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PROJECT Finance? Track What is... PROJECT finance? Track Project finance, also called non-recourse Project loans are made by commercial banks, or limited-recourse finance, is a form of with each lender agreeing that loans will be financing for companies and repaid only from the revenues generated by governments where lenders are repaid the successful, completed project. Loans only through the revenues generated by normally contain loan covenants or agreements the project itself (e.g. the tolls collected between the lender and the borrower about from a toll road, the electricity generated what the borrower should or should not do, by a power plant). Lenders do not have such as providing regular reports and adequate “recourse” to the borrower's own assets if a insurance. Larger, more risky projects often project fails to generate the revenue projected. require syndicated loans. These loans are Project finance is most commonly directed at provided by a group of financial institutions large infrastructure projects. After massive called a bank consortium or a syndicate. The privatization and deregulation of industrial bank coordinating the consortium and the sectors in the 1990's, private financing of syndicated loan is called the arranger, and can development projects grew enormously. be different from the banks' providing the debt. Although the volume of projects decreased in Projects can also be financed through project 2001 as a result of the worldwide economic bonds. In this case, investment banks slowdown and industry-related risks (especially underwrite project bonds by buying the newly in the power sector), project finance began issued bonds at a guaranteed price, and then rebounding in 2002. The total amount of reselling them to institutional investors. Like projects financed through private loans project loans, project bonds rely solely on the amounted to $73 billion in 2003. success and revenues generated by the project The process for repayment; these terms and others are outlined in a bond covenant. Bonds can also be Project finance has a particular nature. The derived from project loans. Through a process deal cycle is typically very long (can take called securitization, the future income from years), and can involve many financiers. The the syndicated loan is used as collateral for the initial costs of big projects are typically very issue of new bonds. high, while the benefits can only be reaped in the longer term. Since all kinds of risks may Actors involved arise (financial, technical, environmental, Most project financing is arranged and financed political etc.), and project finance has evolved by European and American banks. Besides to be a very complex financing method. banks, other (financial) firms also play an Project finance is comprised of a mix of equity important role. Insurance, for example, is of and debt; typically 30-40% of the project is great importance, given the often risky nature funded through equity contributions, while 60- of the projects. Legal and other advisory 70% is funded through debt. Project sponsors services are also critical. typically contribute the equity and “own” the Although governments have left project project, while debt finance can take two forms: financing increasingly to the private sector, loans and bonds. private finance : a public interest they remain involved in the design and the As a result of the adverse consequences big conditions of the projects. For example, local infrastructure projects can have, civil society governments can purchase the infrastructure or has increasingly targeted the financiers services after the project has been finished. involved in the projects. Host governments of the construction CSR initiatives in this domain have become very companies can be involved when their Export important. The Equator Principles are probably Credit Agencies (ECA's) offer insurance for the the most salient, since the banks which payment of their equipment or services. Finally, endorse the Principles arrange over three participants often turn to multilateral quarters of total project finance loans by development banks like the European Bank for volume. Reconstruction and Development or the International Finance Corporation (the World Bank's private arm) to back the project. As a Glossary: result, project finance often takes the form of Underwriting: the process by which an hybrid public-private partnerships. investment bank assists a company or government to issue securities. The underwriter guarantees a The projects certain amount to the issuer, and purchases any The most prominent project finance sectors are securities that are not bought by the markets. telecommunications, power plants, infrastructure, natural and other resources, Bonds: promissory notes that oblige the issuer to petrochemical and chemical plants. Most pay back a certain amount of money within a project finance is destined to projects in certain time (with or without regular payments, or Western Europe. North America is another 'coupons'). major destination, followed by Latin America Syndicated loan: loans for large, risky plus the Caribbean and South-east Asia. commercial or government projects provided by a group of banks, called a bank consortium or a Critical issues syndicate. The bank who coordinates the loan does Project lending may result in unsustainable not necessarily provide financing itself. practices because banks and project sponsors (bank clients) often do not produce adequate Loan/bond covenant: agreement between the environmental and social impact assessments borrower and the lender (or issuer of the bond) of the projects they are financing. In addition, about the conditions of the project, including what financiers may lack sustainability criteria, and the borrower will and will not do. environmental and social regulations in host Securitization: the process of aggregating assets countries can be weak. Finally, the lack of in a pool and issuing new securities backed by the transparency for individual 'savers' (who are revenues expected to be generated by the pool. interested in knowing how the bank is using their savings), and the absence of channels for those savers to voice their concerns, also helps perpetuate unsustainable practices. Web references: www.equator-principles.com www.banktrack.org www.hbs.edu/projfinportal www.ipfa.org (international association for project finance) This fact sheet was produced by SOMO, centre for research on multinational corporations -www.somo.nl- for BankTrack, the campaigners network tracking the private financial sector. T: +31-30-2334343, F: +31-30-2381112, E: [email protected], www.banktrack.org.
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