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SecurityinProjectFinance
Jan‐HendrikRöver
SECUREDLENDINGINCOMMERCIALTRANSACTIONS‐ TRENDSANDPERSPECTIVES‐
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Overview
• What is project finance?• Project finance after the financial crisis• Functions of security in project finance• What is „security“ in project finance?• Security structures in project finance• How secure is security in project finance?
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Whatisprojectfinance?Ageneraldefinition
Projectfinancingischaracterisedbyfivecriteriaandthusclearlydifferentiatedfromtraditionalcorporatelending:
BorrowerLegallyandeconomically
independentprojectcompany
Serviceofprojectloan(repaymentandinterest)
fromfuturecashflowsofprojectcompany
PurposeoffinancingFinancingofaclearlydefined(greenorbrownfield)project
Liabilityofsponsors
Nooronlylimitedrecoursetosponsors• securityinterestsofprojectcompany• (limited)securityinterestsofsponsors
Riskstructuring
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Whatisprojectfinance?TheParties
Sponsor1 Sponsor2
Projectcompany
Bank1
Bank2
Loan1
Loan2
Intercreditoragreement
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Whatisprojectfinance?TheRisks
Risksfacedbyaprojectcompanyanditslenders
ProjectRisk:Creditrisks
Projectrisk:Technicalrisks
Projectrisk:Economicrisks
Projectrisk:Politicalrisks
Projectrisk:Legalrisks
Bankrisk:Syndication
risk
Projectrisk:Forcemajeure
risks
Bankrisk:Refinancing
risk
ForprojectrisksseealsosummaryofrisksinBaselIIPrinciples,appendix 4table1(supervisoryslottingcriteriaforspecialisedlending)issuedbyBaselCommitteeonBankingRegulation(inthisrespectnotsupersededbyBaselIII);seealsoArticle87§ 5ofDirective2006/48/EC
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Whatisprojectfinance?Thetypesofprojects
Power/energy(incl.renewableenergy)
35%
Transportation/infrastructure&publicprivatepartnerships
25%
Mining
4.5%
Othersectors•Leisure&Property•Telecommunications•Petrochemicals•Industry•Water&Sewerage•Waste&Recycling•Agriculture&Forestry
23%
Oil&gas
12.5%
Percentagesrepresent2010shareofsectorintotalvolumeofprojectfinancetransactionsSource:ThomsonReutersProjectFinanceInternational
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Projectfinanceafterthefinancialcrisis(i)
• Banking world in turmoil since insolvency of Lehman Brothers (2008)• Changes in the general framework Accounting changes (IFRS 10*)
If sponsor holds majority of shares in project company he must show debt financing of project company on its group balance sheet (no off-balance sheet financing by sponsors)
Banking regulation
Higher equity requirements for „specialised lendings“**– Five types of specialized lending of which project finance is one
Banks typically use „Internal Ratings-based (IRB) Approach“ to credit risk and allocate risk weightings of up to 250%
– Supervisory slotting criteria for specialised lending
* Applicable since 1 January 2013; incorporated by Regulation (EU) No. 313/2013 of 4 April 2013** See Basel Committee on Banking Regulation, Basel III: A global regulatory framework for more resilient banks and banking systems, revision June 2011
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Projectfinanceafterthefinancialcrisis(ii)
• Change in environment for PPP/PFI projects
Coming to an end of privatisation wave Change in perception of creditworthiness of public entities (in
particular PIIGS countries [Portugal, Italy, Ireland, Greece and Spain])• Change in risk realisations: long-term assumptions in cash flow models were falsified by reality Renewable energy: wind forecasts Transportation: traffic forecasts Oil and gas: gas price development General: tax assumptions
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Projectfinanceafterthefinancialcrisis(iii)
• Changes in project finance structures Generally further increase in risk awareness and risk mitigation leading
to more complex financing structures
Increase of sponsor support (transformation of limited recourse financing)
Lower debt/equity ratios (i.e. higher equity element) More comfortable financial covenants
Shorter loan tenors / incentives for early repayment or refinancing such as margin increases over time Leading to a renaissance of quasi „mini-/medium-perm
financings“
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Projectfinanceafterthefinancialcrisis(iv)
