50,99 €
Mehr erfahren.
- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Wiley Finance Editions
- Sprache: Englisch
Tackle infrastructure development projects in emerging markets with confidence In Project Finance: Applications and Insights to Emerging Markets Infrastructure, distinguished professor and author Paul Clifford insightfully applies the fundamental principles of project finance structuring to infrastructure investments in emerging markets. Using leading emerging market case studies to illuminate the underlying themes of the book, the author provides a practitioner's perspective and incisive analysis of concepts crucial to a complete understanding of project finance in emerging markets, including: · Risk management · ESG and impact investing · The emergence of new global multilateral development banks · China's Belt and Road Initiative Project Finance bridges the gap between theoretical infrastructure development, investment, and finance and the implementation of that theory with instructive and applicable case studies. Throughout, the author relies on a grounded and quantitative approach, combining the principles of corporate finance with straightforward explanations of underlying technologies, frameworks, and national policies. This book is an invaluable resource for undergraduate and graduate students in finance, as well as professionals who are expected to deal with project and infrastructure finance in emerging markets.
Sie lesen das E-Book in den Legimi-Apps auf:
Seitenzahl: 345
Veröffentlichungsjahr: 2020
Ähnliche
Table of Contents
Cover
Title Page
Copyright
Dedication
Preface
Acknowledgments
CHAPTER 1: Principles and Application of Project Finance
ORIGINS AND HISTORY OF PROJECT FINANCE
WHY SPONSORS USE PROJECT FINANCE
PROJECT FINANCE—ASSET CLASS PERFORMANCE
GLOBAL INFRASTRUCTURE OUTLOOK
THE INFRASTRUCTURE GAP IN EMERGING MARKETS
FOCUS—ASIA INFRASTRUCTURE NEEDS
ENDNOTES
CHAPTER 2: Project Finance—Risk Analysis and Mitigation
COMMERCIAL VERSUS CONTRACT VIABILITY
SPONSOR RISK
POLITICAL RISK
CONSTRUCTION AND COMPLETION RISK
OPERATION AND MAINTENANCE RISK
SUPPLY RISKS
RESERVE RISK
SALES/OFFTAKE RISK
APPROVALS AND PERMITS
SOCIAL AND ENVIRONMENTAL CONSIDERATIONS
FINANCIAL RISKS
FORCE MAJEURE RISK
ENDNOTES
CHAPTER 3: Project Finance Agreements and Loan Documentation
CONSTRUCTION CONTRACTS IN PROJECT FINANCE
OPERATIONS AND MAINTENANCE CONTRACTS IN PROJECT FINANCE
OFFTAKE CONTRACTS/CONCESSION AGREEMENTS
SUPPLY CONTRACTS
PROJECT FINANCE LOAN DOCUMENTATION
KEY LENDER PROTECTION MECHANISMS AND STRATEGIES FOR NEGOTIATING FINANCE AGREEMENTS
CHAPTER 4: Risks and Challenges of Project Financing in Emerging Markets
TRACK RECORD OF PROJECT FINANCE IN EMERGING MARKETS—THE ASIAN IPP EXPERIENCE
CURRENCY MISMATCH—LESSONS LEARNED FROM THE ASIAN CURRENCY CRISIS
HOW THE ASIAN CURRENCY CRISIS TRANSFORMED THE APPROACH TO PROJECT FINANCE
ROLE OF MULTILATERAL, BILATERAL DEVELOPMENT BANKS, AND EXPORT CREDIT AGENCIES
STAKEHOLDER ALIGNMENT ISSUES
MITIGATING POLITICAL AND SOVEREIGN RISKS
ENDNOTES
CHAPTER 5: Sources of Financing for Emerging Markets
MULTILATERAL DEVELOPMENT BANKS (MDBS)
BILATERAL DEVELOPMENT BANKS (BDBS)
EXPORT CREDIT AGENCIES (ECAS)
COMMERCIAL BANKS
POLITICAL RISK INSURANCE MARKET—BREACH OF CONTRACT AND NON-HONORING OF FINANCIAL GUARANTEES
PROJECT BONDS
EQUIPMENT SUPPLIERS AND FINANCING
INSTITUTIONAL LENDERS (INSURANCE COMPANIES, INFRASTRUCTURE FUNDS, PENSION FUNDS, PRIVATE EQUITY, AND SO FORTH)
STRATEGIES FOR MULTI-SOURCED FINANCING IN EMERGING MARKETS
ENDNOTES
CHAPTER 6: Financial Structuring and Debt Sizing
THE BORROWER/SPONSOR OBJECTIVES
LENDERS' OBJECTIVES
DEBT SIZING AND SCULPTING
FINANCIAL STRUCTURING—DEBT SIZING AND LOAN AMORTIZATION
LENDER RATIOS FOR DEBT CALIBRATION AND STRESS TESTING
CASH TRAPS AND SWEEPS
ENDNOTES
CHAPTER 7: Environmental and Social Governance (ESG)
SUSTAINABLE INFRASTRUCTURE PROJECT FINANCE AND INVESTING
EQUATOR PRINCIPLES
MULTILATERAL DEVELOPMENT BANKS AND ESG FRAMEWORKS
IFC IMPACT INVESTING PRINCIPLES
GREEN BONDS
SUSTAINABILITY PROJECT FINANCING AND UN SOCIAL DEVELOPMENT GOALS (SDGS)
UNLOCKING INSTITUTIONAL CAPITAL TO MEET EMERGING MARKET SDGS
