necessary approvals from the host government and any local authorities, and that the government will not change its regulation of the project’s operation in such a way as to inhibit the project development and production plans, or the revenue stream. This risk is often difficult to manage in particular in countries with developing or highly volatile legal and regulatory structures. The project structure should be reasonable and flexible, especially where the project in question is to continue over a long period, as the incentive mechanisms may need to change to ensure efficiency as the project evolves over time.
Typical Project Finance Structure
The Typical Project Financing Structure (simplified for these purposes) for a build, operate and transfer (BOT) project and very closely Public-Private Partnership (PPP) project is shown below. As can be seen, there are a number of contracts and the arrangements are complex. The interrelation between the different parties needs to be carefully provided in the agreements. The key elements of the structure are:
– Project Company / Special Purpose Vehicle (SPV) with no previous business or record;
– Sole activity of project company is to carry out the project, it then subcontracts most aspects through construction contract and operations contract;
– For new build projects, there is no revenue stream during the construction phase and so debt service will only be possible once the project is on line during the operations phase (parties therefore take significant risks during the construction phase);
– Sole revenue stream likely to be under an off-take or power purchase agreement;
– There is limited or no recourse to the sponsors of the project (shareholders of project company are generally only liable up to the extent of their shareholdings);
– Project remains off-balance-sheet for the sponsors and for the host government.
Project Financing may allow the shareholders to keep financing and project liabilities off-balance-sheet. Generally, project debt held in a sufficiently minority subsidiary is not consolidated onto the balance sheet of the respective shareholders. This reduces the impact of the project on the cost of the shareholder’s existing debt and on the shareholder’s debt capacity, allowing the shareholders to use their debt capacity for other investments. Clearly, any project structure seeking off-balance-sheet treatment needs to be considered carefully under applicable law and accountancy rules. To a certain extent, Governments can also use project finance to keep project debt and liabilities off-balance-sheet, taking up less fiscal space. Fiscal space indicates the debt capacity of a sovereign entity and is a function of requirements placed on the host country by its own laws, or by the rules applied by supra- or international bodies or market constraints, such as the International Monetary Fund (IMF) and the rating agencies. Those requirements will indicate which project lending will be treated as off-balance-sheet for the government.
Recourse Financing gives lenders full recourse to the assets or cash flow of the shareholders for repayment of the loan in the case of default by the SPV. If the project or SPV fails to provide the lenders with the repayments required, the lenders will then have recourse to the assets and revenue of the shareholders, with no limitation. Project Financing, by contrast is “limited” or “non-recourse” to the shareholders. In the case of Non-recourse Financing, the project company is generally a limited liability special purpose project vehicle, and so the lenders’ recourse will be limited primarily or entirely to the project assets (including completion and performance guarantees and bonds) in the case of default of the project company. A key question in any non‑recourse financing is whether there will be circumstances in which the lenders do have recourse to part or all of the shareholders’ assets. The type of breach of covenant or representation which gives rise to this would typically be a deliberate breach on the part of the shareholders. Applicable law may also restrict the extent to which shareholder liability can be limited, for example liability for personal injury or death is typically cannot be limited.
PMGLOBAL Finance Services and Dedicated Team
PMGLOBAL provides services related to the valuation of a project in terms of the capital needed, risks associated with the project and other issues that need to be sorted out based on size and nature of industry by having a specialized group of people who have expertise in industry analysis and work towards providing optimum funding to any organization. Finance team members specialize to provide the services optimizing time and cost effective sources of finance for your project, be it Equipment Finance, Short or Long Term Funds structured in such a way so as to match the cash flows of the Company and the debt servicing capacity of the project or company, Trade Finance, letter of credit, External commercial borrowing, Structured Finance or any other products. PMGLOBAL Finance Team studies the options available, then sources the most beneficial route for our clients enabling us to deliver cost competitive structural solutions. And, the Target Group for project finance and economic consulting services is a diverse range of public and private sector clients, including utilities, municipalities, engineering and financial advisory firms, and cooperatives.
PMGLOBAL Finance Team also offers to our clients integrated concepts in the infrastructure and PPP sector and provide full service support on infrastructure and other projects – combining the sector and project experience of public procurement and construction lawyers with that of skilled finance and regulatory lawyers. In line with the large variety and the legal complexity of projects, our multidisciplinary practice also incorporates experts in other relevant disciplines, such as corporate and tax law.