Gaining Roots Globally in both Government Finance Essay

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ABSTRACT: Project finance is increasingly gaining roots globally in both government (public) sector and the private sector. Projects that are project financed are mostly large infrastructure like high-speed rail, electricity generation plants, wind turbine, telecommunication tower and multifaceted infrastructure undertakings. More often than not, majority of project- financed projects are influenced by government. This brings to the fore, financing of a project with a flexible cash flow which is usually the concern of the lender (debt provider) who accepts future revenues from a project as a guarantee on a loan. Project finance has an attribute of non-recourse, that notwithstanding, it allow lenders to always look for guarantees mostly from sponsors for effective cash flow that can make up for the debt and also bear risk that they can mitigate. Hence, the need for security as a mechanism of defence for the lender since there is the need for diverse provisions for the cash flow assigned to them, thereby guaranteeing payment of the debt. The paper hereby, looks at the different elements of securitisation; the lender’s risks and how elements of security are employed in their mitigation

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Project finance is increasingly gaining roots globally in both government (public) sector and the private sector. Projects that are projects financed are mostly large infrastructure like high-speed rail, electricity generation plants, wind turbines, telecommunication towers and multifaceted infrastructure undertakings with majority of them influenced by government. This brings to the fore, financing of a project with a flexible cash flow which is usually the concern of the lender (debt provider) who accepts future revenue from a project as a guarantee on a loan. Project finance has an attribute of non-recourse, that notwithstanding, lenders usually look for guarantees mostly from sponsors (companies, partnerships or joint ventures or the host government represented by a government agency or state owned entity) for effective cash flow that can make up for the debt and also bear risk that they can mitigate. Lenders who provide the principal are very crucial and would not come on board unless there is mitigation and allocation of risks and security to ensure the debt recovery. Although the security sought for will not escalate the proficiency of the project and does not guarantee certainty of repayment, however, it ensures that if something goes wrong, lenders do not lose everything. Lenders mostly take some amount of credit risk on the project, thus to determine the practicality of the project. They consider that it is technically feasible and that its commercial forecasts so they can evaluate the available risks and design a sponsoring structure that will allocate those risks. By this, lenders give room for due diligence. Chapter one ponders on the concept of project finance and the concept of security involved in project finance. Chapter two highlights the elements of securitisation in project finance which is not too extensive an option available for debt recovery. Chapter three briefly assesses the various risks which a lender may be exposed to and attempts to identify how security measures are opted to mitigate such risks. Chapter 4 concludes the paper by echoing some salient points about security in project finance. An analytical approach will be employed in the deliberation of these issues.

The concept of Project Finance

The concept of project finance cannot be discussed without an attempt to define project finance and its basic principles. From it unset, project finance is a method of financing where the lender accepts future revenues from a project as a guarantee on a loan. Contrary to this is the traditional method of financing whereby the borrower assigns to the lender a physical or monetary unit (collateral) in the case of default. Practically, most projects are financed by a combination of both traditional methods as well as by guarantee-backed loans. By implication, project finance is suggestive by its name in that, it refers to raising capital by any means to pay for any project. This however refers to a narrow but increasingly more prevailing method of financing capital- and risk-intensive projects across a broad array of industries. Many learned scholars have attempted defining project finance with some of these definitions worth citing. "A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan." [1

From the above definition, it can be deduced that, the definition is informative since project finance is "project specific" meaning that, it focuses on the financing of a specific "project" which can mean anything subject to what the parties define it to be. Moreover, a critical consideration to the word initially in the definition above reveals that, security as collateral is only subordinate to the debt repayment via the cash flow of the project.

When project finance becomes non-recourse to the sponsor, it brings to bear a limited impact on the solvency of the sponsor which aims at arranging to borrow for a project which will profit the sponsor at large. [2

However, oil projects that involves major multinational companies which are financed majorly from the balance sheet of the sponsor normally allows the dispersal of the risk involved from the sponsor to other parties. [3

The deregulation of worldwide utilities and the privatisation of public sector capital investment have giving rise to the recent project financed projects in both developed countries and developing countries. For instance, in 2010 India became the utmost dynamic project-finance market with over $52 billion worth of deals, coming from 131 loans. Spain was second with 67 loans for a total of $174 billion and Australia in the third place with 32 loans worth $14.6 billion. [4] This is to underscore that public sector infrastructure that can take the form of natural resources projects like (gas, mining and oil), independent power projects (IPPs), mainly for power generation in the electricity sector like Sunon Asogli power plant of Ghana, public infrastructure (transport, roads, public buildings, etc.) for example Ghana’s millennium challenge account (MCA) will be on the increase to benefit the people.

