Project Finance Participants and Their Roles Lecture Two Project Finance Participants and Their Roles

PROJECT SPONSOR The project sponsor is the entity, or group of entities, interested in the development of the project and which will benefit, economically or otherwise, from the overall development, construction and operation of the project. It is sometimes called the developer. The project sponsor can be one company, or a group of companies.

PROJECT COMPANY The project company is the entity that will own, develop, construct, operate and maintain the project. The precise nature of organization for this entity is dependent upon a myriad of factors. Of foremost concern is the local law of the country in which the project is based.

The local law must be examined to determine such things as: whether a form of organization is prescribed; whether a foreign entity can do business in the host country; whether a foreign entity can own real property in the host country; the extent to which liability limitations, such as is enjoyed by a corporation or limited liability partnership, is permissible; requirements for local investor participation in the entity organized in the host country, etc.

Other factors also influence the selection of the form of organization for the project company. These include: tax laws in the host country; tax treaties; and foreign exchange rules of the host country.

BORROWING ENTITY The borrowing entity in a project financing is most often the same as the project company. However, in some transactions, another or multiple borrowers are used. For example, in a project financing of a mine, each of the mine owner, the operator and the major off-take purchaser might form a joint venture to develop the project.

Each could enter into borrowing transactions to fund their own individual commitment to the project, while the joint venture itself would have no project debt.

COMMERCIAL LENDER Commercial lenders, including banks, insurance companies, credit corporations and other lenders, provide debt financing for projects. These institutions might be based in the host country or in another country.

Sometimes, the lenders are strategically selected from a range of countries. The purpose of this syndicate diversity is to discourage the host country government from expropriatory acts or other discriminatory action. If the host government elected to do so, it could thereby endanger economic relations with the home country of each lender.

Lenders in the host country are also sometimes included in the lending group for the purpose of restraining the host government from expropriatory acts or other discriminatory action. Also, in countries that limit a foreign entity's right to take a security interest in project assets, selection of a local bank to receive the security interest for all lenders could be important.

The lenders might provide different types of debt to the project The lenders might provide different types of debt to the project. For example, some lenders could provide debt with a right of payment senior in priority to other, subordinated lenders. Also, some lenders might provide a tranche of debt with specific interest rates, amortization and terms different from the tranche provided by other lenders.

Arranging Bank. The amount of debt required in many large project financings requires that several lenders join to provide the debt facility. The lenders act together because any one lender individually does not have the capacity to provide the entire project loan, or because it wants to limit its risk exposure in the financing.

The resulting group of lenders is often called a syndicate, while the lead bank that arranges this type of cooperation is called the arranging bank.

Managing Bank. The managing bank is typically a title assigned to one or more banks in a syndicate to reflect the status of the bank as one of the major syndicate members. It is primarily a title for marketing purposes, and does not usually signify that the bank has accepted any increased responsibilities or duties to the borrower or to the other syndicate members.

Agent Bank. By contrast, the agent bank is a role with responsibilities. It is the bank responsible for administration of the credit and the collateral. It coordinates loan draw downs, monitors covenant compliance by the borrower, issues and receives notices to and from the borrower and is a clearinghouse for information.

It polls the bank group members in situations where a vote is required, such as whether to declare a default or approve amendments to the credit documentation, and communicates decisions to the borrower.

Engineering Bank. The engineering bank is responsible for compliance with technical performance covenants and progress. It coordinates with technical consultants and project engineers, and reports this information to the bank group.

Security Agent. The security agent, or collateral agent as it is sometimes called, is responsible for holding security interests as agent for the project lenders. It also monitors lien filings and other steps necessary to protect the security interests of the lenders. In some transactions, this role is fulfilled by the agent bank.

BONDHOLDERS Another source of debt in international project financings is from bondholders, who purchase project debt in the form of bonds. The bondholders are represented by a bond trustee, a financial institution that acts as the representative for the bondholders in managing the debt transaction.

INTERNATIONAL (MULTILATERAL) AGENCIES The World Bank, the International Finance Corporation, regional development banks and other international agencies provide significant credit support for projects financed in developing countries.

BILATERAL AGENCIES Unlike multilateral agencies, bilateral agencies are designed to promote trade or other interests of an organizing country. They are generally nationalistic in purpose and nationalistic and political in operation. Funding for bilateral agencies generally comes from their organizing governments.

Bilateral agencies are generally of two types: Developmental agencies and export-import financing agencies. Developmental agencies are designed to provide grants or concessional financing to promote economic and political goals of the organizing government in developing nations. An example in the United States is the U.S. Agency for International Development (USAID).

