Challenges to Executing Transactions in the Project

16 • ARTICLE WHO’S WHO LEGAL: PROJECT FINANCE

THE MULTIPLICITY FACTOR

Cynthia Urda Kassis and Ben Shorten, Shearman & Sterling LLP

More than five years after the Lehman Multiple providers where circumstances permit – for Brothers crisis, and despite gradual The mega-fully underwritten commercial example, high liquidity in the relevant improvement, bank liquidity within bank syndicates of yesteryear have market (such as the Saudi Arabian bank the project finance market remains been replaced by financings, which market or in certain Latin American constrained. As a result, since the Lehman combine multiple lending sources, often countries), or where the size of the Brothers’ collapse in September 2008, with different objectives and therefore project debt is small enough to be funded sponsors and lenders have developed very different approaches to analysing, from bank liquidity. However, it happens various techniques to bridge the liquidity conducting due diligence, structuring and in much more limited circumstances than gap. Broadly speaking, the result has negotiating financing. was the case before 2008. almost inevitably led projects to use The potential mix of lending sources multi-source financing plans, in which include: Innovating with instruments funding is provided from different types • multilateral or regional institutions Along with the entrance of a number of of lenders often using different types of such as the International Finance new sources of financing, the resurgence financial instruments. As a consequence, Corporation, the Asian Development of vendor finance and general efforts project financings have become more Bank, the African Development Bank, to increase participation in the market complex. This added complexity results the European Investment Bank, the by all potential sources of funding, we in a number of challenges to executing Inter-American Development Bank and have also seen the development of new transactions; in this article, we examine the Islamic Development Bank; financing instruments. In some cases, some of these challenges and the • export credit agencies (ECAs) such as these instruments have evolved to better techniques that can be used to address the Export-Import Bank of the United address the financial objectives of the them. States, the Japan Bank for International new sources, thus enabling their entrance Cooperation and Export Development into the market. In other cases, the new THE NEW NORMAL Canada, along with a host of European instruments reflect the sources developing Since 2008, efforts to bridge the ECAs; new techniques to address the needs of project finance funding gap have been • domestic development institutions sponsors arising from constrained overall concentrated on, firstly, identifying such as the Brazilian Development market conditions, not only for debt but new sources of liquidity, and secondly, Bank (BNDES), a behemoth of Latin also equity. unlocking such sources by developing America; One of the more popular new new financial instruments, which will • international, regional and local banks instruments is streaming/royalty financing, entice these as well as traditional sources and Islamic financial institutions; and which has developed to address the to enter or increase their participation • the international or local capital persistent liquidity gap for funding both in this sector. The focus on unlocking as markets. equity and debt in the mining sector. One much liquidity as possible results from the of the major attractions of this type of fact that funding from commercial banks, In certain jurisdictions/sectors, pension financing (which is akin to a prepaid (or traditionally the largest source of project funds and insurance companies are active partially prepaid) forward) is its hybrid financing, remains dramatically contracted, project lenders. Private equity as well nature which results in it providing with many pre-Lehman banks either as hedge and sovereign wealth funds certain benefits of equity financing severely reducing their lending or exiting are also now active participants in the without some of the downsides (such as the market. Thus, whereas prior to 2008 project finance debt market. Finally, dilution). There are also the debt/equity the trend had been for ever-increasing there has been a resurgence of funding hybrid instruments favoured by many amounts of project debt to be raised solely from industry sources such as equipment private equity and hedge funds, which in the commercial bank market under manufacturers, commodity purchasers and often take the form of mezzanine debt or vanilla lending structures, often fully construction contractors. preferred/quasi-preferred equity. underwritten by one or a small number This is not to say that projects are Another instrument currently in of banks, today most large project funding no longer financed solely by commercial vogue (though not new) is the project plans use multi-source structures. bank syndicates. This does still happen bond. Very popular in the late 1980s/