Risk mitigation instruments
International financial institutions (A/B loan structure) European Investment Bank (EIB) initiative: Loan Guarantee
Instrument for Trans-European Transport Network Projects, LGTT (networks in the transportation, power and telecommunication sector), launched in 2008
Generally reduced availability of bank financing Increased interest in project bonds as replacement of bank
financing EIB: Europe 2020 Project Bond Initiative, launched in 2012
– First project: Natural gas storage „Castor“ in 2013
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Projectfinanceafterthefinancialcrisis(v)
Source:ThomsonReuters,ProjectFinanceReview,FullYear2012
• Bank world for project finance has contracted from its peak in 2008
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Functionsofsecurityinprojectfinance
• „Securityisashield,notasword“(PhilipR.Wood*)• Limitedmarketvalueofprojectcompany‘sfixedassets• Negative ordefensivefunctionofsecurity(exclusionofthirdpartycreditors);securityprovidespowertoenforceand/orpriorityinenforcement;enablesrestructuring Not: assignment of insurance contracts Not: security assignments of other receivables
•Management functionoffloatingcharge•Positive function:enforcementofsecurity• Priority functionofsecurityininsolvency
*ProjectFinance.SubordinatedDebtandStateLoans,1995,p.30
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Whatissecurityinprojectfinance?(i)
• „Bywayofsecurityacreditorensuresforhimselfaprivilegedstatus,either byestablishingrealrightsoverone,someorallofthedebtor‘s
assets(realsecurity)or byhavingrecoursetoathirdpartywhohasundertaken
responsibilitytothelenderforpaymentifthedebtordefaults(personalsecurity)“*
* Sir Roy Goode and Ewan McKendrick, Commercial Law, 4th ed. (London 2010)
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Whatissecurityinprojectfinance?(ii)
• Partofthedefinitionofprojectfinanceisriskstructuringwithaviewtoriskmitigation Securityinafunctionalsenseinaprojectfinancecontextis
broaderthanpersonalandproprietarysecurity Comprisesanycontractualtoolthatsecuresdebtservice
Includesfinancialcovenants Includesfurtherothercoventants Debtservicereserveaccount Controlofcashflow
BroadviewonsecurityconfirmedbyBaselII„supervisoryslottingcriteriaforspecialisedlending“(seecategory„security“)
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Securitystructuresinprojectfinance(i)
• Securityinanarrowsense(„twolayermodel“) Onthelevelofsponsors Onthelevelofprojectcompany
Includessecurityonthelevelofthegeneralconstructioncontractor(EPC);(performance‐)guaranteeofthegeneralconstructioncontractor
– Providedtotheprojectcompany– Hence,additionalsecurityassignmentofany(future)rightundertheguaranteetolender
• Furthermore,so‐called„directagreements /step‐inrights“(para.6ofSchedule2AInsolvencyAct1986)withmaincontractualpartners(operators,suppliersorofftakers)
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Securitystructuresinprojectfinance(ii)
Sponsors‘sharesinprojectcompany PledgeofsharesLevelofsponsors
Levelofprojectcompany
(continuedonnextslide)
Asset Typeofsecurity
Completionguarantee
Projectcompany‘srightstopaymentofaccountdeposits
Realestate Securityinterestinrealestate
EquipmentandmachineryFixedcharge(UK)/
Securitytransferofownerhip(GER)
SecurityassignmentofreceivablesRightsunderinsurancecontracts
Pledgeforthebenefitofbank
SecurityassignmentofreceivablesRightsundergeneralconstructioncontracts
SecurityassignmentofreceivablesRightsundersupplycontracts
SecurityassignmentofreceivablesRightsunderofftakecontracts
Sponsor‘sassets
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Securitystructuresinprojectfinance(iii)
Levelofprojectcompany
(beginningonthepreviousslide)
Asset Typeofsecurity
Paymentrightsundershareholderloans
Shareholderloansinsteadofcapitalcontributionmaybeefficientformoffinancing,sinceinterestcanbe
deductedfromtaxbase
Securityassignmentofreceivables
Negative„pledge“clause(covenantnottocreatesecurityrights
forthebenefitofthirdparties)
Nosecurityinterest;onlyobligation
(Proprietaryorquasi‐proprietary)securityinpoolofassetslikefloatingchargeofEnglishlawor
nantissementdefondsdecommerceofFrenchlaw
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Securitystructuresinprojectfinance(iv):floatingcharge