The most common type of bilateral agency is an export-import bank The most common type of bilateral agency is an export-import bank. There are many sources of financing available from governments for exporting goods and services. Government-supported export financing includes pre-export working capital, short-term export receivables financing and long-term financing

RATING AGENCY Where projects are financed through access to public debt markets, rating agencies are consulted to provide credit ratings for the underlying debt. These agencies are typically involved at very early stages of project development so that credit concerns can be addressed and structured in an efficient, timely manner.

SUPPLIER The supplier provides raw materials, fuel or other inputs to the project. Because of the importance of inputs to the project, the project sponsors and lenders are concerned with the underlying economic feasibility of supply arrangements, the economic terms of the contracts and the ability of the suppliers to perform the contracts.

OUTPUT PURCHASER The output purchaser is the purchaser of all or some of the product or service produced at the project. In most nonrecourse and limited recourse project financings, the off-take purchaser provides the credit support for the underlying financing.

The output purchaser's financial commitment to the project depends upon how much interest it has in a long-term supply that is priced based on the project's cost rather than market forces. This interest also determines to what extent the output purchaser will be willing to provide credit enhancement, such as guarantees, to assist in the financing process

CONTRACTOR The contractor is the entity responsible for construction of the project, to the extent construction of a facility is a part of the overall project.' It bears the primary responsibility in most projects for the containment of construction-period costs.

OPERATOR The operator is the entity responsible for the operation, maintenance and repair of the project. In some projects, this role is filled by one of the owners of the project company. In others, the operator role is undertaken by a third party under an operating agreement.

FINANCIAL ADVISOR The financial advisor is retained by the project sponsor to provide financial advisory services to the sponsor. These services include preparing the information memorandum. The information memorandum includes a detailed summary of project technical and economic feasibility; the proposed financing structure and proposed terms; a description of the experience of participants; a summary of the underlying project risks; and a description of each of the project contracts and credit support.

The financial advisor also provides advice to the project sponsor on the host country, currency concerns, structuring the transaction, and possible debt sources. Many commercial banks provide financial advisory services.

TECHNICAL CONSULTANTS Technical experts, such as fuel consultants, insurance consultants, engineers and environmental consultants, are retained to advise the project sponsor and lenders on highly technical matters, about which the sponsor and lenders have limited knowledge, or that they want to confirm.

In many financings, these consultants will each prepare reports, such as feasibility reports, for the project sponsor and lenders. During the project, these experts might be retained by the sponsor or lenders to confirm project progress and to analyze the technical aspects of disputes.

PROJECT FINANCE LAWYERS Project finance lawyers represent clients by combining experience with nonrecourse and limited recourse financial structures, experience with the underlying industry and knowledge of project contracts, debt and equity documents, credit enhancement and international transactions.

These lawyers provide specialized assistance to project sponsors, host governments, lenders, investors, and the other project participants in risk identification and risk mitigation techniques.

Project finance lawyers provide advice on all aspects of a project, including laws and regulations; permits; organization of project entities; negotiating and drafting of project construction, operation, sale and supply contracts, negotiating and drafting of debt and equity documents; bankruptcy; tax; and similar matters.

Opinions on various legal matters are issued by these lawyers in connection with the financial closing process.

LOCAL LAWYERS Local lawyers in the host country of the project are typically needed by all participants. These lawyers assist in local legal and political matters, which are often coordinated by the project finance lawyers. Local lawyers also issue opinions on various local legal matters in connection with the financial closing process.

HOST GOVERNMENT The host government is the government of the country in which the project is located.2 As such, the host government is typically involved as an issuer of permits, licenses, authorizations and concessions. It also might grant foreign exchange availability projections and tax concessions.

In some transactions, it is the borrower In some transactions, it is the borrower. The host government can be the owner of the project, whether majority or minority, or can become the owner of the project at the end of a specified period, such as in a build-own-transfer (BOT) structure.

It might also be involved as an off-take purchaser or as a supplier of raw materials or fuel. Where infrastructure or other development is necessary in support of a project, such as roads, railways and ports, host government involvement can significantly reduce project costs.

Yet, such governmental responsibility and participation may be detrimental, as well. For example, if the project is dependent on new infrastructure for success, both must be completed on a coordinated schedule. Ideally, the project company will be intensely involved in all aspects of the new construction, including the schedule.

Yet, the host government will want control over the construction and ultimate operation of the infrastructure since it is paying for it. If the risk of cost overruns is on the government, it will want to reduce its financial risks by managing the construction process. These competing perspectives need to be resolved in a mutually acceptable way to ensure project success.