ENDNOTES
CHAPTER 8: Emerging Markets, Project Finance Bonds, and Local Capital Markets
PROJECT BONDS VERSUS PROJECT LOANS
PROJECT BONDS INVESTOR BASE AND MARKET LIQUIDITY
LOCAL CURRENCY PROJECT BONDS AND PARTIAL CREDIT GUARANTEES/INSURANCE WRAPS
ENDNOTES
CHAPTER 9: China's Belt and Road Initiative
BACKGROUND AND SCOPE OF THE BELT AND ROAD INITIATIVE
CHINA'S FINANCING STRATEGY FOR BRI INFRASTRUCTURE DEVELOPMENT
EMERGENCE OF NEW MULTILATERAL DEVELOPMENT BANKS—FOCUS ON THE ASIA INFRASTRUCTURE INVESTMENT BANK
ENDNOTES
CHAPTER 10: Project Finance Market Developments and Finance Structures
MINI-PERM FINANCING STRUCTURES
BACK-LEVERED FINANCINGS FOR RENEWABLE ENERGY PROJECTS
INFRASTRUCTURE GUARANTEE PRODUCTS—BOND AND PRIVATE CAPITAL CREDIT ENHANCEMENT
ENDNOTES
Bibliography
Index
End User License Agreement
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Preface
Acknowledgments
Begin Reading
Bibliography
Index
End User License Agreement
Pages
iii
iv
v
xi
xii
xiii
xv
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
189
190
191
192
193
195
196
197
198
199
200
201
202
203
204
205
206
207
208
209
Project Finance
Applications and Insights to Emerging Markets Infrastructure
Paul D. Clifford
Copyright © 2021 by Paul D. Clifford. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993, or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data
Names: Clifford, Paul D., author. | John Wiley & Sons, Inc., publisher.
Title: Project finance : applications and insights to emerging markets infrastructure / Paul D. Clifford.
Description: Hoboken, New Jersey : Wiley, [2021] | Includes bibliographical references and index.
Identifiers: LCCN 2020033757 (print) | LCCN 2020033758 (ebook) | ISBN 9781119642466 (hardback) | ISBN 9781119642541 (adobe pdf) | ISBN 9781119642572 (epub)
Subjects: LCSH: Infrastructure (Economics)—Finance. | Project finance—Developing countries. | Economic development projects—Finance.
Classification: LCC HC79.C3 C575 2021 (print) | LCC HC79.C3 (ebook) | DDC 332.609172/4—dc23
LC record available at https://lccn.loc.gov/2020033757
LC ebook record available at https://lccn.loc.gov/2020033758
Cover image: © alexey_boldi/Getty Images
Cover design: Wiley
Marie
Preface
Infrastructure investment needs are forecast to be approximately $3.5–3.8 trillion per year through 2040, with over 60 percent of this demand in emerging markets. Indeed, infrastructure investment is a proven and critical enabler of socioeconomic development. Project finance provides the key financing paradigm for unlocking the investment capital required to deliver this growing demand for infrastructure investment, particularly in developing countries.
When I first came to this field through the private sector in the early 1990s, little was written on the subject, and I often found myself working and learning by doing. The genesis for this book derived from the insights I gained “in the trenches” along with my years teaching a bespoke infrastructure and project finance course to Columbia University MBA students. Project Finance: Applications and Insights to Emerging Market Infrastructure fills this knowledge gap between years of private sector experience and academic scholarship. It covers the fundamentals and principles of applying project finance structuring to emerging markets, supplemented and supported by seminal emerging market case studies, along with my own experience over 20 years advising, structuring, and executing project finance transactions in key developing countries across Asia, Africa, and South America. The book also addresses important current topics such as China's Belt and Road Initiative as well as new trends and developments in the project and infrastructure sector such as impact investing, UN Social Development Goals, the emergence of new global multilateral development banks, renewable energy, and green bonds. My hope is to offer an accessible, comprehensive introduction of the subject from a practitioner's perspective across students, academics, and public and private sector finance professionals involved with, or interested in, project finance and infrastructure investment in emerging markets.
