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Diplomarbeit, 2008, 173 Seiten
Table of Contents
List of Figures
List of Tables
Glossary and Table of Abbreviations
1.1 Structure and goals of the thesis
1.2 Relevance of the thesis
1.4 Focus of the thesis
2 Introduction (Part I)
2.1 Definition of the term “PF”
2.1.1 Development of PF
2.1.2 Early use of PF (until the 20th century)
2.1.3 Fields of application in recent times (20th century until now)
2.2 Characteristics of PF
2.2.1 General Features
2.2.4 Table: Characteristics of PF
2.3 PF process
2.3.1 The Planning Phase
2.3.2 Construction Phase
2.3.3 Operation Phase
2.4 Risks in PF
2.4.1 Bankability risk
2.4.2 Cost overrun risk
2.4.3 Construction delay risk
3 Core Parties in PF
3.1 Project Company (SPV)
3.4 Export Credit Agency
3.4.1 Description of the institution
3.4.2 The typical PF cycle (ECA)
3.5 Multilateral Development Bank
3.5.1 Description of the institution
3.5.2 Typical PF cycle (WB)
3.6 Host Government
3.7 Construction Company
3.8 Supplier and Purchaser
3.9 Other Parties
3.9.1 Technical Advisor
3.9.2 Legal Advisor
3.9.3 Financial Advisor
3.9.4 Operation and Maintenance Company (O&M Company)
3.10 Side note: Developer
3.11 Figure: Core Parties in PF
4 Core Contracts and agreements in PF
4.1 Joint Venture Contract
4.2 Government Support Agreements
4.2.1 Letter of Support
4.2.2 Concession agreements, licenses and permits
4.3 Construction Contract
4.4 Input Supply Agreement
4.5 Loan Agreement and Securities
4.6 Off-take Agreement
4.7 O&M Contract and other Service Contracts
4.8 Insurance Contract
4.9 Side note: Special contracts occurring in PPPs
4.10 Figure: Core Contracts and Agreements in PF
5 Introduction (Part II)
5.1 Current situation in the PF industry
5.2 Previous studies of infrastructure projects
6 Research Question I
6.1 Definition of terms
6.2 Approach to answer Research Question I
7 Identification of success criteria
7.1 Identification of sources
7.2 Source 1: Literature
7.3 Source 2: Expert interview
7.4 Preliminary list of success criteria
8 Method how to identify financial success criteria
8.1 Reasons for an expert questionnaire
8.2 Structure of the questionnaire
9 Results of the questionnaires
9.1 Importance of the criteria for power plant PF undertakings
9.2 Financial Success Criteria that are extremely important
9.3 Additional findings
9.3.1 Specific criteria that are dispensable
9.3.2 Other observations during the analysis
11 Introduction (Part III)
11.1 Current state of environmental and social sustainability
11.2 Environmental and social sustainability in PF
11.2.1 Host Governments
11.2.2 MDBs and other non commercial lending institutions
11.2.4 Commercial lenders
12 Research Question II
12.1 Definition of terms
12.2 Approach to answer Research Question II
13 Environmental Success Indicator (EnSu) Concept
13.1 Underlying methodology
13.1.1 2008 EPI methodology
13.1.2 Reasons for using 2008 EPI’s methodology
13.1.3 The EnSu’s methodology
13.1.4 Side note: Environmental impact assessment as data source for compiling the EnSu value
13.2 Necessary data and information for the EnSu concept
13.2.1 Environmental sustainability data and information
18.104.22.168 Reasons for using EHS TPNP benchmark values and key issues
22.214.171.124 Data and information that will be evaluated to compute environmental sustainability
13.2.2 Social sustainability information
126.96.36.199 Reasons for using IFC PS information
188.8.131.52 Information necessary to compute social sustainability
13.3 Applying the EnSu concept
13.3.1 Main operations used in the EnSu concept
13.3.2 Level 1: Categories
13.3.3 Level 2: Components
13.3.4 Level 3: Parts
13.3.5 Level 4: EnSu
13.3.6 Figure: EnSu’s framework
15.1 Main findings of Research Question I
15.2 Main findings of Research Question II
16 Areas of future research
List of References
Appendix 1 – Risks in international projects
Appendix 2 – Project Cycle IFC
Appendix 3 – Success criteria questionnaire
Appendix 4 – Participants of the questionnaire
Appendix 5 – Example of a Host Government’s rules and regulations for a power plant project
Appendix 6 – Equator Principle institutions
Appendix 7 – EPI framework
I declare in lieu of an oath that I have written this diploma thesis myself and that I have not used any sources or resources other than stated for its preparation. I further declare that I have clearly indicated all direct and indirect quotations. This diploma thesis has not been submitted elsewhere for examination purposes.
Ich erkläre an Eides statt, dass ich die vorliegende Diplomarbeit selbstständig verfasst, und in der Bearbeitung und Abfassung keine anderen als die angegebenen Quellen oder Hilfsmittel benutzt, sowie wörtliche und sinngemäße Zitate als solche gekennzeichnet habe. Die vorliegende Diplomarbeit wurde noch nicht anderweitig für Prüfungszwecke vorgelegt.
Firstly, I am grateful to the experts in the Project Finance industry which participated in the research process. Special thanks go to Ms. Anzola form the RZB and Mr. Hanzlik from the OeKB for their valuable insights into Project Finance and their time they spent on answering my questions.