The host government's ability to benefit from the project varies with its economic stability, natural resources, tax base and other factors. In general, it may have any or all of the following objectives in cooperating in a project's development: quick and efficient development of needed infrastructure provided by the project; economic development;

satisfying multilateral institutions of its development success and economic growth; proper, safe and efficient operation; minimizing use of its own funds or credit for economic growth; obtaining project ownership after private participants receive an agreed equity return; taking control of the project if it is inefficiently operated or otherwise fails; and providing regulatory stability for a project, while limiting- restrictions on its ability to enact new laws and promulgate new rules affecting the business sector in which the project operates.

Whether the host government benefits from a project depends upon the allocation of risks between itself and the other project participants. The risks associated with infrastructure projects in a developing country often necessitates some form of host government support, through a governmental guarantee or some other type of credit enhancement.

Yet, governmental guarantees can undermine the benefits of private sector involvement (privatization). These guarantees can impose significant costs on the host country's taxpayers, and further erode the country's financial health.

Also, if the host government undertakes responsibility for the wrong risks, the project sponsors may lack sufficient incentives for efficient project operation. For example, a host government guarantee of demand for a project's use or output can remove an important market incentive: the project sponsor's incentive to develop only those projects that are strong financially.

Also, the risk structure of a project can allocate too much risk to the host country, leaving the project company with insufficient financial responsibility for taking excessive risks.

The host country can, of course, endeavor to decrease the amount of credit support it must provide a project by undertaking a program of risk reduction. For example, if a host government is successful in maintaining stable macroeconomic policies, it is less likely that project sponsors will require exchange rate guarantees or assurances of currency convertibility or transferability.

Similarly, a predictable regulatory framework, coupled with regulatory agencies that are reasonably independent from the political process, and an independent judicial system for dispute resolution, can combine to reduce the need for governmental guarantees.

Finally, host governments that allow dispute resolution in international arbitration can allay fears of discrimination by the local Project Finance Participants and Their Roles courts, and reduce the need for government-provided credit enhancements.

Developed countries do not typically need to provide governmental guarantees for projects, because the economic and political risks are satisfactory to project sponsors and lenders. This is not a benefit reserved only for developed countries however.

Some developing countries, such as Argentina, in its power industry, and Chile, in its telecommunications, power and gas industries, have achieved an economic and political climate that permits infrastructure development and privatization without the need for governmental guarantees of project debt or performance.

Importantly, project financiers sometimes lose sight of the nature of a government; that is, a government must answer to a wide spectrum of often competing interests. As such, it is very difficult for a government to promise not to change the laws and regulations that affect a project, or if it does so, to compensate the project for the economic implications of such changes.

For example, changes to environmental laws and regulations may be necessary to appease citizens, or to satisfy requirements imposed under treaties or by multilateral institutions. Similarly, new taxes may be needed to respond to changing economic conditions.

It is also sometimes difficult for a host government to control state-owned entities. For example, in an energy project the purchaser of the project output is sometimes a public entity, controlled by a local or state government.

The central government may not have sufficient control over such a public entity to provide a guarantee, however. The solution that may be preferable is for the government to undertake a privatization program, which removes the purchasing entity from many of the risks inherent in public ownership.

A host government is sometimes asked to bear project commercial risks, such as construction cost overruns and output demand risks. Yet, host governments often consider the project company as the entity better able to manage these risks; placing them on the host government can remove important incentives from the private sector for selecting sound projects for development and managing costs.

The project company can be rewarded, in part, for taking these risks by such solutions as lengthening the term of the concession awarded to it when demand is lower than projected, or when the project fails to generate, on a present value basis, a negotiated revenue target.

Similarly, a host government may be unwilling to provide protection against exchange and interest rate risks. From the project company's perspective, this is necessary because the government controls these risks and it encourages the government to maintain stable economic policies.

Also, because project companies typically borrow adjustable rate debt in foreign-currency-denominated loans, project profits are sensitive to fluctuations in the interest rates and currency convertibility levels assumed in project feasibility studies. Yet, from the government's perspective, a government guarantee can encourage a project sponsor to borrow excessive debt in foreign currencies.

Also, such guarantees can discourage governments from taking needed action to cure economic problems, such as a needed devaluation. Finally, a currency depreciation is often coupled with a decline in income and the associated tax base, resulting in a decrease in funds available to a host government at precisely the time the project company enforces the guarantee

INSURERS Insurance providers improve the risks inherent in project financings, whether casualty or political. Insurers typically work closely with the project sponsors and lenders to produce an insurance package that limits risks at an economical price. The acceptability of the insurance package is often confirmed by an insurance consultant, retained by the project sponsor and lenders.