EUP 222

ENGINEERS IN SOCIETY

PROJECT FINANCE

Dr. Sharifah Akmam Syed Zakaria

School of Civil Engineering
Email: akmam@usm.my
Course Mapping We l e a d
 Course Outcome 3: (PO 12)
CO3: Able to carry out project
management and financial
management duties effectively.
PO12: PROJECT MANAGEMENT
AND FINANCE
 Topic Outcomes:
1. Introduction to Project Finance
2. Capital Budgeting
3. Analyzing Project Cash Flow
4. Capital Investment Decisions
 Topic Outcomes:
1. Introduction to Project Finance
2. Capital Budgeting
3. Analyzing Project Cash Flow
4. Capital Investment Decisions
 WHAT IS PROJECT FINANCE? We l e a d

The term Project Finance was developed by

bankers to refer to a particular method of
mobilizing corporate finance.
Projects that use this technique are highly
leveraged and financed by lenders with
limited recourse to the sponsor(s).
 We l e a d

Even if the project is not generating as much

cash flow as originally anticipated, the lenders
can expect to get paid if the cash flows from
the various other commercial activities of the
corporate entity remain robust.
In Project Finance, the lenders' sources of
debt repayment are limited to the discrete
cash flow and other assets belonging to the
project vehicle.
BENEFITS OF PROJECT FINANCE We l e a d

Well-capitalized corporations often select a

Project Finance structure to assist in
undertaking large debt commitments while
minimizing any direct impacts on the
companys financial status.
Important financial objectives sought by such
corporations/projects.
 We l e a d

Minimizing, as well as tailoring, the debt

commitment to be delivered to any one
particular project.
Negotiating risk-sharing arrangements that
are appropriate to the project being
developed, the primary purpose being to
move risk away.
Reducing taxes by using a limited partnership
or contractual joint venture structure to
implement the project
 We l e a d

Achieving diversification of exposure and

revenue among a (future) portfolio of
projects.
DISADVANTAGE OF PROJECT FINANCE
We l e a d

An adequate risk-sharing structure is often

difficult to put in place and almost always
creates unanticipated delays.
Lenders consider this type of finance to be
riskier and, hence, charge a higher risk
premium for associated loans.
Lenders insist on having greater oversight of
the project, and thus the sponsor(s) or project
management has less managerial discretion
over it.
 We l e a d

Documentation is lengthy and complex, and

costs a great deal to put into place.
MAJOR PARTICIPANTS IN PROJECT
FINANCING We l e a d

A greenfield development involves a large

number of project participants
 Sponsor(s) We l e a d

A project sponsor(s) may consist of an

individual but more often is organized as a
company. It usually has some previous
experience in the implementation and
operation of the project that is being
undertaken.
The sponsor(s) must demonstrate that it
possesses a previous track record and relevant
experience in the implementation and
operation of the facility that is to be built
and/or operated.
 Construction Contractors We l e a d

The construction contractor is the entity that

builds the project under an engineering
procurement and construction (EPC) contract,
the terms of which guarantee the fixed-price,
required specifications and schedule of
construction.
To achieve the contractual equivalent of
single-point responsibility, each contractor is
required by the lenders to cross-guarantee the
other's obligations.
 Lenders We l e a d

There are many types of lenders.

Multilateral and bilateral agencies.
Multilateral organizations encompass
organizations such as the World Bank,
International Finance Corporation (IFC) and
Multilateral Investment Guarantee Agency
(MIGA).
The term also includes regional development
banks such as the Asian Development Bank
(ADB) or the Inter-American Development
Bank (IADB).
 We l e a d

Commercial lenders. The commercial lenders

are commonly private banks, insurance
companies, credit corporations and other
financial institutions, based either abroad or
in the host country.
In higher income emerging market and
industrialized countries, the largest part of the
debt financing mobilized for a given project is
forthcoming usually from commercial lenders.
 Insurance Providers We l e a d

The project sponsor(s) will procure all

insurance coverage required by applicable law.
In addition, the terms of the service
agreement and the requirements of lenders
often result in the need to obtain a broader
portfolio of insurance policies and coverage. In
some cases, sponsor(s) may seek additional
insurance coverage, such as political-risk
insurance, to protect their investment.
 Other Parties We l e a d