I have structured the book into three major sections: an introduction to the foundational principles and key qualitative and quantitative project finance structuring tools, application of these techniques to projects in emerging markets, and finally a discussion on the current developments in the project finance market.
Introduction and general background on project finance along with discussion and insights on asset class performance and sizing the emerging markets infrastructure gap
.
Chapter 1
provides a brief history on the origins, uses, and applications of project finance, what defines project finance, along with an overview of the performance of project finance as an asset class and defining the infrastructure gap in developing countries;
Chapter 2
covers project finance risks and how to analyze, mitigate, and allocate those key risks to project parties. The Mozal, Mozambique, project case study demonstrates how effective project finance contract risk allocation is used to de-risk projects.
Chapter 3
addresses key project finance agreements, loan documentation, and project security along with the key loan structural features and term sheet negotiation strategies for lenders and investors. The Samba, Brazil, project case study highlights how a project finance security package and related structural features operate in practice.
Application and implementation of project finance in emerging markets, critical sources of financing, and financial modeling and important debt sizing quantitative techniques
.
Chapter 4
reviews the track record and key lessons learned from emerging markets project finance. The Dabhol, India, power project provides valuable insights on the risks and challenges for large-scale infrastructure projects in emerging markets.
Chapter 5
offers a comprehensive review of the main sources of project finance for infrastructure investments and the relative pros and cons with each source of financing. The Nam Theun 2, Laos/Thailand, project case study illustrates how superior execution of a complex multi-source project financing can be achieved.
Chapter 6
provides a primer on financial modeling from both debt and equity investor perspectives along with debt sizing, application, and interpretation of debt service coverage ratios and loan amortization techniques. The Sabine Pass LNG, USA, project highlights the effective use of bank loans and project bonds in the finance plan.
Discussion on environment, social, and governance, UN SDG's and impact investing, tapping debt capital markets and project bonds, the scope and objectives of China's Belt and Road Initiative, and new and emerging project finance structures and market trends
.
Chapter 7
addresses sustainable project finance and infrastructure investment, the origins and applications of Equator Principles by commercial banks, the current trends and developments concerning impact investing, ESG-linked lending, and green bonds. The Manzanillo, Mexico, project illustrates the important role played by multilateral development banks in addressing and mitigating ESG risks.
Chapter 8
covers debt capital markets and project bonds, the key institutional investors in project bonds, the merits and drawbacks of project bonds versus bank loans, as well as structuring and execution issues. The Mong Duong, Vietnam, project showcases a successful project bond refinancing in a frontier emerging market.
Chapter 9
focuses on China's Belt and Road Initiative, the scope and key components of the largest and most ambitious infrastructure investment initiative ever undertaken along with the strategic, commercial, economic, and financial objectives of China. The challenge of financing the Belt and Road Initiative is addressed along with a profile of the new multilateral development banks and other financial institutions established to assist with the required funding.
Chapter 10
spotlights a number of key project finance structures and market developments including the advent of min-perm structures, multilateral development bank credit enhancement guarantees to mobilize institutional investor capital, and back-levered debt structures.
Acknowledgments
The germ of the idea for this book was nurtured over many years and decades working with, and learning from, wonderful colleagues, friends, mentors, and peers. I will be eternally grateful to the many people who helped shape the contours of this volume, without whom it would not have come to fruition. Nikita Baryshnikov and Michael Whalen generously read, reviewed, and provided invaluable feedback, encouragement, and guidance throughout the development of this book. I would also like to thank Columbia University Business School for the opportunity and privilege to teach my project finance and infrastructure course: it provided the ideal forum to test and forge many of the principles and ideas in the book with a brilliant and engaging cadre of students. Thanks also to Columbia Business School MBA student Rafael Matos for helping with formatting certain charts and tables. I am immensely grateful for the assistance and support provided by McKinsey & Company, Standard & Poor's, The World Bank, the Asian Development Bank, the Global Infrastructure Hub, Refinitiv, and the Climate Bond Initiative for allowing me to draw on their research material for the book. A special thanks to friends and associates, in particular Sergio Sanz and Conor McCoole, for their wise counsel and advice. Thanks also to Susan Cerra, Samantha Enders, Richard Samson, Mike Henton, and all of the editorial team at Wiley Publishing for their unstinting commitment and support during the writing process. Finally, I would like to thank my family and friends, especially my wife and fellow academic and published author Laura, without whose encouragement, support, and belief this book would not have seen the light of day. To the rest of my family and my children Haley and Darcy for your unwavering support and love, which sustained me over the last year writing this book. Thank you one and all.