Additionally, I want to thank the various people at the World Bank Group for replying my mails and leading me through the multitude of documents they provide.
Also I want to thank Mr. Schwand, for his valuable input in helping me to design a questionnaire that was used in order to gather information necessary for the thesis.
Last but not least, I also want to thank my thesis coach Mr. Fietz for arousing my interest in this topic. I also very much appreciated his guidance, patience and counseling throughout the process of writing the thesis.
To the greatest people in my life:
To my mother, Evelyne, for all her maternal care and unconditional love
To my father, Manfred, for his genuine respect and friendship
Only you and I know how important a role you two play in my life.
Although measures are taken to ensure that the investment in a Project Finance venture will pay off, studies of the recent past have shown that the bigger the projects and the larger their monetary value, the more susceptible the project was to suffer distress and the higher the chances of incurring losses.
Another issue that has emerged during recent years is the topic of environmental and social sustainability in Project Finance. At the dawn of the new millennium, environmental and social sustainability of a project was no longer a by-product of sound project design, but a requirement for obtaining the necessary financing.
In order to address both issues, the thesis has the following structure: Besides a concise introduction into the nature of Project Finance, the thesis deals with financial success as well as with environmental and social sustainability of a selected group of Project Finance undertakings.
Concerning the issue of financial success, the paper identifies success criteria of Project Finance undertakings in general. From that basis, criteria which are of particular relevance to the financial success of power plant Project Finance ventures are determined.
Considering the issue of environmental and social sustainability, a concept is developed to facilitate the evaluation of environmental and social sustainability of a project in its entirety.
The results concerning financial success criteria of power plant Project Finance undertakings indicated that there is no clear distinction between general and financial success criteria. Yet, it strongly emerges that some criteria are of more relevance to financial success than others.
In terms of environmental and social sustainability, the result of the research is a concept to measure the impact of the project. The concept evaluates the data and information on a mostly qualitative basis and aggregates the results in order to obtain one final value reflecting the overall extent to which environmental and social guidelines as well as benchmarks were met.
Airports, bridges, gas, mining, oil, petrochemicals, ports, power, property and tourism development, rail, roads, stadia, telecoms, tunnels, utilities and water.
These are just some sectors where Project Finance is a popular financing method. Some recent Project Finance undertakings include:
- “International Power's [..] [EUR] 1.839 billion purchase of Trinergy which is the largest project financed acquisition of a wind portfolio ever.” (pfi (2007a ); n.p.a.)
- “Lancashire signs [..] [GBP] 2 billion PFI waste disposal contract […] which is the UK's largest signed PFI contract to date.“ (IPFA (2007a); n.p.a.)
- “Saudi Arabian mobile operator Mobily closed a [..] [USD] 2.875 billion equivalent Islamic financing that is one of the largest and cheapest ever syndicated in the region.” (pfi (2007b); n.p.a.)
- “The [..] [EUR] 988 million […] A5 Nordautobahn PPP financing […] was the […] the biggest privately funded infrastructure project in Austria to date.” (pfi (2007c); n.p.a.)
The possibilities of being able to make huge investments with no, or little, financial backing but heavily rely on the promise of being able to pay back the loan in the future caused the author to familiarize himself with this financing option and he decided to elaborate on this topic in course of this diploma thesis. The topic should be treated in three parts:
Firstly, a general but concise overview of the topic Project Finance should be provided.
Secondly, due to the fact that although these undertakings are of significant monetary value, it is not unusual that projects suffer financial distress and have to be restructured. Hence, this thesis aimed at researching which financial success criteria exist in Project Finance that minimize a project’s likelihood of experiencing financial distress.
Thirdly, it was attempted to research if financial successful projects are also environmentally beneficial. In days of increasing environmental consciousness – and environmental sustainability as a prerequisite for a project’s financing – the author wanted to analyze if projects that provide financial benefits are also providing benefits to the environment they are placed in. Therefore, it was decided to design a new theoretic concept that allows assessing the environmental and social sustainability, i.e. the environmental success, of Project Finance undertakings in a specific industry sector.
Figure 1: Core Parties in PF
Figure 2: Core Contracts and Agreements in PF
Figure 3: Relevance of criteria for power plant PF undertakings
Figure 4: Binary standardization scale
Figure 5: EnSu’s Categories
Figure 6: EnSu’s Components
Figure 7: EnSu’s Parts
Figure 8: EnSu’s value
Figure 9: EnSu’s framework
Figure 10: Hunan Power Development Project. Environmental Protection Policy
Table 1: Characteristics of PF
Table 2: Bankability risks
Table 3: Types of Project Agreements with the public sector
Table 4: Success criteria by Nevitt/Fabozzi
Table 5: Success criteria (2) by Nevitt/Fabozzi
Table 6: Success criteria by PF expert (RZB)
Table 7: Preliminary success criteria list
Table 8: Final list of financial success criteria for power plant PF undertakings
Table 9: Dispensable criteria for power plant PF undertakings
Table 10: Criteria whose relevance for power plant projects’ financial success could not be evaluated
Table 11: Additional financial success criterion for power plant PF undertakings
Table 12: Environmental sustainability relevant data and information
Table 13: Social sustainability relevant data and information
Table 14: Data and information needed to compute the EnSu value
Table 15: Risks in international projects
Table 16: Project cycle at the IFC
Table 17: Success criteria questionnaire
Table 18: Participants of the questionnaire
Table 19: Equator Principle institutions
Table 20: Part 1: Weights, Sources, and Targets of EPI Objectives, Categories, Subcategories, and Indicators
Table 21: Part 2: Weights, Sources, and Targets of EPI Objectives, Categories, Subcategories, and Indicators
illustration not visible in this excerpt
The purpose of this initial section is to introduce the reader to the structure and goal of this paper as well as to outline the relevance, the methodology used and the research questions of this paper.