Categorically, divergent financing mechanisms could be put in place for different project in project finance; conversely, basic features applicable to them all have been identified:

There is in place a special-purpose vehicle SPV or Project Company whose only business is borrowing for a particular project to achieve the limited goals of construction and operation of the project.

Project finance is normally used in financing new projects unlike existing projects, however, there could be financing loans for existing projects.

Project finance is normally non-recourse to the sponsor and no guarantee is needed for the project debt.

Lenders always look out for the cash flow that will be generated from the project for the recovery of the loan rather than the asset of the project.

In terms of a default on repayment, the SPV becomes the main security available to the lender for the recovery of the loan due to the ownership right to resource, awarding of contracts and licences of the SPV. [5

From the above features, point (V) can be said to be the nub of this paper which is to state that in project finance, lenders only look out for the assets of the project for securitisation of the loan and to have full control over the asset which is being financed.

The primary objective of security in project finance is to safeguard the debt which is usually the larger share of the financing structure but which doesn’t yield higher returns if the project has an upside. [6

Security over the project is widely ranged and differs from project to project. A commentator’s view is that the lender’s security is in four stages;

Control over the cash flow of the project.

The ability of the lender to step-in to project administration under direct agreements.

Guaranteeing and assignment of SPVs assets and major agreements and contracts.

Security over company shares.

The Concept of Non-Recourse

There are two basic types of recourse project financing: limited recourse project financing and nonrecourse project financing. Limited recourse gives the lenders some recourse to the sponsor in the form of the pre-completion guarantees or/and other assurances of some form of support for the project. Limited recourse project financing is typical for emerging market projects and projects posing significant risks. Nonrecourse project financing is an arrangement under which lenders do not have any direct recourse to the sponsors. Their security includes various assets of the project company (including the assets being financed) and relies on the operating cash flow generated by the project company. There is the possibility of a default on the payment of a term of a loan. Normally when it does happen, lenders fall back on the borrowers assets for the recovery of the advanced loan. Ideally, in project finance the loan is normally non-recourse to the sponsors; thus the loan is repaid only from the cash flow generated by the project with the sponsors providing no guarantees to the lenders. The concept of non-recourse project financing thus implies that the sponsors’ assets for the debt recovery is of no recourse to the project company, however, lenders might have recourse to the project’s assets. Thus, lenders will look out for the credibility of sponsors in terms of security of the capital involved by recouping the debt as projected regardless of the completion of the project.

This is opposed to traditional lender/borrower relationship like corporate financing whereby lenders normally secure the repayment of loan by demanding on some form of collateral or security which most often might not be necessarily the same as the value of the loan. This brings to the fore, the notion of project finance relying on the viability of a project rather than the credit value of the sponsor which in theory gives the project sponsor no direct legal obligations to reimburse the project debt and pay for interest.


The main aim of security is to safeguard the debt which most scholars believe its role in project finance is defensive and do not offer the lenders the right to actualise on the assets as they would in conventional secured finance. Lenders are mostly fascinated about the operator’s demonstrated aptitude in project finance since the repayment of the loan rely heavily on the achievement of the operator rather than the value of the project assets. [7

Lenders in most cases take aggressive security over assets they have financed just to ensure that they are able to sell off the asset in question on an execution of its security. This notwithstanding is not the ultimate goal for lenders in taking the security; instead, the aim of lenders to achieve their security goal is in two stances. Firstly, they look out for security with an eye on a complete security package that gears towards a defensive mechanism which aims at preventing other creditors taking security over the assets they have financed and also to avert other creditors who might try to rely on those assets. Secondly, the other stance for which lenders would want to take up security is for the sole aim of controlling the future of the project should a default occur so they can complete the project thereby operating it in order to generate the cash flow needed for the repayment of the loan. The lenders ability to achieve this aim is however dependant on the jurisdiction in which the principal project assets are located. A table that illustrates the elements of a project finance security package is shown hereunder:

Table1. Typical Elements of a Security Package [8





Mortgage on project assets

Pre completion guarantee

Entitlement payments

related to government

concessions( for example

the assignment of

compensation due if

concession is terminated


Offtake agreements to

ensure output demand

(quantity and price)

Project funds agreement;

other financial support:

subordinated loans in case

of shortfall of project cash


Letter of credit

Supply agreements

Construction and operation

supports: arrange turnkey

construction contract,

supply key managers,

arrange management


Political risk insurance

Assignment of


Financial Covenants

Pledge of shares

Escrow accounts to receive

project revenues: onshore

and offshore, local and

foreign currency

Assignment of insurance


2.1 The Escrow Account

The escrow account is said to be an account held in the name of the SPV or borrower by a bank with an escrow account agreement between the lender and borrower which gives rise to an immutable instructions from the borrower with a binding effect that all operational revenue or proceeds from the sale of assets of the project will be paid into this account. [9] Lenders tend to use the escrow account as a measure of control over the project revenues and also use the funds accrued for the settlement of the project expenses and also for the repayment of the loan.

If a project cash flow is insufficient to settle the payment of the debt, lenders can also call for the setting up of an escrow account so that a trustee can withdraw from the escrow fund to service the debt. [10] A trustee can hold the trust on behalf of all creditors to avoid creating a separate trust for separate creditors and also introduce new creditors by means of a pre-agreed deed of accession. [11] However the escrow account when used to mitigate foreign currency risks helps to fulfil contractual responsibilities. [12

There are some key features of an escrow account that serve as security in project finance. Some of these features have been identified;

It allows for the use of hard currency project revenue to pay for hard currency project debt.

It is normally held offshore in a jurisdiction (country) where there is low foreign currency exchange convertibility and transfer risk.

The escrow account forms part of the lenders security package as the cashflow is the principal concern of lenders.

Normally the government of the host country requires approval for the creation and operation of the escrow mechanism. [13

2.2 Assignment of Project Agreements and Other profits

There is yet another measure that works to reinforce the security package which involves the assignment of rights under the key contracts of the project that serves as concretisation of (off-take contract, concession, construction contracts, etc.) security for the lender which is more prevalent under the operational stage of the project. [14] This process which could be called "Direct Agreements" have the aim of allowing the lender to take the place of the SPV should there be a default in the loan repayment by subjecting the borrowers privileges under the underwritten contract. Project receivables and agreements assignment has also been discoursed to enable creditors regulate project funds should the project encounter any challenge. [15


3.1 Lenders Risks Assessment and how they are mitigated by Securitisation

Every discreet lender will resort to the method of project risk analysis when presented with a project finance proposal. This will enable the lender to come in terms with the scope, rationale and the objectives of the project at hand to be sure that they are flawless and feasible. In the same vain, the assessments of potential risks are measured on the same scale. Lenders have various reasons why they would want to advance funds for various projects. Some of these reasons include; profiting through attractive lending margins and other fees, the assumption of measured risk, to control credit agreements and the project as a whole in time of difficulties. This next section will discuss the assessment of a lender’s risks and the elements of security which can be employed to mitigate them.

Political Risks [16

These are inevitable and very much intrinsic in business which affects all stages of various projects right from the very beginning to the very end. This brings to the fore an evaluation difficulty with the utmost of it being expropriation by the government. [17] The tendency of existing political order collapsing, new taxations, exchange transfer restrictions, and nationalisation more often than not, put projects of both borrowers and lenders alike in jeopardy. [18] Not all, political risks such as war, civil unrest, default or failure of government agencies, changes in law and delays by governmental bodies to grant necessary approvals or licences for the project or components thereof can be a major concern to lenders. As if this is not enough, the ability of the host government to expropriate properties in return for relative compensation for the sole aim of public interest is a source of concern to the lender. This risk can hereby be mitigated by insurance against political risks and assurances against expropriation with a guarantee that proper compensation will be payable in that event. This risk can further be mitigated by a requirement of the host government to stand in as full guarantor of all the debt. [19] Lastly, it can be mitigated by participation of partners like the World Bank and multinational organizations (like MIGA, which has a special political insurance service) providing insurance in a traditional sense, in addition to issuing performance bonds that guarantee completion.

Completion Risk

The lender is faced with this risk when there is the difficulty of completing the project at hand. This goes a long way to affect the full operation capacity of the project as scheduled both on time frame and as budgeted. [20] This can be mitigated by the lenders looking to the sponsor for completion guarantees in order to ensure that they can make up for the cost involved.