CHAPTER 1Principles and Application of Project Finance
ORIGINS AND HISTORY OF PROJECT FINANCE
Project finance is a highly versatile, if often misunderstood and misapplied, financing paradigm. There is no one single definition that succinctly captures project finance. Ostensibly, it is the long-term financing of infrastructure and industrial projects based upon the projected cash flows of the underlying project rather than the balance sheet of the project sponsors. Project finance refers to the financing of long asset life infrastructure, industrial and public assets, and services using non- or limited-recourse financing raised by an enterprise with a single line of business/finite asset life in accordance with contractual agreements.
Project finance is a tried and tested financial discipline that has been around for many centuries. The history and origins of project finance can be traced back to the 13th century when Italian banks financed a silver mine in Devon, England, with the loan repayment source being a lease over physical silver production from the mine. It has been used to finance maritime voyages to the new world in the 17th and 18th centuries with the merchant investors dividing the cargo spoils from returning ships. Project finance's application to infrastructure can be traced to the original construction of the Panama Canal and was key to financing wildcat upstream oil and gas investments in the early 19th century in the US along with the development of the North Sea oil fields in the 1970s and 1980s. The seminal market development that established the modern version of long-term contract-based project financing was the oil crisis in the US in the early 1970s. The fears and concerns over energy dependence forged the passage of the Public Utilities Regulatory Policy Act (PURPA) in the US in 1978. PURPA served to open the US electricity market to non-utility generators (NUGs) in an effort to increase energy supply, which heralded the origins of deregulation of the US electricity sector. PURPA essentially required vertically integrated monopoly utilities to purchase power from NUGs at their “avoided cost,” which is the cost a utility would pay to generate power itself. This opened the energy market up to what became known globally as the Independent Power Producer (IPP) market and created the ability to raise project financing on the back of long-term power purchase agreements with creditworthy electricity purchaser utilities.
WHY SPONSORS USE PROJECT FINANCE
Project finance is both a financing and a governance structure. It is based on the notion that project risks are identified upfront, allocated to those best able to bear them, and mitigated such that the residual risks are acceptable to lenders. While project finance risk analysis and mitigation is not unique to this asset class, the process of contractual allocation of risk is unique to project finance. Project finance is sometimes referred to as “contract financing.” The scope of the project along with the financing and security arrangements granted to lenders are set out in a comprehensive set of contractual documents entered into by the project company—and identified project risks are effectively allocated to those parties best able to bear them via these project contracts.
While there are many and varied reasons why project sponsors choose to use project financing versus on balance sheet corporate financing, according to Benjamin Esty it is to reduce capital markets imperfections or the net costs associated with the following:1
Transaction Costs:
Project finance deals generally take anywhere from 6 to 12 months to structure, negotiate, and execute the financing. The incremental legal, financial, and other costs associated with execution of the project financing can represent, on average, anywhere from 3% to 5% of total project costs. As such, transaction costs for project finance deals exceed comparable costs for corporate-financed deals.
Asymmetric Information:
Project finance capital providers to a greenfield infrastructure project—which is highly leveraged, thinly capitalized, and typically a single-asset special purpose company with no cash flows—require extra due diligence (independent consultants, insurance/legal advisors, and financial modeling), reporting, and controls (cash flow waterfall, financial and non-financial covenants, step-in rights, pledge of security/contracts, etc.). This reduces asymmetric information between lenders and owners/sponsors. The robust due diligence process that project finance lenders undertake also ensures that negative net present value (NPV) projects will not be undertaken as would be the case in corporate deals where project cash flows are co-mingled, fungible, and subject to cross-subsidizing between positive and negative NPV projects.
Incentive/Agency Conflicts
:
Project finance helps reduce incentive/agency conflicts due to higher leverage/risk of default and assignment of most of the project cash flows toward servicing debt. This dissuades stakeholders (shareholders, governments, construction companies, operators, etc.) from cash flow diversion actions that would negatively affect the project. The high risk and high leverage typical of project finance deals would normally mean investors and creditors would require higher risk adjusted returns (as measured by the internal rate of return, or IRR) and a higher risk premium on debt, which in turn requires larger project cash flows and heightens the risk of stakeholder interference and adverse actions. The contract structuring and associated risk allocation, which is the essence of project finance, serves to mitigate and reduce risk and therefore reduce required project returns by investors and creditors, which in turn lowers incentive conflict.
