Firstly, what is the difference between project finance and corporate finance?
Project finance, by definition, relies primarily on the cash flow generated by a project, with the project's assets serving as collateral, the so-called ring-fencing. One main characteristic is its non-recourse or limited recourse structure, where guarantees of the sponsors are limited to the construction phase and to the start-up phase. The Borrower is mostly a special purpose vehicle (SPV).
Due to its complexity, project finance is not suitable for small projects.
In contrast, thereto, corporate finance in a broader sense covers all sources of finance of a corporate or a group, including different forms of debt capital, equity or hybrid forms of capital. In a narrower sense, it refers to syndicated loans that are to be applied towards general corporate purposes, which are on balance sheet and for which the Borrower is liable with all of its assets.
Due to its complexity, project finance is not suitable for small projects. While project finance is more expensive, it enables sponsors to finance projects off-balance sheet, which makes this form of finance attractive for PPPs, infrastructure projects, joint ventures or other projects where a sponsor wishes to shield its other assets from the risk of a project failure.
What are the main features of project finance?
Such arrangements with public entities need to be carefully reviewed to avoid conflicts with public procurement law or with budgetary rules.
Due to the non-recourse or limited recourse structure, project finance requires a sustainable financial model, and a contractual framework that procures that the ability of the project to generate debt service is protected against a wide array of project risks.
This implies that bankability requires long-term project contracts. It is common that key project contracts, such as concession agreements, EPC contracts, or long-term supply or off-take agreements are supplemented by direct agreements among the lenders or their agent and other project parties. These contracts may not only restrict the ability of other contract parties to terminate their contracts with the SPV, but also provide for step-in rights, that enable the lenders to replace the project company if the same fails. If state-owned enterprises or public entities are involved, lenders will frequently ask for government guarantees.
Ultimately each project is different, and it is part of the task of the lawyers to assist their clients to find sustainable and bankable solutions that mitigate all relevant risks and provide legal certainty.
Such arrangements with public entities need to be carefully reviewed to avoid conflicts with public procurement law or with budgetary rules. Public procurement law may, in particular, be relevant in the context of step-in rights, or if commercial terms are subject to adjustments to address changing circumstances. And budgetary rules may limit the ability of a government to issue guarantees, in particular, if the maximum liability thereunder is not clearly defined.
Generally, it is key to identify all relevant project risks and, in an ideal world, to allocate such risks to that party which is in the best position to control the relevant risk. In real life, this principle is not always followed. Local law or public procurement rules, or simply the economic power of a project party may lead to different risk allocations. At the end of the day, lenders have to evaluate whether the remaining project risks are acceptable, or whether bankability standards require a higher level of recourse to the sponsors.
Ultimately each project is different, and it is part of the task of the lawyers to assist their clients to find sustainable and bankable solutions that mitigate all relevant risks and provide legal certainty.
Cross border projects also suffer more and more from sanctions risks.
Data shows that there was a massive increase in project finance loans in renewable energies that started in 2001. Why was this the case?
This development is attributable to a number of reasons. Not only that technical progress and climate change call for more renewable energy projects. Their eligibility for project finance also benefited from the fact that the relevant technologies, in particular for wind parks or photovoltaic, are proven, and that these projects experienced a much higher degree of standardisation than any other type of projects. This does not only enhance bankability; it also leads to lower transaction costs than in case of infrastructure or new technology projects that require more complex and innovative solutions.
Nevertheless, the landscape is different for other types of renewables such as biogas or waste-to-energy.
Furthermore, the impact of subsidies or regulated feed-in tariffs remains a challenge in many markets. Another limiting factor is the available grid, in particular in relation to offshore projects.
Are there other challenges that have an impact on project finance?
It is sad to see that many legitimate projects are prevented by existing sanctions, or by an unpredictable aggravation of sanctions risk.
Last but not least, it should be mentioned that infrastructure projects are exposed to political risks. This means not only classic risks like the impact of a change of administration during the lifetime of a project. Cross border projects also suffer more and more from sanctions risks. This does not only relate to existing sanctions, which may either prevent a project or allow a project if structured properly. Bearing in mind that infrastructure projects are long-term projects, there is an even worse impact of aggravation of sanctions risks that cause sponsors and lenders to shy away even from projects that are entirely legal under the current sanctions regime, but where the uncertainty about future sanctions reaches a level of risk that effectively prevents sponsors and lenders to proceed.
It is sad to see that many legitimate projects are prevented by existing sanctions, or by an unpredictable aggravation of sanctions risk. Although there are promising efforts by the European Union or the German Government to mitigate the impact of foreign sanctions, all corporates and lenders will have to comply with the different sanction regimes applicable to their business, and to assess carefully whether a project remains viable if it is exposed to aggravation of sanctions risks.
Dr. Dietrich F. R. Stiller
Rechtsanwalt
SZA Schilling, Zutt & Anschütz
Rechtsanwaltsgesellschaft mbH
Taunusanlage 1
D-60329 Frankfurt am Main
Germany
Tel: +49 69 9769601 160
E-Mail: dietrich.stiller@sza.de
Internet: www.sza.de
Dietrich specializes in banking law and finance with a focus on project finance and BOT structures as well as export finance and refinancing of distressed enterprises. He has a rich experience with domestic and cross-border projects involving multiple jurisdictions, including the German aspects of the NordStream I pipeline as well as projects in the airport, telecommunication, power, renewables or health care industry.
SZA Schilling Zutt & Anschütz is one of the leading German law firms with offices in Frankfurt am Main, Mannheim, Munich and Brussels.
