Why The World Needs Project Finance (And Project Finance Lawyers…)

"Any fool can make something complicated. It takes a genius to make it simple."

- Woody Guthrie

The financial crisis exposed weaknesses in a number of structured finance products (such as collateralised debt obligations, structured investment vehicles and certain derivatives) and business models that were, in essence, arbitrage plays, heavily dependent on shortterm debt funding to finance portfolios of long-dated, illiquid investments. By way of contrast, project finance has proved itself to be an asset class that has demonstrated the intrinsic value of productive tangible assets, extensive due diligence, strong collateral packages and transparent financial structures that have become increasingly relevant post financial crisis.

Despite the recent market volatility, there remains a pressing need throughout the world for large-scale investment in infrastructure across a broad spectrum of industries (in particular in emerging markets such as Africa). Large-scale project finance typically focuses on "greenfield" projects in sectors ranging from power generation (conventional, nuclear and renewables) to transmission, oil and gas, petrochemicals, infrastructure, mining and telecoms. Global economic growth and demand for energy and commodities is a major driver for capital investment in these sectors and notwithstanding recent market volatility, the economies of fastgrowing countries such as Brazil, India and China have underpinned the upward trend in energy and commodity prices. Some of the largest projects in the world are currently being developed in emerging markets: projects involving capital expenditures of $10 to $30 billion are moving forward in countries such as Saudi Arabia, the United Arab Emirates and Malaysia.

The increase in global competition for resources has led to a corresponding increase in the size and complexity of infrastructure projects. Today's governments, institutional investors and the private sector are unable to shoulder the burden of financing projects of this scale alone. This means that large-scale infrastructure projects are now financed using ever more sophisticated and complex financial instruments, which are, in turn, provided by an increasingly diverse pool of public and private finance institutions. In recent years, project financiers and sponsors have become adept at mobilising these diverse sources of finance and developing innovative structures combining commercial banks, capital markets investors, Export Credit Agencies ("ECAs"), Multilateral Development Finance Institutions ("DFIs"), Islamic banks, loans sourced from government-affiliated lending institutions and, in recent years, debt and equity from infrastructure and private equity funds - the latter becoming increasingly important, even in emerging markets. As a result of this seismic shift in the financial landscape, project finance lawyers require a degree of familiarity with a range of financial instruments, including commercial

bank loans and conventional capital markets instruments, domestic government-funded loans, export credit and multilateral agency loans and guarantees and Islamic Shari'ah-compliant financing structures. Whilst providing desperately needed sources of liquidity, this diversity of finance and financing structures (combined with the expansion of project finance into new industry sectors and jurisdictions) has meant that the accompanying legal issues have become progressively more complex. Notwithstanding this complexity, a combination of proper legal frameworks, sound commercial structures and robust collateral packages have helped ensure that these new structures have been welcomed and effectively integrated into the project finance market.

The financial crisis demonstrated that the key to a successful project financing (or, indeed, financing of any nature) is due diligence. A full awareness of the risks inherent in a particular project and its host country (and who bears which of the many costs involved in financing a project) is the first step in identifying mitigants to those risks. A project finance lawyer must be fully conversant with evershifting market trends as well as the project company's business because, in order to advise their clients on the risks associated with a project, they will need to have first considered all aspects of the underlying project. Only once a comprehensive analysis of the underlying project has been undertaken, from the security of its feedstock and fuel supply right through to any potential political, regulatory, legal and environmental issues, will it be possible to identify the material risks to that project's future success.

Having considered the technical, political and legal risks of the project, a lawyer will then use this expertise to help the parties structure the project and its financing, secure consensus as to how those risks should be mitigated and, finally, accurately reflect the parties' agreement in the underlying project agreements and financing documentation.

Before we consider further the all-important question of why the world needs project finance lawyers, we have set out below some key issues that any participant in a project financing should consider.

A Brief History of Project Finance

Although project finance techniques are applied throughout the world today in a wide range of industries, project finance can trace its roots back to ancient Greece and Rome where it was used to finance maritime operations and infrastructure development (shipping merchants utilised project financing techniques to dilute the risks inherent in maritime trading as loans would be advanced to a merchant on the basis that the loans would be repaid through the sale of shipped cargo; in other words, the financing would be repaid by the internally generated cash flows of the project). Project finance in the Civil Law jurisdictions of continental Europe (in the form of "public private partnerships") can find their origins in the Roman concession system. Project finance in the Anglo-American world came to prominence in the mid-20th century in the United States where it was used to finance mining and rail companies and evolved into its modern incarnation in the 1980s when it was principally used by commercial banks to finance the construction of natural gas projects and power plants in Europe and in North America following the 1978 Public Utility Regulatory Policy Act. Project finance techniques developed in the 1980s were subsequently honed in the 1990s in emerging markets such as the Middle East, Latin America and Asia. In the 1980s and 1990s, project financiers and sponsors (the term used to describe the ultimate owner of a project company) were predominantly based in London, New York and Tokyo.

Until the financial crisis, commercial banks had dominated the project finance lending market; however, in recent years there has been a dearth of liquidity from such institutions (an issue further amplified by the application of the Basel III framework, which means that commercial banks now have to assign a higher percentage of their liquidity to back long-tenor commercial debt financing). As a result, many sponsors have had to look elsewhere to find sources of finance and in recent years we have seen many new entrants to the project finance market, including commercial banks from Asia, the Middle East and Latin America as well as larger roles for ECAs and DFIs. Due to funding pressures facing commercial banks, ECA direct financing has become an increasingly important feature for emerging markets' greenfield infrastructure finance. Finance has also been forthcoming from the Islamic finance market and (for the largest projects) the bond markets. A number of the institutions that have stepped in to fill the funding gap left particularly by European banks (such as Japanese commercial banks) appear to have access to relatively deep pools of lower cost dollar funding, low exposure to sovereign debt and are aggressively seeking to expand their project finance loan portfolios.

The involvement of an ECA in a project financing can be invaluable, not least due to their provision of either (or both) direct loans and credit protection for the development of projects, but also because ECAs act as important anchors and facilitators to attract commercial banks to club deals or syndications where banks would otherwise be hesitant to participate due to risk allocation or credit concerns. Similarly, the involvement of a DFI (such as the African Development Bank, the Asian Development Bank or the International Finance Corporation) can also be critical in providing a so-called "halo" effect for a project.

Although...

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