project finance session 02

Project FinanceSession 2 – Project Risk Management

Project Finance - Session 2 2

Agenda

Revision – Session 1

Project Risk Management Risk Management Processes

Identifying Project Risks

Risk Allocation with Contracts

Role of Advisors Legal

Independent Engineer

Insurance

2009



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

2009



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

2009

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

Pre-completion Phase

Activity Planning

Technology

Construction

Post-Completion Phase

Supply Risk

Operational Risk

Market Risk

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Common Risks

Interest Rate Risk

Exchange Risk

Inflation Risk

Environmental Risk

Regulatory Risk

Legal Risk

Credit / Counterparty Risk

Risk Breakdown Structure (RBS)


Indentifying Project Risks

Level 0 Level 1 Level 2

Project Risk

Planning

Feasibility

Master Planning

Design

Execution

Scheduling

Procurement

Construction

Controlling

Scope Control

Finance / Cost Control

Operations

External

Economic

Market

Political

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Risk Measurement & Analysis

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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

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Input Supplier

Project Company

Alternative

Supplier

Indexed Payments

The Input supplier bears the price

risk on finding an alternative

supplier – either directly or indirectly

Supply of raw materials from Alternative Source


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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Insurance (General)

Insurance is an important risk mitigation tool that must be properly coordinated and linked to the project’s contractual

structure.

Insurance should be used when the Project Company’s 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

2009

project finance session 02

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