It should be noted that this work is essentially structured in three individual parts, covering a different aspect of PF each, and followed by an overall conclusion. Therefore, each part provides its own introductory section. Furthermore, Part II and III cover one specific research question each: the first about financial success factors and the second one about environmental and social sustainability. Each of them contains a separate section highlighting the limitations arising from answering the specific research question.
The four parts of the thesis are structured to achieve the following:
Part I: Provides a general overview of the topic PF, whereby its development and characteristics, a typical PF process as well as specific PF risks are highlighted. Additionally, it covers the topics of the most significant parties found in a typical PF undertaking as well as the core contractual agreements used. At the end of Part I, the reader should have a concise perception of PF.
Part II: Identifies criteria that facilitate the financial success of power plant PF undertakings. Based on recent incidents in the PF industry and backed by previous research on infrastructure ventures, the need for research on success criteria is outlined. Establishing general success criteria of PF at first, focus is then put on analyzing the criteria for financial performance of power plant PF undertakings. For this reason questionnaires were sent out to experts in the field. At the end of this process financial success criteria for power plant PF ventures will have been identified.
Part III: Elaborates on the increasing importance of environmental and social sustainability in general as well as in the PF industry in particular. Additionally, the importance for meeting environmental and social standards as a precondition to obtain financing of the project is highlighted. Due to the absence of a concept with which to assess the environmental impact on a qualitative basis, the thesis develops a new concept, which enables the user to qualitatively assess the environmental success of power plant PF undertakings. The interested party should thereby be able to interpret the findings of the environmental impact study more easily and evaluate whether a power plant project in its entirety meets environmental and social standards that are a prerequisite for financing.
Part IV: The concluding part of the thesis discusses the main findings made in answering the research questions and provides an outlook for possible future research on topics related to PF and this thesis in particular.
Rationale of Research Question I (dealt with in Part II)
Research Question I: What criteria distinguish financially successful from less- or unsuccessful power plant projects in PF?
Large scale investments are the rule in PF, considering the current volume of the PF market as well as the traditional financial value of PF undertakings. As shall be argued in Part II, despite the significant amount of money involved, studies have shown that large infrastructure investments often do not achieve the anticipated objectives but suffer from some kind of distress, be it financial or operational.
The fact that not all PF undertakings live up to their objectives but some have substantial problems reveals the need for identifying specific criteria to evaluate the financial success potential of a PF undertaking.
Rationale for Research Question II (dealt with in Part III)
Research Question II: How can environmental success of power plant projects be measured qualitatively?
As advocated by Part III of this paper, environmental and social sustainability are topics of increasing importance not only for private individuals but increasingly also in the business world. It is therefore not surprising that the PF industry is affected by these topics as well. Host governments as well as significant lending institutions in the PF industry should all have more or less sophisticated guidelines to ensure the environmental and social viability of a prospective project.
Due to the importance of environmental and social sustainability as a prerequisite for financing, it is crucial for sponsors and lenders alike to know whether or not the project at hand fulfills all the relevant standards and benchmarks. Therefore, a concept should be present in the industry that measures the extent of environmental and social standards being met by a project.
After researching this topic, however, it was found that there is to date no such concept in place. Therefore, Research Question II addresses this issue and designs a theoretical concept which provides the means of assessing qualitatively how environmentally successful a power plant PF undertaking is and whether or not it meets environmental and social standards in its entirety.
In order to achieve all the goals defined above, a sound foundation of the research methodology has to be established. The following section discusses the methodology used for each part for the thesis:
Part I: For this part a hermeneutic research method is applied and uses a variety of well-established literature, including books and articles, as well as additional reliable internet sources to distill the information necessary to develop a sound foundation of the topic PF.
Part II: Due to the lack of secondary information that could be used to answer Research Question I, Part II uses hermeneutic and empiric research. At the beginning, hermeneutic research is used to provide the basis for further research. The findings are thence verified and applied to a particular PF industry segment by using empiric research (expert interviews).
Part III: This part of the thesis uses a hermeneutic method to inquire as to the importance of environmental sustainability in the PF industry. This is followed by the development of a theoretical concept of how to measure environmental success for power plant PF undertakings qualitatively.
As a result of the issues the thesis covers, it is indispensible to limit the focus and scope of the research as otherwise it is impossible to make sound and significant statements. Part II, which identifies financial success criteria, and Part III, which designs a concept with which to measure environmental success, are both too complex to elaborate on them in general terms. Therefore, the focus of the thesis is on a particular field of application of PF, i.e. on power plant projects. The following paragraphs provide the rationale for this decision.
In order for there to be growth there must be energy with which to fuel it (Jorgenson (1998); p.1). If this statement were untrue, then developing countries (especially China) would not be in such frenzy these days to obtain fuels of various kinds to maintain their economic growth, thereby increasing world market prices to new record heights (Economist (2008); n.p.a.).
