WHAT IS PROJECT FINANCE?
BANKING HANDY GUIDE
An introduction • Allocation of risk between the parties and risk
mitigation are important and hotly negotiated
The project finance model is typically used for the points, because of the many risks which are
purpose of financing the delivery of long-term associated with large projects. Examples include
infrastructure or natural resource projects, with deals environmental risk (where issues with the project
including a wide variety of energy (e.g. wind, solar site lead to delays with construction) and technical
and hydro) and infrastructure (e.g. roads, schools and risk (where the technology fails to perform to the
hospitals) assets. required level).
While this structure has many of the same features • Often a public element with private entities building
as a general corporate finance deal, its highly and operating projects for public-sector bodies
structured and multi-phase nature means that there under a concession or project agreement.
are a number of project finance-specific concepts.
This guide looks at the key features of project finance
before discussing some of the terminology you would
expect to see on this type of deal.
While this structure has many of the
same features as a general corporate
finance deal, its highly structured and
multi-phase nature means that there
are a number of project finance-specific
concepts.
What are the key features?
• A special purpose vehicle (SPV) is used to hold all
rights and assets required for building and running
the project.
• The majority of the finance on a project finance
deal is debt, with a smaller amount of equity
investment being injected by a sponsor (i.e. the
ultimate owner of the SPV).
• Detailed facilities agreement which deals with both
the construction and operation phases of the
Did you know?
project. The SPV will be the borrower under the Brodies advised the purchaser
facilities agreement. on the financing of its
successful bid to aqquire the
• Full suite of security (e.g. floating charge, standard
Lochaber Hydro Plant and
security, share pledge and assignation in security)
Smelter Works and the
and step-in rights to allow the lender to take control
of the project in the event of a default by the Kinlochleven Hydro Plant and
borrower. various related estate lands
from British Alcan Aluminium
• The main recourse available to the lender in the
event of a default relates to the cash flow generated
by the project, rather than the specific assets of the
borrower or sponsors. Project finance is therefore
generally known as ‘limited recourse’ or
‘non-recourse’ finance.
What is project finance? Banking handy guide. Discover more at brodies.com
Key terminology Direct agreements
An element of the security package which creates a
Bankability direct contractual relationship between the lender
and the project document counterparties. In the
Whether a project is 'bankable' or not depends on the event that the borrower defaults or the project is not
willingness of lenders to provide finance. This decision operating effectively, the direct agreement allows a
will be based on a number of factors which are lender to step into the contract.
assessed by lenders carrying out due diligence. Where
a project is not considered to be 'bankable', public
authorities or governments may step in to provide
guarantees in order to give assurances to lenders. Whether a project is 'bankable' or
not depends on the willingness of
Borrower lenders to provide finance.
As mentioned above, the borrower (or project
company) is an SPV which does not have any assets
other than those which relate directly to the Financial covenants
construction and operation of the project. The
majority of the rights held by the borrower are Project finance deals require detailed forecasting
contractual, but it will also own the relevant property models to predict the performance of the asset over
rights relating to the project site. the life of the loan. At regular calculation dates, the
ability of the borrower to repay the loan is tested by
reference to the financial covenants set out in the
Cash flow waterfall
facilities agreement. These include various cover
ratios which look at different variables relating to the
This dictates how the revenues generated by the
project, such the debt service cover ratio, loan life
project are allocated, both before and after a default.
cover ratio, and debt to equity ratio. These assess
Generally the order of application of proceeds is as
whether the cash flow generated by the project will
follows: first, repaying the lender (including expenses,
be sufficient to meet the loan repayments at a
principal amount of the loan and any interest);
particular date or over a specific period of time and
second, payment of the capital and operating costs of
whether there is a sufficient equity cushion.
the project; third, maintenance of debt service cover
amounts (see below); and fourth, payment of
dividends to the sponsor/holding vehicle.
Concession agreement
A contract between a public-sector body and a
project company, which allows the project company
to carry out the project – e.g. by allowing it to use
land owned by the public-sector body. This is central
to the BOT (build, operate, transfer) model which sees
the project company build the asset, operate it for a
certain period and then transfer it to the public-sector
body which granted the concession.
Contractor
Construction and engineering companies who
construct the project on behalf of the SPV, and who
have experience of building similar assets. These
companies will usually take on the risk of
construction overrunning on time.
What is project finance? Banking handy guide. Discover more at brodies.com
Financial model Project documents
This is used to assess the viability of the project, and Contracts which the SPV enters into with a variety of
for testing the 'health' of the project throughout its counterparties relating to the construction of the
life, and the life of the loan. The financial model is project asset, as well as the operation and utilisation
used to calculate the cover ratios at set calculation of the asset once it's operational.
dates, to test whether the borrower is able to repay
the loan. Sponsor
Lenders Investors who set the ball rolling on the project by
setting up the SPV and obtaining the funding and
Project finance deals are usually financed by a contracts required for the construction and operation
syndication of major banks because of the high-value of the project. Sponsors have an equity investment in
nature of the underlying project. the SPV.
Off-taker Step-in rights
The party who buys the product created by the These allow lenders to step into the various contracts
project – e.g. the energy generated by a wind farm. which the SPV enters into with contractors. If the
project is not performing properly, having step-in
rights allows the lender to step-in in place of the SPV
to take control of the project.
How Brodies can help you
Brodies' infrastructure finance practice draws a
wealth of experience from a number of legal service
areas, including finance, projects and real estate.
The practice advises widely within the sector, acting
for a number of different of borrowers and lenders on
a variety of projects.
Key contacts
PPP/PFI
Michael Stoneham
In the context of infrastructure projects, a PARTNER
'Public-Private Partnership' is a cooperation +44 (0)131 656 0061
agreement between the public and private sector [email protected]
with the end goal of delivering services or facilities for
use by the general public – e.g. schools or hospitals.
A subset of PPPs is the 'Private Finance Initiative'
model which uses private investment (in the form of
debt and equity) to deliver public-sector Billy Kay
infrastructure projects, which is then paid for by the MANAGING ASSOCIATE
public-sector body over the life of the project. +44 (0)131 656 0056
[email protected]
Project bond
A source of finance for projects, which provide
long-term funding options at a fixed rate. This
funding option tends to be cheaper than bank debt,
but does have disadvantages such as the fact that
bonds are generally repayable on maturity, rather
than in installments over the life of the bond.
What is project finance? Banking handy guide. Discover more at brodies.com
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