Unpacking project financing

Project financing transactions are intricate deals which usually require several participants in interdependent relationships. A project finance transaction is a complex contractual web which revolves around the special purpose vehicle (SPV). Each party to the transaction concludes contracts with the SPV. These contracts refer to specific phases or stages of the project. Frequently, the deal is consummated when all the interests of the parties involved are simultaneously satisfied.

On account of their complex nature, not all projects adhere to the same structure and not all of the participants described in this article participate in all projects. It is also important to note that a single participant in a project finance transaction can assume numerous roles. For example, in co-generation projects the contractor can concomitantly be the sponsor, builder and operator of a plant. Banks can concurrently act as sponsors and lenders.

It is little wonder, therefore, that the sponsors in a project finance deal seek to participate in a variety of ways. In fact, the chief interest of most sponsors is to commandeer the biggest share of cash flows generated by the project. Therefore, by fulfilling multiple roles, sponsors gain from greater flows in terms of both higher revenue and lower costs. For instance, if the sponsor also buys the SPV’s output at particularly favourable conditions.

Host Government

Generally, governments participate only indirectly in projects; however, they still play a very influential role. Among other things, governments often get involved in granting approval of the project, control of the state entity which sponsors the project, issuing operating and environmental licenses, granting tax holidays, supply guarantees, imposing industry regulations or policies and providing operating concessions. Governments can also be involved as off-takers or suppliers of raw materials.

Project Company

The project company is a single-purpose entity incorporated to execute the project. Controlled by project sponsors, it lies at the epicentre of the project through its contractual arrangements with operators, contractors, suppliers and customers. The project company will own, develop, construct, operate and maintain the project. The SPV is controlled by its equity owners.

In most cases, the tariff or throughput charge from the project is the project company’s only source of revenue. Typically, the off-take agreement comprehensively details the amount of the tariff or charge. The off-take agreement, therefore, is the project company’s sole means of repaying its obligations. Usually the project company is the borrower for the project. The incorporation of the project company and its function as borrower represent the limited recourse characteristic of project finance.

Sponsor/Owner
The project sponsors are the project owners with an equity stake in the project. A project can be sponsored by a single entity or by numerous entities in joint venture. Your typical project sponsors include foreign local companies, multinationals, contractors, operators or suppliers. These sponsors come in a variety of guises. They can be industrial sponsors, who see the initiative as linked to their core business. They can also be public sponsors (central or local government, municipalities, or municipalised companies), whose aims are motivated by social welfare. Not infrequently, they can be contractors or sponsors, who develop, build, or run plants and are interested in participating in the initiative by providing equity and/or subordinated debt. They can also be purely financial investors.

Because of their equity, the sponsors will receive any profits either via equity ownership (dividends) or management contracts (fees). Usually, the sponsor brings management, operational, and technical know-how to the project. The project sponsor may be required to provide guarantees to cover certain liabilities or risks of the project. Such guarantees are meant to ensure that the sponsor is sufficiently incentivized as to the project’s success.

Borrower

The borrower might or might not be the SPV. This depends on the structure of the financing and of the operation of the project. A project may in fact have an assortment of “borrowers”, for instance, the construction company, the operating company, suppliers of raw materials to the project and off-takers of the project’s production.

Lender
Lenders represent a primary source of funds for project financings. However, the substantial size of projects being financed often makes it impossible for a single lender to handle. In other cases, a lender may wish to limit its risk exposure in the financing or diversify its lending portfolio and avoid risk concentration.

This problem is usually resolved by arranging a loan involving numerous lenders providing funds under one loan agreement. Such a group of lenders is called a syndicate. The syndicate is important not only for raising the large amounts of capital required, but also for de facto political insurance. Lenders are usually commercial banks, multilateral agencies, export credit agencies or bond holders.

Contractor

The contractor is responsible for constructing the project to the technical specifications stipulated in the agreement with the project company. Sometimes contractors also own equity stakes in projects.

In infrastructure projects the contractor is one of the key participants. The contractor, as previously mentioned, is directly engaged by the project company to design, procure, construct and commission the project facility. The contractor is also responsible for the timeous completion of the project facilities frequently referred to as the “turnkey” model.

Supplier

The supplier provisions the essential input to the project. In the case of a coal power plant for example, the supplier would be the coal supplier. However, the supplier does not necessarily need to provide a tangible commodity. For instance a government may act as a supplier to a mining project through a mining concession. In the case of pipelines or toll roads, the critical input is the right-of-way for construction which is granted by the government.

Operator

Typically, where the SPV itself is not operating or maintaining the project facility, a separate entity will be engaged as an operator once the project facility has been completed.

The operator is responsible for maintaining the quality of the project’s assets and operating the project facility, for instance a power plant or pipeline, at maximum efficiency. This daily operation and maintenance is usually discharged in terms of a pre-specified framework. It is not unusual for operators to also hold an equity stake in a project.

Depending on the project in question, the operator might be a local company, multinational, or a joint-venture. It is common for a sponsor to double as the operator.

Off-taker

The off-taker or customer is the party who is willing to purchase the project’s output. The output can comprise a product, for instance, electricity or minerals. It can also be a service, for example electrical power transmission or pipeline distribution. The objective of the project company is to get customers who are willing to conclude long-term off-take agreements.

Conclusion

The kind of players that you find in a given project is usually determined by the nature of the project. Different projects often have a different line-up of participants. This article provides a fairly extensive list of the typical players you are most likely to find in project finance transactions. Other players, for instance legal advisors, financial advisers, rating agencies and various other professionals also discharge important functions in transactions of this nature. www.ebusinessweekly.co.zw