Financial Distress
:
Project finance reduces or eliminates project sponsor risk contamination as the legally independent special purpose vehicle (SPV) project borrower ensures the project debt is “off balance sheet” to the sponsor from an accounting treatment perspective. It is more difficult to achieve full “off credit risk” treatment as credit rating agencies typically take the view that the debt and the underlying project is an intrinsic and strategically core part part of the sponsor company's business operations. The sponsor would be viewed as never exercising its non-recourse rights (“walking away”) should the project default. It is one of the main reasons integrated oil and gas majors such as Xon and Chevron typically do not use project financing unless they need to accommodate a financially weaker joint venture partner or are seeking to mitigate country risk. However, it is exactly why a company like US IPP Calpine Corp with 95% debt-to-equity and a sub-investment grade rating was able to successfully raise $5 billion in project finance loans to construct 25 new power generation plants in the early 2000s.
PROJECT FINANCE—ASSET CLASS PERFORMANCE
Source: Refinitiv 2019 Global Project Finance Review.
The global project finance market is relatively small—the total project finance loan market amounted to $297 billion in 2019—relative to the US leveraged loan market ($1.6 trillion) or the US capital markets ($3 trillion).2 That said, project finance is a critical lynchpin for catalyzing and crowding in other forms of private sector capital (insurance companies, pension funds, infrastructure funds, sovereign wealth funds, private equity, etc.) along with development financial institutions (DFIs) such as multilateral and bilateral development banks and export credit agencies.
Source: S&P Global Market Intelligence, Annual Global Project Finance Default and Recovery Study, 1980-2014 (S&P Global Market Intelligence, 2016).
Notwithstanding that project finance involves financing a thinly capitalized, high leveraged single asset with no cash flows and material construction risks, it has proven to be a resilient asset class able to withstand adverse, unexpected external events. A Standard & Poor's (S&P) 2016 study analyzed project finance default rates and recovery from 1980 to 2014.3 The study covered over 8,000 projects across all industries and geographies. The S&P study revealed that the project finance annual default rate peaked in 2002–03 at around 4.8%; however, since then the annual default rate has averaged 1.5% per annum compared to 1.8% annual average default rate for secured corporate lending. The 2002–03 peak in project finance defaults resulted from the following coterminous macroeconomic events:
The 2001 Argentina sovereign debt default and currency devaluation, which negatively affected natural resource (mainly oil and gas) and power projects;
The 2002 US energy crisis resulting from the bankruptcy of Enron (at the time the largest corporate bankruptcy in US history), which caused the US and European energy markets to decline, resulting in increased project defaults and the demise of the merchant power sector;
The 2002 dot-com Internet asset bubble collapse, resulting in telecom corporate defaults (WorldCom, Global Crossing, etc.)
Source: S&P Global Market Intelligence, Annual Global Project Finance Default and Recovery Study, 1980-2014 (S&P Global Market Intelligence, 2016).
The S&P study found that the annual marginal default rate for the project finance deals correlated to a sub-investment grade double B rating in years 1–3 following financial close and trended toward single A investment grade by year 10. The study also confirms that highest project risk is in the first 3–5 years during the construction period and initial operational ramp-up. Default rates fall dramatically after year 5 as an operational track record is achieved and stable cash flows are established such that the 10-year cumulative default rate equates to triple B investment grade rating. Approximately 75% of all project finance loan defaults occur in the first 5 years. Annual marginal default rates decline dramatically after year 3–5, and by year 10 they are close to single A-rated corporate issuers. Not surprisingly the majority of project finance loan defaults occurred in the power sector (36%) due to the historic collapse of the US merchant power sector and effect of the Enron default as well as renewable energy loan defaults in Europe due to reduction/elimination of subsidies and feed-in-tariffs arising from fiscal austerity measures implemented by Spain and Italy and other countries in the aftermath of the 2008 financial crisis. Infrastructure project defaults were 24% due mainly to the spike in toll road loan defaults in European countries (Greece, Portugal, Italy, Spain) following the 2008 financial crisis. Despite thin capitalization, high gearing, and long loan tenors, project finance loans are structured to be very robust and resilient to a wide range of potential risk events and to minimize any post-default economic losses. The S&P study demonstrates that risk allocation, structural features, underwriting disciplines, and incentive allignments have proved effective. The key structural features of project finance loans that serve to reduce default risk include:
Effective Contractual Risk Allocation:
Construction risk is typically mitigated via fixed price, date-certain turnkey Engineering, Procurement, and Construction (EPC) contracts with performance guarantees and liquidated damages (LDs) or penalties for delay and performance shortfalls. Revenue risk is typically addressed via predictable, resilient cash flow streams based on long-term offtake contracts with firm take or pay obligations provided by strong, creditworthy offtakers. Demand/volume risk and price risks are typically risk transferred to the offtaker. Project finance lenders do not finance against the full term of the offtake contract and usually require a 2–3 year “contract tail” between the loan maturity date and the offtake contract termination date.