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early 1990s, there has been a resurgence of institutions, ECAs and multilaterals often under which certain lenders receive project bonds, in particular for renewable have prescribed board and stakeholder different treatment from others, this projects and projects in Latin America approval processes that include infrequent outcome is not guaranteed outside certain and the EMEA region. In addition, other meetings and long pre-meeting notice historically agreed market practices instruments in the capital markets are periods once the documentation is such as in bank/bond financings, where being retooled for use to fund projects agreed. Debt capital market issuances bondholders have a much lighter covenant including high yield bonds and – in the typically involve set procedures required and event of default package than the US – various municipal bond structures. by relevant rating and listing agencies, as ECA and commercial lender tranches. Finally, with the increased role of well as satisfaction of applicable statutory By combining sources and structures domestic governmental institutions in requirements. Islamic financing structures with care, sponsors can consider the many countries focused on encouraging are subject to approval of the shariah benefits thereof and avoid inadvertently the development or refurbishment of committees of each of the participating losing such benefits due to inconsistent basic infrastructure, we are seeing a financial institutions. “New” lender classes requirements of other sources/structures variety of direct lending instruments such as pension funds and private equity within the financing plan. and credit support facilities from these may not be familiar with project finance For example, if a covenant-lite institutions designed to mobilise funding principles and need a high degree of arrangement is the goal, combining from other sources. These instruments discussion through the process. project bonds with ECA or multilateral have a wide range of structures, including To address the management issue, financing might not be appropriate, tax credit structures and long-term, sponsors and financial advisers must be whereas a project bond/Term B financing semi-subordinated debt arrangements highly forensic and proactive in planning may be more effective. Alternatively, if (such as under the US Department of the financing process, so that the various maximum refinancing flexibility is sought, Transportation’s TIFIA programme). issues are considered in accordance with combining structures which require pro the relevant timeline (working backwards rata repayment in all circumstances or NAVIGATING THE NEW LANDSCAPE from the target financial close date). have high prepayment premium would Faced with a terrain that is more complex The increased number of participant not be optimal. than prior to the financial crisis, what groups and the issues that this brings are some of the key challenges presented often means that the process benefits from Pushing the envelope? in executing a financing plan today? a higher number of face-to-face meetings Given the process issues in multi- How can parties seek to manage these to achieve timely financial closing, though source financing, sponsors need to be challenges and avoid the pitfalls? finding a mutually agreeable time to mindful of the parameters in which The key challenges arise from the meet can be a challenge if not planned they are operating. The general rule diversity of the current financing plans. well in advance. Such meetings should be of thumb is: the more liquidity that is The different objectives of the sources incorporated into the timeline. needed, the less room sponsors have to lead naturally to different approaches be aggressive. In other words, where to due diligence, the credit analysis and Seeking alignment relatively large quantities of debt are approval process, and the desired terms. With more diversity in the lender groups needed, the terms and conditions tend to The different objectives also potentially and types of instruments involved, it is be more conservative (especially where lead to concerns across different lenders important that one seeks, to the fullest one or more MLAs or ECAs are anchor regarding the administration of the extent possible, to use lenders with a lenders). Therefore, any bankability financing in the ordinary course and in common approach who have previously analysis needs to take into account the the context of restructuring. Below, we worked together. Using lending sources likely requirements of the participating have set out a few tactical and strategic and structures that have been previously institutions and any sponsor-proposed actions that may help in efficiently combined, and thus have previously term sheet should be crafted with this executing multi-sourced financing. negotiated common covenant packages constraint in mind. In addition, alternative and intercreditor arrangements, can sources such as royalty/streaming or Managing the process avoid the extended negotiation process private equity arrangements, which tend Increasing the number of funding sources which comes from being a pioneer in to be entered into in advance of other (by including multiple tranches of lenders structuring such arrangements. It can also elements of the financing plan, need to and/or multiple types of financing prove beneficial in avoiding the “lowest have terms that anticipate the needs of the instruments) typically complicates the common denominator” effect of multi- balance of the lending group. negotiation of the financing phase of a source negotiations. And it increases the project. However, the challenge comes likelihood of a successful closing as there The pricing/tenor balance not just from managing a larger or more is precedent for success. With multiple classes of lenders and diverse group of lenders, but from the Regarding the “lowest common financing instruments, it is critical for specific requirements that each brings denominator” effect, though it may be sponsors to avoid the “lowest common to the process. For example, as public possible to negotiate an arrangement denominator” effect, particularly on

financial terms (ie, funding costs/average interests and objectives often compete. to agree an arrangement, rather than the life/maturity at the level of the worst While certain decisions can be made ability to replicate exact structures. offer). Many lenders, though not all, based on customary pool majority-voting will accept pricing differentials between principles, others may need to be on DRAWING CONCLUSIONS different lending sources. In fact, multiple the basis of tranche voting or individual The multiplicity of funding sources debt sourcing can be useful in creating lender sign off. For example, ECAs often and financial instruments is expected to pricing tension amongst different lender require veto/control rights regarding continue for the foreseeable future. It is groups. There remains a risk of cross- policy matters irrespective of the size of therefore critical to achieving successful pollution, however, so sponsors need their participation. financing that the complexities and to be mindful of managing lenders’ There are a number of customary challenges arising from such multiplicity expectations. Differentials in average life considerations to be addressed in any be recognised and pro-actively managed. and maturity of debt can be more difficult intercreditor structure, such as consent/ This will often require a combination to achieve, especially outside the bond waiver voting, control over enforcement of multilateral and bilateral negotiations, context. In crafting the financing plan, in a default scenario and consultation finely balanced to manage the knowledge of the internal lender policies arrangements. However, it is important expectations of all. Finally, it needs to be on acceptable mismatches in this regard is to recognise that many intercreditor recognised by both sponsors and lenders very important. arrangements are highly bespoke, based that highly bespoke financing plans mean on, among other things, the specific that a one-size-fits-all approach based on Made-to-measure intercreditor composition of the lender group and the precedent cannot be followed; flexibility Multiple lender groups and financial exposure of each group. Thus, precedent and creativity will need to be employed. instruments mean more complex is more relevant for process considerations intercreditor arrangements, as the various and evidence a particular group’s ability