According to a World Bank report (2006, p.vii), it is estimated that developing countries have to make capital investments of USD 300 bn each year until 2030 (a total of USD 8.1 trillion) to meet their energy needs.
This assumption is backed by Exxon Mobile in the report “The Outlook for Energy- A view to 2030”. The report states that the global energy demand will increase by 1.7% annually until 2030, to almost MDBOE 325 mn; which is 60% more than in the year 2000. (ExxonMobile (2006); pp.1-3)
Additionally, the report states that the sources of energy (primary energy, nuclear, hydro, wind, solar, etc.) are all set to increase between 1% and 11% annually until 2030, although fossil fuels will remain as the primary contributors to energy production (ibid., pp.5-7).
By 2030, the collective energy demand of the OECD member countries will be MTOE 6,000 and that of developing countries more than MTOE 8,000 per annum (IEA (2006); pp.68-71). The fact that power plant projects nowadays seem to be of increasing importance in the PF industry is reflected by data from Thomson Financial (2007; p.1), which outlines that the power industry received the biggest share of capital investment among all PF activities in the first half of 2007 (USD 34.4 bn).
The combination of the ever-increasing demand for energy in the developed countries and an insatiable one in the developing countries such as e.g. China and India makes PF undertakings in the energy industry, and in particular power plant projects, an interesting subject of research, because they are capital intensive and could have severe impacts on the environment they are placed in.
Introduction to PF
Part I of this thesis is introducing the topic of Project Finance (PF). Its purpose is to provide a concise overview of the main topics of this financing method. This is done by elaborating on the following issues:
- Introduction (Part I): In this chapter the term “PF” is defined, the development and current state of the PF industry is analyzed, typical PF characteristics, specific risks and a typical PF process are outlined
- Core parties in PF: This chapter discusses the core parties present in a typical PF undertaking
- Core contracts and agreements in PF: This chapter elaborates on core documents that regulate the relationships between parties in a PF undertaking
Experts have not agreed upon a single definition of the term “PF”. Therefore, subsequent definitions show different aspects of PF in order to highlight as many aspects of the term as possible:
“[. . .] [PF is] the raising of funds to finance an economically separable capital investment project in which the providers of the funds look primarily to the cash flow from the project as the source of funds to service their loans and provide the return of and a return on their equity invested in the project.”(Finnerty (2007); p. 2)
Another definition describes PF the following way:
“[...] a group of agreements and contracts between lenders, project sponsors, and other interested parties that creates a form of business organization that will issue a finite amount of debt on inception; will operate in a focused line of business; and will ask that lenders look only to a specific asset to generate cash flow as the sole source of principal and interest payments and collateral.” (Standard & Poor's Corporation (2003); n.p.a)
How precise ever these definitions might be one important characteristic of PF, the non-recourse nature of the project, is not explicitly mentioned yet. Consequently, a third definition is stated that addresses this characteristic:
“Project finance involves the creation of a legally and economically independent project company financed with nonrecourse debt (and equity from one or more corporate sponsors) for the purpose of financing a single purpose, capital asset usually with a limited life.” (Esty (2004); n.p.a.)
Considering these three definitions the reader has now a general understanding of what this financing method is about. The next section deals with the history and development of PF.
PF as it is known today is no invention of the present. This special form of financing has already existed thousands of years ago. The financial purpose of PF has never since changed: Cost intensive (long term) projects are financed on the basis of future cash flows the project will create without the lender’s ability to be compensated in any other way than via the project’s assets and future cash flows.
One of the oldest uses of PF could be found in ancient Greece when traders raised money used for financing voyages of their ships on a PF basis. The money was raised upfront and the lenders were remunerated from the proceeds of the sold cargo. However, the lenders were not guaranteed repayment when the shipment was lost at sea, which is one key characteristic of PF. (Sosic/Albisser/Baumgartner/Baumgartner (1999); p.7)
In the year 1299 the English Crown enlisted a Florentine merchant bank to help in developing a silver mine. The bank was paying all the operating costs without the English Crown giving it a security of repaying the loan. Instead, the bank was compensated by receiving a one year lease on the total output of the mine. (Kensinger (1988); pp.69-81)
17th and 18th century
During this time PF was used in early trade expeditions. The Dutch East India Company as well as the British East India Company raised monetary funds for voyages to Asia from potential investors. In exchange for the provided capital the investors were compensated according to their share of the cargo when it was sold. (Eitmann/Stonehill/Moffett (1998); pp. 606-07)
18th to 19th century in England
Due to a lack of public (royal) funds available, the English road systems were renewed based on private investments. Thereby, private individuals provided the necessary capital needed to rebuild the roads based on the future compensation they would earn from the toll revenues they could demand (Yescombe (2002); p.5).
19th century in other countries
PF was used in many other countries to develop various other kinds of industries or systems. It was utilized in developing the railway industry, building water, gas and electricity systems as well as (later on) developing the telephone industry. (ibid.)
In the past 100 years industrialization as well as the development of civilization generated various fields in which PF was used. Some of these applications are outlined below:
1930s in the United States
One of the earliest modern applications of PF was derived from natural resource projects in the United States in the 1930s (ibid; p.6). In those days, oil explorers in Texas and Oklahoma borrowed money to be able to exploit oil fields. (Smith/Walters (1990); pp.214-19)
Throughout the 20th century another application of the PF principles could be found in the development of real estate. Developers financed their projects as stand alone commercial entities which limited the sources and possibilities of the lenders to be compensated (Esty (2003); p.27).