Covenant Structure:
Serves to control the project scope and constrains the project company against deviating from its core business activity. Protective forward-looking covenants, reserve accounts, cash traps/cash sweeps, dividends distributions tests, and other structural features mitigate liquidity risk. These measures serve to insulate the project from unexpected cash flow stress scenarios.
Project Due Diligence:
Lenders' advisors (independent technical consultant, market consultant, legal advisor, insurance consultant, etc.) produce due diligence reports identifying all risks and recommend risk allocation/mitigation. Effective risk allocation is materially achieved in large part via detailed due diligence and appraisal of project life cycle operational and maintenance costs. Detailed financial models are developed using lenders base case assumptions and stress test sensitivity analysis derived from the various due diligence reports. The third-party due diligence also ensures that negative NPV projects are not undertaken.
Detailed Terms Sheet and Negotiation of Financial Terms:
The rigorous and robust term sheet negotiations between lenders and project sponsors ensures that all risks are identified/allocated/mitigated such that residual risk is within acceptable parameters (i.e., bankable). The integration of the due diligence risk identification and the underlying project finance model provides a comprehensive basis for detailed negotiations and agreement on lending terms and conditions between project sponsors and lenders. This serves to ensure that all critical risks are clearly allocated and assigned such that residual risks that remain with the project borrower are acceptable to lenders.
Proactive Monitoring by Agents:
The scope of information reporting/monitoring in project finance is much greater compared to corporate lending. During the construction period, for example, project finance borrowers are typically required to furnish monthly construction reports to lenders, and in some cases the loan distributions during construction are subject to “cost to complete” tests by the lenders' independent engineer to ensure there are sufficient debt and equity proceeds available to complete the project. Physical and financial completion tests (typically 90 days) may also be required by lenders and subject to the independent engineer's sign off. Monitoring and reporting requirements during the operational period include quarterly financial reports, notice of any material changes or developments, compliance with negative and positive covenants, as well as financial covenant tests when the cash flow waterfall is run every quarter or semi-annually (minimum Debt Service Coverage Ratio, or DSCR, maintenance of a Debt Service Reserve Account, dividend distrubution tests, etc.).
The S&P study indicates that post-default project finance loans achieve a high loan recovery rate—averaging 79.5%, or almost 80 cents on the dollar—with ultimate loan recovery rates much higher for restructuring/workouts versus distressed loan asset sales. The loan recovery rates for project finance loans are almost twice the loan recovery rates of comparable secured corporate loans, which average 45%. Over 50% of project finance loan recoveries are in the 90–100% range with a median of 92%, so it is effectively a barbell distribution with some lenders recovering close to 100% while other lenders recover minimal amounts.
Project finance characteristics that mitigate loss given default (LGD) and result in higher post-default loan recovery rates include:
Covenant and Security Package:
Project finance lenders have a first-priority security interest in all project assets, shares, contracts, insurance policies, and cash flows. Allied to this, they also have a “step-in” regime (remedy, cure rights) pre-agreed with the project company's key project contract counterparties. This provides lenders with sufficient time to remedy a default (for example, replacing the project operator) and as a result, threshold covenants may be triggered before lenders incur any economic loss. Pre-agreed inter-creditor rights covering decision-making and voting rights in respect to enforcement and acceleration actions also serve to make the process more efficient.
Structural Mitigation:
The legal sanctity of the senior secured preferred creditor status of project finance lenders—and the ringfenced/bankruptcy remote nature of the project SPV—helps to ensure that other creditors cannot emerge during bankruptcy proceedings, or the administrative process of project shareholders or related project parties, and attach claims against the project assets and contracts.
Strategic or Essential Nature of the Project:
The robust nature of project finance structuring negotiations serves to achieve optimum stakeholder alignment and a balanced sharing of risk-adjusted returns across all stakeholders. The underlying philosophy that determines project success or not is essentially “If it's not fair, it's not sustainable.” There are many examples of failed projects that can be traced back to an unequal or imbalanced sharing of the project economics among shareholders. Many people think that the financing is concluded at financial close when the reality is that financial close is just the beginning. For any project to overcome the unexpected economic events that will inevitably happen, there needs to be strong stakeholder interest alignment and a mutual incentive to find ways to ensure the project overcomes these external shocks. The commercial, economic, and strategic alignment that underpins the importance of a project ensures that project structures have built-in incentives for project stakeholders to mitigate economic loss.
