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
Politicial 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 benefits of using Project Finance?
There are many benefits to funding a project with a project finance package, these are namely

Comparatively low finance cost
Does not impact the Balance Sheet of the sponsor (“Off Balance Sheet”)
Widely available around the world
Debt Capital Markets are ’Deep’ ~ 20 Trillion US Dollars in 2006
Most risks have well understood structural solutions available
Well organised and reputable providers

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