Project Finance

Session 2 Project Risk Management

Agenda

Revision Session 1 Project Risk Management

Risk Management Processes Identifying Project Risks Risk Allocation with Contracts

Role of Advisors

Legal Independent Engineer Insurance

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Revision Session 1

Characteristics of Project Finance

Debtor is a Project Company (SPV) Legally Independent from Sponsors Investing in a Capital Asset Lenders have limited recourse to Sponsors Assets

Risk (more) Equitably Allocated

Finance Granted on the basis of future cash flows

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Revision Session 1

Current Trends in Project Finance

Overall Project Finance market down 61% (3rd Qtr) Shift in Market Dynamics

Developing Countries Banks Types of Projects

The Future of Global Infrastructure

$ Billions to Maintain current living standards

Power, Roads

Project Finance - Session 2

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Session 2 Risk Management

Project Risk Management

From a Project Finance perspective

Proper Risk Management helps to ensure consistent cash flows throughout the life of the Project, thereby reducing likelihood of default on debt servicing requirements.

From a Project Management perspective

Risk Management helps to ensure that the probability & impact of Positive events are increased (negative events are decreased), thereby optimizing profitability of the venture.

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Risk Management Standards

Globally Recognised Standards include:

AS4360: Risk Management COSO ERM Framework IRM: Risk Management Standard OGC: Management of Risk PMI: Risk Management Standard

All documents have a similar methodology for the identification, analysis & treatment of Risks

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Risk Management Processes

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Identifying Project Risks

Risk Breakdown Structure (RBS)

Pre-completion Phase Activity Planning Technology Construction Post-Completion Phase Supply Risk Operational Risk Market Risk

Common Risks Interest Rate Risk Exchange Risk Inflation Risk Environmental Risk Regulatory Risk Legal Risk Credit / Counterparty Risk

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Indentifying Project Risks

Level 0 Level 1 Level 2
Feasibility

Planning

Master Planning Design

Scheduling

Execution Project Risk

Procurement Construction

Scope Control

Controlling

Finance / Cost Control Operations

Economic

External

Market Political

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Risk Measurement & Analysis

Forecast: Journey time to work
180

Cumulative (%)

100 80 60 40
20 0 25 40 Time (min)
47 minutes

160 140 120 100 80 60 40 20 0

60

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Frequency%

Risk Allocation with Contracts

The Project Company normally allocates risk through the config. of prelim. contracts before soliciting funds. However, Bank Analysis may reveal further risks, in which case:

Financing is postponed Additional covenants are included in the loan agreements

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Construction Risk

The price paid to the contractor is usually the largest capital expenditure incurred by the project company. The contract is also the most likely source of significant cost overruns. Turnkey / EPC Contract

Is usually fixed price, the contractor taking the risk of any fluctuations in the cost of labour or materials FIDIC / NEC / Bespoke

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Turnkey / EPC Contract

Features:

(Fixed) Price Completion Date

Handover, Testing & Commissioning (FAC)

Plant Performance (Minimum Standards) Liquidate / Make Good

Guarantees & Warranties

Damages (Liquidated)
Force Majeure

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Supply Risk

Put-or-Pay Agreements

Supplier Sells @ Pre-agreed Prices If supply is lacking, the Risk lies with the Supplier i.e. Compensates the Project Company

Input Supplier
The Input supplier bears the price risk on finding an alternative supplier either directly or indirectly

Indexed Payments

Project Company

Alternative Supplier

Supply of raw materials from Alternative Source

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Operational Risks

O&M Agreements

Fixed Price Contract: The Operator assumes risks relating to the fluctuations in operating costs

Pass-Through Contract: The Operator receives a fixed payment and performance bonuses
*Step-In Right: Lenders may request the right to remove the original operator and substitute with another.

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Market Risk

Offtake Agreements:

Long-term contracts where the Offtaker agrees to purchase nominated volumes/quantities of a good or services from the Project Company Take-or-Pay: the offtaker is obligated to pay even if it does not actually take the good or service i.e. PPA Shadow Toll System: payment is made by the Public Admin. on the basis of the volume of traffic & service level. Shadow refers to the fact that the end user does not actually pay the toll.

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The Role of Advisors

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The Role of Advisors

Each project finance deal has a critical minimum-size threshold below which structuring costs become excessive in relation to its forecasted income and cash flows.

Although efficiency is questionable, the role of advisors is essential to the closure of Project Finance Deals

Legal Advisors Independent Engineers Insurance Advisors

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Legal Advisors

Usually the first Advisors to be appointed by both Sponsors & Lenders Address specifics of International Legal Systems i.e. Civil Vs Common

Activities involved in, include:

Incorporation of the Project Company (SL) Due Diligence (AL) Legal Opinions (AL) Project Contracts (SL)
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Independent Engineer

Oversees & monitors the Project on behalf of the lending banks There may be a number of Independent Engineers dependent upon the technical nature of the project.

Activities involved in, include:

Due Diligence Reporting Certification / Issuing of Progress Reports Oversight of Testing & Commissioning Monitoring of Operations
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Project Finance - Session 2

Insurance (General)

Insurance is an important risk mitigation tool that must be properly coordinated and linked to the projects contractual structure.

Insurance should be used when the Project Companys cost of risk mitigation using insurance policies is less than the premium for risk expressed in the interbank interest rates requested by banks if no coverage exists.

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Insurance Advisors

The scope of work for an insurance advisor includes:

Preliminary Insurance Report Identifying analysis of contractual documentation & recommendations for risk coverage Final Insurance Report (Construction) Issued at the time of Financial Close typically constitutes a condition precedent for disbursement (drawdown). Conformity of Insurance Program Finance Insurance Report (Operations) Issued before start-up of Operations

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Typical PF Insurance Products

The most common forms of coverage used are:

Construction / Contractors All-Risks Transport Policy Material & Damage All Risks Force Majeure

Key Man Insurance

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Summary

Project Risk Management is an extremely important tool in the identification, analysis and mitigation of Project Risks. Advisors (Legal, Engineering & Insurance) play a crucial role in the mitigation of risks through:

Specialized Expertise Due Diligence Structure / Viability of the Project Monitoring

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