Due to experiences in financing the development of oil fields (primarily in the United States), increasing oil prices in the 1970s boosted the development (and hence necessary financing) of oil fields around the world. Additionally, other natural resources projects (such as natural gas) have been triggered in Australia and various developing countries. (Yescombe (2002); p.6)
The dawn of the 1980s
Another application of the use of PF developed in the late 1970s in the United States. In 1978 the Private Utility Regulatory Policies Act (“PURPA”) was issued and promoted investment in the development of “more energy-efficient and environmentally friendly commercial energy production” (Energy Vortex (2006); n.p.a.).
Thereafter, PF established itself as the method of choice in financing the development of power generating projects. Plants that were financed this way are known as independent power producers (IPPs). (Buljevich /Park (1999); p.27)
In the early 1990s PF found once more its way to public infrastructure finance. It was used to finance the development of roads and other transport systems as well as public buildings. The United Kingdom played a decisive role in developing PF for the public sector, whose initiative is known as the Private Financing Initiative (PFI). (Yescombe (2002); p.6)
Collaboration between the public and the private sector using PF to execute infrastructure projects is also known as a Public Private Partnership (PPP).
In recent times there is an increasing activity of collaboration between the public and the private sector in order to finance the development of infrastructure projects. However, due to increasing capital constraints on the side of the public sector, PPP is a welcomed alternative of financing to the public sector. Possible motives therefore are that the private sector is more efficient in executing the project than the government. Moreover, PF decreases the financial burden to the government as the private sector undertakes most of the necessary expenses to construct the project. (HM Treasury (2007) n.p.a.)
In the late 1990s the soaring demand for mobile telephone networks led to the application of PF in this field to finance the development of this capital intensive infrastructure. (IPFA (2007b); n.p.a.)
What all these modern developments outline is that since the early 1990s, deregulation, privatization and globalization encouraged the application of PF in developed as well as in developing countries. Furthermore, they triggered the use of PF for a much larger range of assets.
The following examples provide evidence for the range and versatility of PF (Davis (1996); pp.47-199):
- Malaysia: Using PF for the USD 3.4 bn North-South expressway
- Indonesia: The development of the USD 3.7 bn Paiton power plants using PF
Additionally, the following projects also highlight the different areas and regions in which PF is used (Esty (2003); pp.93-112 and 169-90 respectively):
- Australia-Japan: PF used to finance a USD 520 mn cable project
- Europe: Using PF to develop the USD 13 bn project of the Airbus A380 super jumbo jet
The increasing popularity of using PF for the development of large projects is also supported by numbers:
Esty (2003) provides an outline that shows the development of PF form 1994-2002. This outline captured the total global PF market which was estimated at USD 41 bn of private sector investments in 1994. Since then the total amount of funds invested using PF continuously increased and amounted to USD 217 bn in the year 2001. A year later total investment in PF was estimated to be USD 135 bn. This decline the experts attributed to a slow-down in economic growth and excess supply of the products generated by PF projects. Therefore shrinking prices were faced by an increasing number of projects which ultimately made it less attractive to develop projects using PF (ibid.; p.29).
Rob Morrison, editor of PF International, in the Yearbook 2002 summarized the events in that way:
“2001 has been a game of two halves. The first part a gentle decline in the world economy, some nervousness, a general feeling of financial unease after the collapse of the stock market in 2000 and events such as the California power crisis. After the summer holidays, the situation turned ugly with September 11th overshadowing everything. But in addition there were other events such as Enron and Railtrack. We all look forward to 2002.”
However, since then PF again has gained momentum and investment has gradually increased and is currently (end of 2007) trying to beat its all time high. According to the PF Magazine (2007, n.p.a.) global PF activities hit a new all time high in October 2007. PF volume reaches USD 179 bn, exceeding the old record high of the same period which was USD 177.8 bn in 2000.
Although PF was used throughout history in one way or another, today’s experts find it hard to draw a clear border between PF and other forms of financing. Modern PF – because of its application in non-traditional areas – makes a clear cut to other financing techniques increasingly difficult (Yescombe (2002); p.12).
However, in the light of increasing popularity of PF (FT (2007); n.p.a.) understanding key characteristics of this financing technique are advisable and the reason for this section.
Although each PF undertaking is unique certain features can be identified that are inherent in a large majority of PF undertakings.
Considerable project size
PF is usually used to finance large scale, capital intensive projects where commercial finance has its limitations, such as pipelines, power plants, infrastructure projects, etc. (Comer (1996; p.3).
For example, the 1994 World Bank Development Report (1994; pp. 94-95) stated that in that year the average infrastructure project size was USD 440 mn while at the same time projects of even higher average values were negotiated.
Many parties involved
Considering the number of participants as well as the broad scope of the contractual framework PF can become increasingly complex. On average, a usual PF undertaking can include up to 15 individual parties as well as up to 40 contractual agreements (Esty (2003); p.27).