Environmental Risk

Controversies that arise from environmental law as results of environmental pollution emanating from activities of project are inescapable to lenders. In mitigating this risk, there will be the need for the borrower to carry out social and environmental impact assessment plan. A laid down plan to monitor and manage this risks will equally be required. The need for lenders to abide by this management plan is crucial for the loan as non-compliance will be deemed as a default on the term of the loan.

Force Majeure risk:

Project finance has a high potential for vulnerabilities in that, force nature risks such as earthquakes, floods, strikes, civil disturbances and change of law can interrupt a project’s operations and confound its cashflow. A particular force majeure can bring about a default depending on the sternness of the particular accident. It will therefore be prudent if an analysis of force majeure events that could hamper the project’s progress be discussed. This can be mitigated by assigning the necessary insurances coverage for any eventuality as well as bring to bear the timely payment of insurances by the insurance companies.

Market/Price Risk

This type of risk involves fluctuation of price which has an adverse impact on the project revenue as well as the debt settlement. There is the need for the lender to put in place a price projection for long term contract for the sale of the project’s product. The project’s viability depends on this. To mitigate this risk, there should be in place long-term sales contracts for the product and a market guarantee agreement for the product should also be in place. [21] Mitigations like price hedging and derivatives could also be useful. These are but just a few of a lenders risk and how they are mitigated.

4: Conclusion

The objective of the paper was to deliberate on the concept of project finance, its securitisation elements and how the various risks of lenders are mitigated. The paper employed analytical approach which gives it a safe landing on the grounds that; Securitisation is the back bone of project finance since lenders will not advance funds to project without repayment assurances.

Security for the debt repayment can be in divergent means in as long as it is deemed fit for a particular project for the security of the debt at hand. Mitigation and securitisation are the only means by which a lender will assume risks.

In conclusion, the more prevailing security measures in a particular project mitigate more risks and this is the bedrock on which lenders would lend to a project.


Primary Sources

Judicial Decisions

Re Bond Worth [1980] 1 Ch.228 at 248.


Nevitt, P.K., and Fabozzi, F.J., Project Financing (7th Ed.)(London, UK: Euro money, 2000).

Yescombe, E.R., Principles of Project Finance (London, UK: Academic Press, 2002) 5.

Vinter, G., Project Finance: A Legal Guide (2nd Ed.) (London, UK: Sweet & Maxwell, 1998).

Ahmed, P.A., and Fang, X., Project Finance in Developing Countries: IFC Lessons of

Experience No.7 (World Bank Publications, 1999).

Clifford Chance (Law firm), Project Finance (London, England: IFR Publishing, 1994).

Hoffman, S. L. The Law and Business of International Project Finance (The Hague,

Netherlands: Kluwer Law International, 1998).


Esty, B.C., and Megginson, W.L., "Creditor Rights, Enforcement, and Debt Ownership

Structure: Evidence From the Global Syndicated Loan Market", Journal of Financial and

Quantitative Analysis, Vol. 38, No. 1, (2003)

Internet Sources

Cadwalader, Wickersham & Taft (law firm) Moving towards Hybrid Project Financing at (last visited on 26/12/12).

Islamic Development Bank, Risk Management guidelines for project finance, Group Risk Management Department,Muharram,1431/January 2010 (last visited on 20/12/12) Guidelines.


Dow, S., Presentation for lecture 2 of International Project Finance Module at the CEPMLP, University of Dundee, (2012)

Achonwa, J.,what are the elements of security in project finance and how does it limit the lenders exposure to project risks? (Unpublished LLM Dissertation Submitted to the CEPMLP, University of Dundee, 2009).

Adesokan, A., Addressing Legal Issues Regarding Lender Protection and the Treatment of Security at the Completion Stage (Unpublished LLM Dissertation Submitted to the CEPMLP, University of Dundee, 2008).

Omenuko, L., "How can the Risks Associated with the Exploration and Production of Oil

and Gas be Mitigated for the Purpose of Securing Finance" (Unpublished LLM Dissertation

Submitted to the CEPMLP, University of Dundee, 2007).

Smith, V., "Escrow Accounts in Project Financing" Material on VLE, International Project

Finance Folder, CEPMLP, University of Dundee (2012).

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