GLOBAL INFRASTRUCTURE OUTLOOK
Infrastructure investment is a critical enabler of social and economic progress and development. The socioeconomic return on infrastructure investment is approximately 20% according to a June 2016 study by McKinsey Global Institute.4 Thus, in effect, $1 of extra infrastructure investment increases gross domestic product (GDP) by 20 cents. The Asian Development Bank (ADB) arrived at a similar conclusion, determining that the elasticity of total output to infrastructure investment is 0.20–0.40.5 Yet despite the overwhelming evidence that infrastructure investment is a positive catalyst for improved capital and labor mobility, as well as increased productivity and knowledge transfer within and across economies, emerging market countries in Asia and Latin America—as well as the developed economies of the US and Europe—show a widening gap between actual, current infrastructure spending and infrastructure needs. Several industry estimates suggest that the global investment spend on infrastructure is approximately $2.5 billion per annum versus the $3.5–3.7 billion per annum estimated to be required to support and underpin current and projected economic growth.
The Global Infrastructure Hub estimates infrastructure needs at $94 trillion between 2016 and 2040, or $3.7 trillion per year, equivalent to the annual GDP of Germany.6 This is 19% or about $18 trillion higher than current infrastructure spending trends. Globally, we are currently allocating about 2.5–3% of GDP toward infrastructure spending when we need to be allocating 3.4–3.7% of GDP to meet future economic growth. Meeting the UN's Sustainable Development Goals (SDG's) for drinking water, sanitation, and access to electricity will require a further $3.5 trillion of infrastructure investment by 2030.7 Asian economies represent the greatest infrastructure investment requirements from 2016–2040 at over 54%, of which China is 30% or $28 trillion of the total.
Source: Global Infrastructure Hub, Global Infrastructure Outlook, Global Infrastructure Hub, Global Infrastructure Outlook, (Global Infrastructure Hub and Oxford Economics 2017).
Source: McKinsey Global Institute, Bridging Global Infrastructure Gaps.
While Asia and particularly China have the largest infrastructure needs, these economies are outspending the rest of the world; Asia is investing on average about 5% of GDP on infrastructure compared to 2.5% in the case of US, Europe, and Latin America. In fact, China spends more on infrastructure as a percent of GDP than the United States, Canada, and Western Europe combined.8
A major cause for the widening infrastructure gap in emerging markets is increases in public debt to GDP, which constrains public financing options, while many Western economies have significantly reduced infrastructure spending due to fiscal austerity following the 2008 financial crisis. Measures that could increase the flow of private sector institutional investor capital toward infrastructure investment and unlock part of the estimated $120 trillion of institutional capital across banks, pension and insurance companies, infrastrucure funds, and private equity along with sovereign wealth funds include:
Accounting treatment—changing the way that governments account for infrastructure spending by depreciating the cost over the project life cycle versus incurring as an upfront budget expense;
Better pipeline of well developed/bankable projects—more effective and efficient project selection/management, land acquisition/permits in place along with a one-stop shop national infrastructure agency that prioritizes which projects will proceed;
Improved risk-adjusted returns for investors—many projects are awarded based on lowest construction cost bids versus total life cycle costs. Ultimately cost overruns are passed on to, and borne by, taxpayers;
Bundling infrastructure assets to address transaction costs and illiquidity. There is pent-up demand on the part of pension funds and insurance companies for infrastrucure investment assets as they provide optimal alignment and matching of assets and liabilities; and
Better cross-border coordination and real market transperancy and standarization.
THE INFRASTRUCTURE GAP IN EMERGING MARKETS
Emerging markets will constitute an increasingly larger share of the global infrastructure market as economic growth shifts from slower growth developed markets to faster growing emerging markets. Global challenges such as population growth, urbanization, and climate change are accelerating the critical need for infrastructure investment in emerging markets. Two-thirds of the estimated $69 trillion of global infrastructure investment needs from 2017–2035 will come from emerging markets with Asia constituting 54% and China and India combined representing 42%.9 McKinsey notes that at the current rate of infrastructure investment spending, the shortfall or gap in infrastructure spending will be 11% or $350 billion per year.
Government debt has increased over the last ten years, with average debt-to-GDP levels for developing countries approaching and exceeding 50%—debt levels not seen since the 1980s. These fiscal constraints on government spending have led to declining public spending on infrastructure and exacerbated the infrastructure spending gap.