Debt repayment based on future cash flows
Lenders to a PF undertaking base the decision on whether or not to grant the necessary funding to a large extent on the projects future ability to create sufficient cash flows; those are then used for the repayment of debt and its interest. However, usually lenders will require some sort of securities or guarantees from the project to not entirely rely on the future cash flows. (Caselli/Gatti (2005); p.9)
Low equity contributions
Almost every PF project has a high debt-to-equity ratio, i.e. more money is raised via debt than through equity, to help develop and execute the project. Only after the construction is finished the project can start “living on its own” and produce its own cash flows. Depending on the source, the amount of debt employed in a common PF undertaking ranges between 60-90% (Karpova (2002); n.p.a.) which highlights the project’s (extensive) reliance on debt.
As can be seen from the various definitions of PF as well as its history the establishment of a separate legal entity for the purpose of executing the project is a key characteristic of PF. Thereby the limited lifetime of the independent entity (also called the “project company”) is implied: The entity’s sole purpose of existence is the project and once the project is terminated also the project company will cease to exist. (Yescombe (2002); pp.7-8)
Usually an undertaking in PF is considered to be rather long term. This is the case as planning and construction of a project are both, lengthy as well as cost intensive. In order to compensate for the initial costs of establishing the project as well as to acquire a decent level of profit the life-time of a project has to be long term. (Esty (2003); p.6)
This is one of the key distinguishing features setting PF apart from other forms of financing. Non-recourse means that the debt lenders of the project will only be compensated by the project’s future cash-flows. On the other hand, with limited recourse the lenders have limited access to the sponsor’s assets in order to be compensated for their investment (World Bank (1994); p. 94).
After the general features of a typical PF undertaking were highlighted, the following two sections will deal with advantages and disadvantages of using PF.
As mentioned earlier, the non-recourse or limited recourse nature of PF is beneficial to the sponsors of the project, as the lenders’ ability to be remunerated from other sources than a project’s assets and cash flows is limited. Additionally, capital reserves requirements, which serve as collateral to the undertaken debt amount are reduced which is beneficial to the sponsor. (Finnerty (2007); p.19)
Off-balance sheet financing
Due to the capital intensive nature of common PF undertakings financing the project using commercial financing would have a significant burden on the company’s financial situation and to its balance sheet. Using commercial financing for raising debt the project will directly appear on the sponsor’s balance sheet. Creating a separate legal entity just for the purpose of the project and the thereby resulting non- or limited recourse feature significantly decreases the liabilities side of the sponsor’s balance sheet. (Esty (2003); p.7)
However, usually lending institutions are more cautious about the creditworthiness of a project because there are no securities other than the assets of the undertaking (and the promise to pay the debt with the project’s future income) to reimburse them. To address this issue, a sponsor might be required to provide additional securities, for example additional capital, the pledge on a mortgage, escrow facilities, provisions, and so on. (ibid.)
As most commonly known, interest on debt is cheaper than interest on equity. Thereby, using large amounts of debt lead to lower interest rates and at the same time the sponsor ‘s return on the equity invested is higher (Yescombe (2002); pp.14-15).
Usually interest on debt is tax deductible, whereas interest on equity (payments for using equity, also called the “dividends”) is not. On the other hand, other kinds of tax breaks could also be possible in PF. (Fight (2006); p.5)
Risk sharing is another key advantage of using this form of financing. The PF structure, because of the different contractual relationships, allows the effects and impacts of a risk to be shared or rolled over to other parties besides the one being usually associated with a certain kind of risk. This could not only facilitate transactions within a PF structure but also increase cooperation and commitment of various parties to the undertaking (Export-Import Bank of the United States (2007); n.p.a.).
Complex and time consuming
The multitude of participants in a PF undertaking as well as the coordination of the different interests is both, time consuming and complex (Caselli/Gatti (2003); p.6).
There has to be a minimum amount of value to make any PF undertaking feasible. Considering the interest rates and the principal payments – which can be 2-3 times as much as under corporate finance due to high leverage and the lack of securities – the cost of setting up and maintaining the project as well as the costs incurred to provide for addressing risks, it is obvious that the undertaking has to be of a critical minimum value so that setting up a complex PF structure is legitimate. (Yescombe (2002); p.14)
This statement is confirmed by looking at a sample size of more than 1,000 PF undertakings between 1997 and 2001 in the US: No more than 14% of the projects had a value of USD 50 mn or below. The majority (> 50%) of these projects had a value of between USD 150 mn and USD 500 mn; and almost 4% of the researched projects had a value of more than USD 2 bn. (Esty (2003); p.65)
Since the lenders employ a significant amount of money in the project they want to have the possibility to participate in the undertaking. This could be achieved either by direct participation, by supervision of the project as well as by implementing various reporting requirements which inform lenders about the development of the project. Moreover, imposed covenants in addition to possibilities of participation by the lenders lead to a certain level of inflexibility of the project when it must react to changes. (Fight (2006; pp.6-7)
After the general features, advantages and disadvantages usually associated with using PF were discussed, the following table summarizes the individual findings:
illustration not visible in this excerpt
Table 1: Characteristics of PF
The goal of this section was to briefly outline the characteristics of PF. The next section deals with a typical PF process.
This process of a typical PF undertaking is based on practices of the OeKB (2006b, pp. 53-63).
Generally speaking, a PF undertaking can be distinguished into three different phases:
1. The Planning Phase
2. The Construction Phase
3. The Operation Phase
In this phase the sponsor develops the initial idea of a project. This idea is then further developed to not only include the project’s purpose but also a specific project design, the technology used and the provisional cost of the undertaking.