• Floatingchargeswereconvenienttoolforprojectfinancingsinthepast;theyallowedappointinganadministrativereceiverandthusmanagingprojectcompanyindefault Roleininternationalfinancingshasalwaysbeensomewhat
limitedduetothefactthatcontinentallegalsystemswerenotabletorecogniseEnglishlawfloatingcharge
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Securitystructuresinprojectfinance(v):floatingcharge
• SincethereformoftheEnglishEnterpriseActanadministrativereceivercanbeappointedonlyinexceptionalcases Pursuanttosec.250EnterpriseAct2002andsec.72BInsolvency
Act1986onlyexceptionsforso‐called„qualifyingfloatingcharges“,e.g.for (2)public‐privatepartnershipproject, (3)utilityproject, (5)afinancedproject(projectfinancing)withatotaldebt
amountofatleast£50million– Scopeof“project”unclear
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Several lenders
Syndicatedloan Sub‐participation(e.g.EBRDA/Bloan)
Securitystructuresinprojectfinance(vi):securitytrustee
Bank1 Bank2
Projectcompany
Loan2
Bank2
Bank1
Projectcompany
Loan
Loan1
Sub‐participationagreement
Inter‐creditoragreement
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• Relevantforsyndicatedloans• SecuritytrusteeunderEnglishlawforproprietarysecurityinterests• MorecomplextruststructureunderGermanlaw Non‐accessory(non‐ancillary)securityrights*
Creationfor(Germanlaw)trustee Accessory(ancillary)securityrights**
Creationforeachbankinordertosecureloanobligation– Securityholdermustalsobecreditorofthesecureddebt
Creationofsecurityforthebenefitofa(Germanlaw)trustee tosecureaparallelsecureddebt(debtacceptance[Schuldanerkenntnis])
Creation of security if there are several lendersSecuritystructuresinprojectfinance(vii):securitytrustee
* I.e. non-accessory real estate mortgage for security purposes, security transfer of ownership, security assignment of receivables** Pledge of accounts, pledge of shares, accessory real estate mortgage (the latter is not often used in practice)
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Howsecureissecurityinprojectfinance?(i)
• Thereisnodifferenceinthelegalefficiencyofsecurityinanarrowsenseinprojectfinancecomparedtoothertypesoffinancing• However,theeconomicefficiencyisquitedifferent Atleastattheearlystagesofaprojectifprojectworks(and
thererforesecurityisnotneeded)• Therefore,securityinanarrowsenseinprojectfinancehasmainlyadefensiverole Atleastattheearlystagesofaprojectifprojectworks(and
thererforesecurityisnotneeded)
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Howsecureissecurityinprojectfinance?(ii)
• However,inunderstanding project finance security structures oneshould notfocus onsecurity inanarrow senseonly There are functional security instruments used inproject
finance structures which supplement personaland proprietarysecurity
Leadsto highfinancial stability of projects(provided thatassumptions are correct)
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Germansecuredtransactionslaw Jan‐HendrikRöver,RealsicherheitenundDirektvereinbarungen,in:UlfR.Siebel,
Jan‐HendrikRöverandChristianKnütel(eds.),RechtshandbuchProjektfinanzierungundPPP,2nded.(Cologne,Munich2008)
HansjörgandJörg‐AndreasWeber,Kreditsicherungsrecht,9thed.(Munich2012)Englishsecuredtransactionslaw HughBeale,MichaelG.Bridge,LouiseGulliferandEvaLomnicka,TheLawof
SecurityandTitle‐BasedFinancing, 2nded.(Oxford2012) MichaelBridge,PersonalPropertyLaw,3rded.(Oxford2002) MichaelBridge,LouiseGullifer,GerardMcMeelandSarahWorthington,TheLaw
ofPersonalProperty(London2013) SirRoyGoodeandEwanMcKendrick,CommercialLaw,4thed.(London2010)
US‐americansecuredtransactionslaw JamesJ.WhiteandRobertS.Summers,UniformCommercialCode,6thed.
(St.Paul,Minn.2010) JamesJ.WhiteandRobertS.Summers,PrinciplesofSecuredTransactions
(St.Paul,Minn.2007)
Bibliography(i)
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EasternEuropeansecuredtransactionslaws Jan‐HendrikRöver,SecuredLendinginEasternEurope.ComparativeLawof
SecuredTransactionsandtheEBRDModelLaw(Oxford2007)Westernsecuredtransactionslaw (inparticularEuropeanUnionsecured
transactionslaws) Eva‐MariaKieninger(ed.),SecurityRightsinMovablePropertyinEuropean
PrivateLaw(Cambridge2004) HarryC.SigmanandEva‐MariaKieninger(eds.), Cross‐BorderSecurityover
Tangibles(Berlin2007) HarryC.SigmanandEva‐MariaKieninger(eds.), Cross‐BorderSecurityover
Receivables(Berlin2009) HorstEidenmüllerand Eva‐MariaKieninger(eds.),TheFutureofSecuredCreditin
Europe(Berlin2008)
Bibliography(ii)