FOCUS—ASIA INFRASTRUCTURE NEEDS
Infrastructure is a critical catalyst for reducing poverty, driving economic growth, and improving quality of life. Despite significant infrastructure investment in Asia, the continent still has over 400 million people with no access to electricity, 300 million with no access to safe drinking water, and 1.5 billion people lacking basic sanitation. In 2009, the Asia Development Bank (ADB) produced a report analyzing infrastructure investment (defined as transport, power, telecommunications, and sanitation) requirements for developing Asia in 2010–2020.10 The study covered 35 of the 45 Asian developing member countries (DMCs) and covered four sectors: electricity, transportation, telecommunications, and water and sanitation. The report estimated that total infrastructure investment needs (the gap between current infrastructure investment spend and projected needs) between 2009 and 2020 would be slightly less than $8 trillion or about $750 billion per year.
In 2016, the ADB updated its 2009 report for the period 2016–2030 and significantly increased the estimation of infrastructure needs in Asia to $22 trillion or $1.5 trillion per year—effectively a 100% increase from the $750 billion per year estimate in 2009.11 This was based on an assumption that economic growth would range from 3% to 7% across Asia. In terms of GDP spend, the $22 trillion of projected infrastructure needs represents 2.4% per annum of Asia's annual GDP—5% when China is excluded. The ADB also studied the cost impact of climate change (cost of climate mitigation primarily related to greenhouse gas reduction in the power sector and climate-proofing transport infrastructure). The ADB estimated the incremental climate change investment costs were $4 trillion between 2016 and 2030, bringing the total infrastructure investment needs for Asia to a staggering $26 trillion or $1.7 trillion per year for the region. East Asia (primarily China) accounts for 60% of the $26 trillion investment need while power and transporation represent over 80%. Asia currently invests $880 billion per year on infrastrcuture, resulting in an infrastructure gap of 50% or 2.4% of annual GDP (5% when China is excluded). While China has been one of the largest infrastructure investors in the world (spending around 8–10% of annual GDP over the last decade), it still has a long way to go to close the gap with developed countries in terms of the level or stock and quality of infrastructure. For example, the stock of road transport infrastructure in China is $283 million per square km. This compares with $1.275 billion per square km in OECD countries.
The ADB report highlights the escalating challenge of meeting the growing infrastrucuture needs of the 45 countries comprising developing Asia, which will reach $22 trillion (factoring in climate change mitigation increases the infrastructure gap to over $26 trillion) over the next 15 years according to the ADB. The scale of the numbers should serve as a rallying call to mobilize and prioritize both private and public sector support for infrastructure investment solutions. The solutions required to close the infrastructure gap in Asia will be many and varied, from unlocking private sector finance and investment in infrastructure to public sector tax and spending reforms while maintaining public debt sustainability. Equally important, the public sector needs to establish robust regulatory frameworks to encourage private sector investment and participation in infrastructure.
ENDNOTES
1
. Benjamin Esty,
The Economic Motivations for Using Project Finance
(Harvard Business School, 2002).
2
. Refinitiv,
Global Project Finance Review
(Full Year 2019), 2.
3
. S&P Global Market Intelligence,
Annual Global Project Finance Default and Recovery Study, 1980–2014
(S&P Global Market Intelligence, 2016).
4
. McKinsey Global Institute,
Bridging Global Infrastructure Gaps
(McKinsey & Company 2016).
5
. Asian Development Bank,
Meeting Asia's Infrastructure Needs
(ADB 2017) Manila. © ADB.
https://www.adb.org/publications/asia-infrastructure-needs
.
6
. Global Infrastructure Hub,
Global Infrastructure Outlook
(Global Infrastructure Hub and Oxford Economics 2017). Licensed from the Global Infrastructure Hub Ltd under a Creative Commons Attribution 3.0 Australia License. To the extent permitted by law, the GI Hub disclaims liability to any person or organization in respect of anything done, or omitted to be done, in reliance upon information contained in this publication.
7
. Global Infrastructure Hub,
Global Infrastructure Outlook
(Global Infrastructure Hub and Oxford Economics 2017).
8
. McKinsey Global Institute,
Bridging Global Infrastructure Gaps
.
9
. McKinsey Global Institute,
Bridging Global Infrastructure Gaps: Has the World Made Progress
(McKinsey & Company 2017).
10
. Asian Development Bank, “Infrastructure for a Seamless Asia” (ADB 2009) Manila. © ADB.
https://www.adb.org/sites/default/files/publication/159348/adbi-infrastructure-seamless-asia.pdf
.
11
. Asian Development Bank,
Meeting Asia's Infrastructure Needs
(ADB 2017) Manila. © ADB.
https://www.adb.org/publications/asia-infrastructure-needs
.