Thereafter a feasibility study is undertaken to estimate not only the technical possibility to execute the project but also to see if the estimated cash flow and the general financial returns of the project are sufficient. Additionally, the project will be checked for its environmental impacts. Also other project relevant information is assessed, for example the political and legal situation.
During this planning process the sponsor hires experts that help him with the technical, legal, environmental and financial issues of the project to see if the project has enough merit to employ further resources.
In this planning process possible suppliers and off-takers are identified and – in the ideal case – contracts already negotiated. However, these contracts might only be effective if financing is granted to the project.
Also, regulatory agencies in the host government are addressed to get the necessary permits, licenses and concessions needed to conduct the project.
Thereafter financial institutions are approached and the terms and conditions of the loan are negotiated. An Information Memorandum summarizes the technical and economic situation of the project as well as outlines the organizational structure as well as the required amount of financing. Financial advisors are usually helping the sponsor in this part of the process as they have the necessary experience.
The end of this negotiation process is marked by the Term Sheet, where the terms and condition of the loan are stated.
The end of the Planning Phase marks the Financial close where the amount of required financing is ensured. If not done already, precedent to approaching banks for the loan, all other contracts are now negotiated.
After the financing has been secured the project is executed. Generally speaking, a general contractor is hired who should execute the project according to specifications and on budgetary limitations. Sometimes the contractor is already involved at an earlier stage, the Planning Phase; if this is the case, then an EPC Contract regulates the contractual obligations of the contractor.
In the Construction Phase there are several problem factors pending, which, when not addressed properly and adequately, could lead to cost overrun, completion delay or the project’s inability to be executed according to specified standards. In such cases, provisions, guarantees or other securities should be in place to mitigate these negative effects.
During the Construction Phase the loan is disbursed according to conditions set out in the Term Sheet and the money is used to pay the costs incurred during this phase.
After test runs of the project, the Provisional Acceptance Certificate (PAC) marks the end of the Construction Phase. With this document the SPV takes over the project and confirms that it is constructed accordingly and operates as specified.
However, from the PAC onwards a warranty period starts, where the contractor can still be hold liable for defects in the projects, which he was responsible for and that did not occur at the point the PAC was signed.
After this warranty period, whose length was negotiated beforehand, the Final Acceptance Certificate (FAC) marks the contractual end of the Construction Phase. Hereby it is worth mentioning that the Construction Phase and the Operation Phase can overlap.
In this phase the project starts its operation, ideally performs as projected and generates the forecasted cash flow with which to satisfy debt claims and later on also remunerate the sponsor. The success in this phase builds on actions that have been taken previously, which are thorough research and preparation of the project, well negotiated documents and adequate risk management.
However, the lender will still monitor the project until his claims are fully satisfied. At this point in time, sponsors with no interest in maintaining their ownership (=developers) drop out of the project.
The last section of this chapter will elaborate on specific risks encountered in a classical PF undertaking.
The following section deals with the different PF relevant risks. The author groups the different kinds of risk into two main categories:
- General risks in international ventures
- PF specific risks
The first category comprises all types of risks that could occur in any international project, including PF undertakings. The second group comprises risks that are of particular importance in PF. The first group of risks will not be discussed in this chapter, but an overview of the general risks in international projects can be found in Appendix 1. However, it must not be underestimated that general risks can also, if not addressed properly, adversely influence the project and lead to severe negative impact. Therefore, besides the PF specific risks, also the general risks have to be paid close attention to and be mitigated appropriately to insure that a PF undertaking does not suffer form negative impacts. (Beenhakker (1997); pp.29-31)
The second group will be dealt with in more detail in the subsequent paragraphs because these risks are of particular relevance in PF. There are three particular PF risks:
1. Bankability risk
2. Cost overrun risk
3. Construction delay risk
“Bankability” means that a project is structured in such way that the banks are willing to provide capital because the risks are appropriately mitigated and accounted for. (Vinter (1998); p.85)
This type of risk is primarily associated with the lender of a PF undertaking. Bankability is an umbrella term which includes a number of particular PF risks that a lender is generally not willing to accept; hence the project will not receive the necessary financing. Under bankability the following risks are grouped:
illustration not visible in this excerpt
Table 2: Bankability risks
Source: Vinter (1998); pp.86-87
Lenders are generally not willing to accept a change in law risk because the risk cannot be foreseen and could be infinite in its impact. Due to the unpredictability of this risk it is necessary to mitigate it accordingly before seeking financing for the project. (Vinter (1998); p.86)
Discriminatory taxation usually means that the host government taxes the PF undertaking differently than other commercial undertakings, which ultimately means that less cash flow is available to serve debt (Finnerty (2007); p.318). Since this risk can also not be predicted and its outcome can be open-ended, lenders will not assume this kind of risk.
Furthermore, lenders are unlikely to tolerate a sponsor’s prior extraction of distributions before the first repayment of the loan as this decreases the cash basis for the repayment of the loan. (Vinter (1998); p.86)
Similar to the previous risk, lenders demand that revenues deriving from an earlier completion of the project are used to decrease the loan amount as this increases the likelihood of their claim being satisfied. (ibid.)
