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mai 2015

Project finance: non-recourse funding

Publié par Margaret ARMSTRONG (Doct P80) | N° 479 - FINANCEMENT DE PROJETS

Professeur de Finance, MINES ParisTech

Non-recourse funding is used to finance large projects such as power plants, bridges and autoroutes, water treatment and waste management plants, oil fields, LNG plants, mines and smelters. For example, the Ichthys LNG project located 200km offshore from West Australia was financed in this way. So was the Talifa Wind Farm in Jordan. The wind farm cost about 240 million euros; the budget for the Ichthys project is about $16 billion.

Special purpose company: risk mitigation

In non-recourse funding of projects, the revenues from the project are the main source of repayment of the financing package. Should the project fail, the banks and financial ins­titutions which have loaned funds have only limited recourse on shareholders or third parties. The financial package is usually granted to a special purpose company (SPC) which is devoted solely to running the project. To minimize the risk of failure the SPC sets up a network of contracts with all the par­ties involved as shown in Figure 1.

In order to carry out the project, the SPC needs the legal agreement of the government. For example, if the project is an oil field, it needs government permission to explore the area and then to exploit the reserves. The Ichthys project plans to construct an LNG pipeline 890 km long from the oilfield to Darwin, where it will construct an LNG plant to compress the gas for export to Japan and Korea. All of these require permits which must be in place before the lenders agree to provide the funds. Next the SPC sets up a contract to build the project – usually this is a turn-key contract where a contractor tenders to construct the project for a fixed fee within a given time.


Margaret AMSTRONG (Doct P80)

After having completed a Masters in Mathematical Statistics at the University of Queensland in Australia,Margaret Armstrong came to France to do a doctorate in Geostatistics at the Ecole des Mines de Paris

From 1980 to 2000, she worked as a researcher in mining geostatistics at the Centre de Géostatistique at Fontainebleau; then she and Alain Galli moved to the Cerna in Paris where they set up the quantitative finance group. They are in charge of teaching the intensive 1-week

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Figure n°1 : Margaret ARMSTRONG (Doct P80)

course on Project Finance which attracts about 35 students from leading engineering faculties all over Europe as part of Athens Week.


The Increasing Role of Multi-lateral Agencies and Export Credit Agencies in Project Finance

Since the global financial crisis in 2009-2010, traditional com­mercial banks have been unable to finance projects to the same extent as earlier, and so multi-lateral agencies such as the IMF, the EIB, the EBRD and the various developments have been playing a much more important role. So have export credit agencies (ECAs). The Ichthys project is a good example of this. The two main sponsors are Total (30%) and the Japanese oil company, INPEX (66%). As Japan lacks natural resources, securing stable long-term supplies of key resources is vital for the country.

The financial package was set up by JBIC (the Japanese Bank of International Development) with strong support from all the main Japanese banks. ECAs provided $5.8 billion in direct loans and they insured and/or guaranteed more than $10 bil­lion in loans from commercial banks. The main ECA involved was the Japanese ECA (NEXI) but the Korean Export-Import Bank (KEXIM), the Korean Trade Insurance Corporation (K-sure), and the ECAs from Holland (Altradius), Germany (Euler Hermes) and France (COFACE) also participated.


The Gefyra Bridge in Greece

The Greek company Gefyra S.A. was set up by VINCI and six Greek construction companies in order to sign the contract for the concession for the Rion-Antirion bridge, which crosses the 3km wide Corinth Gulf Straights. In its role as concessionaire Gefyra S.A. was responsible for designing and constructing the bridge, and for operating and maintaining for a period of 42 years. To do this it signed more than 50 contracts. The most important ones were the one with the Constructor and the financial package with the Lenders. The total cost including financial costs during construction was 800 M€: 42% State Financial Contribution, 10% in equity from the shareholders plus a loan 48% from the European Investment Bank (EIB). During the construction period, the Concession holder had

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Figure n°2 : Figure 1: The contractual links between the special purpose company (SPC) and other companies

to guarantee the financial equilibrium of the project and its day-to-day running costs.

The bridge is the longest multi-span cable-stayed bridge in the world with 2,252m of continuous and fully suspended deck on a high seismic environment. It was opened 5 months ahead of schedule on the eve of the 2004 Olympics. Before the bridge was opened, the travel time by ferry was 45 minutes; now it is just 5 minutes.


The Equator Principles for addressing Social and Environmental Risks

Projects such as mining, building a dam and making bio-fuel (from palm-oil) may negatively impact biodiversity. Power generation projects raise the issue of climate change. The location of pipelines and infrastructure may be critical (e.g. in sensitive areas such as rainforests). In developing countries, social impacts are sometimes huge and may not be adequately addressed (e.g. displacement of populations, forced or child labour, poor working practices).

Over the past 20 years, society as a whole has become more conscious of these issues which have been taken up by different NGOs. The so-called “social licence to operate” is essential. From the lender’s point of view, the environmental and social impacts of projects can turn into a credit risk. Delays linked blockades, legal action or accidents can be costly. Increased operating costs due to penalties or to rehabilitation costs can make projects unprofitable. They can also lead to reputation risk for the lenders involved. Since project finance requires extensive due diligence the environmental and social aspects can be included in this process together with other considerations (technical, marketing, legal, etc). Social and environmental covenants can be included in the loan documentation.

The Equator Principles are a voluntary, private industry initia­tive set up a group of commercial banks to address these risks. There is no formal legal obligation or any monitoring agency, but starting out from a small group of banks in 2003, the group now includes all the main banks involved in project finance. The constraints apply to:

  • Project finance with a capital cost of $10M or more (since June 2003)
  • Project

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Figure n°3 : Figure 2: two of the four spans of the Gefyra Bridge in Greece

finance advisory services (since July 2006)
  • Some project-related corporate loans (over $100M, with an initial commitment of $50M) since June 2013
  • Bridging loans (since June 2013).
  • The IFC which is a member of the World Bank Group had developed environmental and social standards and guidelines that are used for the Equator principles.

    Advantages and Disadvantages of Project Finance

    The detailed analysis of all aspects of the project (technical, economic, legal,...) is one of the advantages of project finan­ce. External consultants are called in to check the assumptions used by the sponsors. All of the project risks are identified and are attributed to the partner who is best able to handle that risk so as to minimize the risk/reward ratio for all parties. An economic model is set up and is used to track the project’s performance over the whole of the project life.

    The additional time and effort required in the due diligence process generates extra costs and makes the process lengthy. The reporting constraints during the construction and the operating phase are another disadvantage. As the lenders do not have recourse to the sponsors, the borrowers have to pay a higher spread (i.e. interest rate) than for a corporate loan. Having said that, projects such as the Ichthys project that are too large for corporate finance can be funded using project finance.

    The example of Rion-Antirion Bridge in Greece proved that the Project Finance Model is robust, since its was able to withstand the Greek financial crisis with a drop in traffic up to 40% in the last five years.

    Through the complexity of the contract documents and due diligence processes of Project Finance structure a better balanced, clear and fair allocation of risks is achieved. ■

















    Margaret ARMSTRONG (Doct P80)

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