Depending on the project, there may be other

parties involved, e.g. third party equity
sources.
There are the project managers who are
designated by the active sponsor(s) to run the
facility as well as other parties who assist
during the development or operation period,
e.g. financial advisors, engineering
consultants, environmental advisors and
lawyers.
MAJOR PARTICIPANTS IN PROJECT
FINANCING We l e a d

A greenfield development involves a large

number of project participants
 Interest of the Major Parties We l e a d

Major parties to an infrastructure facility

located in a developing country will have
some basic interests, as described below.
Host government. The host government,
including its regulatory authority and its
ceding authority, typically will seek to protect
certain fundamental public interests, for
example:
 We l e a d

Provision and continuity of the infrastructure services.

Satisfaction of environmental protection, health, safety,
security and quality standards applicable in the host country.
Appropriate prices charged for the project services.
Non-discriminatory and fair treatment of customers and
users.
Appropriate level of disclosure of information on operations
and activities of the project vehicle.
Flexibility to meet changed conditions in the future.
Fitting the project in the current or anticipated future market
structure.
 We l e a d

Private sponsor(s). For private investors, certain

interests are fundamental, such as:
Ownership rights and/or protection of private
investment.
Timely issuance of consents and permits from
government at all levels needed to build and operate
the proposed facility.
Enforceable contracts.
Currency conversion and transfer.
Recourse to international arbitration, when needed.
 Principles of Risk Allocation We l e a d

Given the above interest of major parties, an

important part of any project is the allocation
of project risks.
By structuring risk appropriately, the project
participants can maximize the likelihood that
the project will be successful.
 We l e a d

Typically, governments are willing to accept political

risks in the host country:
legislative changes;
failures and interference of host government
authorities;
currency inconvertibility;
general strikes and other non-project-specific labour-
related interference;
political unrest; war and
similar events involving the host country, etc.
DIMENSIONS OF PROJECT FINANCE
IN DEVELOPING COUNTRIES We l e a d

Project Finance is common in industrial

countries however, is the cumulative
investment in infrastructure projects that has
taken place in developing countries during the
1990s.
Project Opportunities in Developing
Countries We l e a d

The information captures new investment in:

(a) telecommunications;
(b) power generation and transmission;
(c) natural gas trans-mission or distribution;
(d) passenger and cargo transport through air,
rail or road facilities; and
(e) other municipal infrastructure such as bulk
water treatment and supply, sewerage, solid
waste disposal and other similar facilities.
Recap - Type of projects and appropriate
method of financing: We l e a d

Project Finance:
Large, highly risky projects with cash
flows highly correlated with those of
sponsor.

Projects appropriate for high leverage

(those with predictable cash flows, low
distress costs, and minimal ongoing
investment requirements)
 We l e a d

Projects that are more transparent and

easier to monitor during construction,
development, and ongoing operations
(transparency can lower cost of capital by
facilitating credit decisions).
Projects with a structure that minimizes
overall costs associated with market
imperfections.
When it is possible and cost effective to
allocate the project risks contractually.
Projects whose cash inflows and outflows
can be set by long-term contracts.
 Project Finance We l e a d

For oil industry, production projects, rather than

exploration or development: Banks generally
reluctant to lend on project basis until the
underlying stock/flow is proven and capable of
production ( reducing variability and risk).
High risk projects such as first-time
investments in new industries, markets,
technologies: project finance may bring added
discipline and access to experienced partners.
Projects exposed to high degree of
sovereign/political risk may benefit from the
existence of outside lenders in project finance
structure: host governments cannot risk project
due to potential reaction from international
finance community.
 We l e a d

Project financing may help accommodating

critical partners (such as governmental
agencies) who cannot finance their shares
via corporate borrowing (Joint venture
projects).
Project finance is preferred when it results
in higher combined variance when added to
corporate portfolio.
When creation of an independent entity
allows project to obtain tax benefits not
available to sponsors.
END OF TOPIC OUTCOME 1 We l e a d

Topic Outcomes:
1. Introduction to Project Finance
2. Capital Budgeting
3. Analyzing Project Cash Flow
4. Capital Investment Decisions

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