Project Finance in Theory and Practice (eBook)

Cover 1
Contents 8
Foreword 14
Preface 18
Acknowledgments 20
About the Author 22
Chapter 1: Introduction to the Theory and Practice of Project Finance 23
Introduction 23
1.1 What Is Project Finance? 24
1.2 Why Do Sponsors Use Project Finance? 24
1.3 Who Are the Sponsors of a Project Finance Deal? 26
1.3.1 Industrial Sponsors in Project Finance Initiatives Linked to a Core Business 26
1.3.2 Public Sponsors with Social Welfare Goals 27
1.3.3 Contractor/Sponsors Who Develop, Build, or Run the Plant 28
1.3.4 The ‘‘Purely’’ Financial Investor 29
1.4 Overview of the Features of Project Finance 29
1.4.1 The Contractor and the Turnkey Construction Contract (TKCC) 30
1.4.2 Operations and Maintenance Contractor and the O& M Agreement
1.4.3 Purchasers and Sales Agreements 31
1.4.4 Suppliers and Raw Material Supply Agreements (RMSAs) 31
1.4.5 Project Finance as a Risk Management Technique 32
1.5 The Theory of Project Finance 32
1.5.1 Separate Incorporation and Avoidance of Contamination Risk 33
1.5.2 Conflicts of Interest Between Sponsors and Lenders and Wealth Expropriation 37
Chapter 2: The Market for Project Finance: Applications and Sectors 41
Introduction 41
2.1 Historical Evolution of Project Finance and Market Segments 41
2.2 The Global Project Finance Market 44
2.2.1 A Closer Look at the European Market 48
2.2.2 PPP Development 49
Chapter 3: Project Characteristics, Risk Analysis, and Risk Management 53
Introduction 53
3.1 Identifying Project Risks 54
3.1.1 Precompletion Phase Risks 55
3.1.2 Postcompletion Phase Risks 57
3.1.3 Risks Found in Both the Pre- and Postcompletion Phases 57
3.2 Risk Allocation with Contracts Stipulated by the SPV 67
3.2.1 Allocation of Construction Risk: The Turnkey (or Engineering, Procurement, and Construction„EPC) Agreement 67
3.2.2 Allocation of Supply Risk: Put-or-Pay Agreements 70
3.2.3 Allocation of Operational Risk: Operations and Maintenance (O& M) Agreements
3.2.4 Allocation of Market Risk 71
3.3 Summary of the Risk Management Process 83
Chapter 4: The Role of Advisors in a Project Finance Deal 85
Introduction 85
4.1 The Role of Legal Advisors in Project Finance Deals 86
4.1.1 Legal Advisor, Legal Advisors, and Law Firms: The International Part and Local Legal Counsel 87
4.1.2 Project Financing Development Stages and Impacts on the Role of Legal Advisors 88
4.2 The Role of the Independent Engineer in Project Finance Deals 97
4.2.1 Initial Due Diligence Reporting 98
4.2.2 Monitoring Realization of the Project (Engineering and Construction) 100
4.2.3 Assistance at the Time of Plant Acceptance 105
4.2.4 Monitoring Operations Management 109
4.3 Role of Insurance Advisors and Insurance Companies in Project Finance Deals 110
4.3.1 Rationale for Using Insurance in Project Finance Deals 111
4.3.2 When Should Insurance Products Be Used? 112
4.3.3 Areas Where the Insurance Advisor Is Involved 113
4.3.4 Types of Conventional and Financial Insurance Products Available for Project Finance Deals 115
4.3.5 Integrated Insurance Solutions„Structure and Content 119
4.3.6 Classification of Insurance Underwriters 120
Chapter 5: Valuing the Project and Project Cash Flow Analysis 123
Introduction 123
5.1 Analysis of Operating Cash Flows and Their Behavior in Different Project Life-Cycle Phases 124
5.1.1 Inputs for Calculating Cash Flows 127
5.2 Defining the Optimal Capital Structure for the Deal 138
5.2.1 Equity 140
5.2.2 Senior Debt 141
5.2.3 VAT Facility 143
5.2.4 Stand-by Facility 145
5.2.5 Identifying Sustainable Debt/Equity Mixes for Sponsors and Lenders 146
5.3 Cover Ratios 154
5.3.1 What Cover Ratios Can Tell Us and What They Can’t 156
5.3.2 Cover Ratios as an Application of the Certainty Equivalents Method 161
5.4 Sensitivity Analysis and Scenario Analysis 162
5.4.1 Which Variables Should Be Tested in Sensitivity Analysis? 163
Chapter 6: Financing the Deal 169
Introduction 169
6.1 Advisory and Arranging Activities for Project Finance Funding 169
6.1.1 Advisory Services 171
6.1.2 Arranging Services 174
6.1.3 Integration of Advisory and Arranging Services 175
6.2 Other Roles in Syndicated Loans 179
6.3 Fee Structure 179
6.3.1 Fees for Advisory Services 180
6.3.2 Fees for Arranging Services 181
6.3.3 Fees to Participants and the Agent Bank 181
6.3.4 Example of Fee Calculation 182
6.4 International Financial Institutions and Multilateral Banks 184
6.4.1 Multilateral Organizations 186
6.4.2 Regional Development Banks 193
6.5 Bilateral Agencies: Developmental Agencies and Export Credit Agencies (ECAs) 200
6.5.1 Developmental Agencies 200
6.5.2 Export Credit Agencies (ECAs) 201
6.6 Other Financial Intermediaries Involved in Project Finance 205
6.7 Funding Options: Equity 208
6.7.1 Timing of the Equity Contribution and Stand-by Equity and Equity Acceleration 208
6.7.2 Can Shares in an SPV Be Listed on a Stock Exchange? 210
6.8 Funding Options: Mezzanine Financing and Subordinated Debt 210
6.9 Funding Options: Senior Debt 216
6.9.1 The Base Facility 217
6.9.2 Working Capital Facility 217
6.9.3 Stand-by Facility 218
6.9.4 VAT Facility 218
6.9.5 Loan Remuneration 218
6.9.6 Loan Currency 219
6.9.7 Repayment Options 219
6.9.8 Refinancing Loans Already Granted to the SPV 223
6.10 Project Leasing 230
6.10.1 Valuing the Convenience of a Project Leasing 230
6.10.2 The Tax Effect 232
6.11 Project Bonds 233
6.11.1 Investors in Project Bonds 236
6.11.2 Various Categories of Project Bonds 237
6.11.3 Municipal Bonds 241
6.11.4 When Should Project Bonds Be Used? 242
6.11.5 Procedure for Issuing Project Bonds 246
Chapter 7: Legal Aspects of Project Finance 255
Introduction 255
7.1 The Project Company 256
7.1.1 Reasons for Incorporating the Project in a Project Company 257
7.1.2 The Project Company as a Joint Venture: Another Reason to Develop a Project in an SPV 258
7.1.3 The Project Company and Groups of Companies 259
7.1.4 Corporate Documentation: Articles of Incorporation 259
7.1.5 Outsourcing the Corporate Functions of the Project Company: How the Company/Project Is Actually Run 260
7.2 The Contract Structure 261
7.2.1 Before the Financing: The Due Diligence Report and the Term Sheet 261
7.2.2 Classification of Project Documents 264
7.2.3 The Credit Agreement 265
7.2.4 Security Documents: Security Interests and What They Do 287
7.2.5 Other Finance Documents 296
7.2.6 Project Agreements 300
7.3 Refinancing Project Finance Deals 307
Chapter 8: Credit Risk in Project Finance Transactions and the New Basel Capital Accord 311
Introduction 311
8.1 The Basel Committee’s Position on Structured Finance Transactions (Specialized Lending, SL) 312
8.1.1 Classes of Transactions Included in Specialized Lending 313
8.2 Rating Criteria for Specialized Lending and Their Application to Project Finance 314
8.2.1 Financial Strength 315
8.2.2 Political and Legal Environment 315
8.2.3 Transaction Characteristics 316
8.2.4 Strength of Sponsors 316
8.2.5 Mitigants and Security Package 316
8.2.6 Summary of Grading Criteria 316
8.3 Rating Grade Slotting Criteria of the Basel Committee and Rating Agency Practices 318
8.4 The Basel Accord: Open Issues 319
8.4.1 Effects of the Basel Proposal on the Syndicated Project Finance Loan Market 320
8.5 Introduction to the Concepts of Expected Loss, Unexpected Loss, and Value at Risk 326
8.6 Defining Default for Project Finance Deals 328
8.7 Modeling the Project Cash Flows 330
8.7.1 Defining a Risk Assessment Model 330
8.7.2 Identifying Project Variables and Key Drivers 331
8.7.3 Input Variables: Estimation and Data Collection 336
8.7.4 Estimating Project Cash Flow and Valuing Results 339
8.8 Estimating Value at Risk through Simulations 339
8.9 Defining Project Value in the Event of Default 341
8.9.1 Deterministic vs. Stochastic LGD Estimates 342
8.9.2 LGD Drivers: The Value of Underlying Assets vs. Defaulted Project Cash Flows 343
8.9.3 Restructuring vs. Default 343
Case Studies 345
Case Study 1: Cogeneration 345
C1.1 Situation 345
C1.2 Production Process 346
C1.3 Sponsors of the Deal 346
C1.4 Agreements Underpinning the Deal 347
C1.5 Financial Structure 350
C1.6 Conclusion: In Arrigoni’s Office 351
Case Study 2: Italy Water System 353
Introduction 353
C2.1 Business Plan of the Project 353
C2.2 Assumptions 354
C2.3 Capital Expenditure 356
C2.4 Financial Requirement and Sources of Financing 356
C2.5 Operational Period 359
C2.6 Economic and Financial Ratios 361
Appendix to Case Study 2: Structure and Functioning of the Simulation Model 363
Introduction 363
A.1 Breakdown of the Financial Model 364
Case Study 3: Hong Kong Disneyland Project Loan 381
C3.1 Background on Syndicated Bank Lending 382
C3.2 The Hong Kong Disneyland Project Loan 385
C3.3 Designing a Syndication Strategy 392
C3.4 Executing the Syndication Strategy 397
C3.5 Conclusion 399
Glossary and Abbreviations 401
References 417
Index 423