Lenders are not willing to finance a SPV which assumes the majority of risk on its own and does not provide a possibility to pass different risks away from the SPV to other parties of the project, e.g. sponsors. Making risk sharing an issue in the PF undertaking, lenders prevent a SPV from becoming a dumping ground for risks associated with the undertaking. (Gatti (2007); p. 41)
As stated later on in Part II of the thesis, lenders usually want to see sufficient levels of equity being invested in the SPV. This on the one hand increases the collateral of the undertaking and on the other hand ensures that the sponsors are committed to the project and not likely to abandon it. (Nevitt/Fabozzi; p. 11)
Another incident where the impacts on a PF undertaking are not foreseeable is when a SPV is liable for consequential losses, i.e. loss of profits, incurred from a breach of contract or any obligation under a project contract. This liability could quickly lead to bankruptcy of the SPV which makes it highly unlikely for the lenders to be fully redeemed. (Haskell (2005); pp. 26-27)
Even if all the above mentioned risks are addressed and the SPV is set up properly, if there are any faults in the design of the project which makes its operation difficult or renders it impossible, the SPV is fully liable and does not have recourse to any other party. This does also imply that there is no chance for liquidated damages. Despite the malfunction of the project liquidated damages serve to provide sufficient cash flow to remunerate lenders and thereby ensure that a loan can be repaid. Therefore, for a lender it is important that the SPV is not responsible for the design. (Cornell Law School (2007); n.p.a.)
In cases where the SPV cannot provide sufficient cash flow to repay its loan, lenders exercise their right under the loan agreement to satisfy their claim. When this happens other parties should not be allowed to exit the project and terminate the contract on the basis of “frustration of contract”, as this would make it unlikely that a lender has the necessary resources to ensure that his claim is satisfied. (Vinter (1998); p.87)
The other risks, cost overrun and construction delay risk, also affect the lenders of a project but are rather associated with the sponsors of an undertaking or the SPV itself.
Cost overrun occurs in the construction phase of a project and means that the costs for executing the project exceed the projected amounts. As shall be seen in Part II, this is a risk which is common not only in infrastructure projects of a significant size but also present in PF undertakings in particular. Although commonplace, this risk is disadvantageous as it increases the capital expenditure of a project. Cost overrun can ultimately lead to financial distress of a project if it is not properly addressed in the first place; with e.g. stand-by facilities form the sponsor or other financial institutions or, if possible, recourse to the party which is responsible for the cost overrun. (Nevitt/Fabozzi (2000); pp.25-26)
The last PF specific risk is the construction delay risk. This risk signifies that the construction of the project is not finished on schedule which not only leads to a cost increase (as interest on loans is still pending) but also delays the ability of the project to generate cash flow with which to repay operational expenses, debt payments and remunerate the sponsor. This delay would also lead to financial distress if it is not appropriately addressed; with e.g. stand-by facilities, liquidated damages and so on. (ibid.)
This last section has introduced the reader to the three most prominent PF specific risks. Thereby it was shown that these risks – if not addressed properly – could have severe negative impacts on the undertaking. Not only can these risks lead to financial distress but, in the worst case, also bankruptcy of a PF undertaking. Consequently, mitigating these three risks is of particular importance. However, it must not be forgotten that the general risks, associated with any international project, can also have detrimental influence on the PF venture if not addressed appropriately.
The remaining chapters of Part I will deal with the different parties and elaborate on the contractual framework in PF.
PF is a complex undertaking. Sometimes it is difficult to remain on top of the whole project. The following sections aim at providing a structured outline of the major parties involved in a typical PF undertaking.
For structuring this section the author used the outline of Fight (2006, pp.11-31). The following entities to a PF undertaking will be discussed in more detail:
1. Project Company (SPV)
4. Export Credit Agency
5. Multilateral Development Bank
6. Host Government
7. Construction Company
8. Supplier and Purchaser
9. Other Parties
10. Side note: Developer
The Project Company is established by the sponsors of the project. Also called a Special Purpose Vehicle (SPV) the Project Company is a legal entity which is limited in scope and purpose. The SPV’s purpose is to realize, operate and maintain the project which it was designed for. The SPV is typically set up in the country the project is located and therefore it is subject to local legislation. (ibid.; pp.11-12)
Furthermore, the SPV raises debt for the project and is also responsible for collecting and distributing the cash flows generated. Although acting as a legal buffer – due to the non- recourse nature of PF – an SPV is not always considered necessary when setting up a project. Sometimes the sponsor decides to set up other financing structures to realize the project, e.g. equity financing, mezzanine financing or other debt financing structures. (Sosic et. al (1999); pp.7-8)
Without going into further detail, some alternative debt financial structures similar but not equal to a PF structure are: secured debt, vendor-financed debt, lease, joint ventures, asset backed securities, leveraged buyouts or project holding companies (Nevitt/Fabozzi (2000); pp.25-26).
Sponsors typically become equity holders in the SPV and equip the SPV with special know-how necessary for the project (management, operations, technical expertise, and so on). The Sponsor(s) participate in the profits of the SPV either directly (dividends) or indirectly (fees). Also other parties of a PF undertaking can fall under this category, e.g. contractors, suppliers, purchasers, or users of the project’s facilities, and so on. (Yescombe (2002); p.34)
Although the ideal situation of a PF structure would be that the lender does not have recourse to the Sponsor, which would secure the Sponsor’s asset basis, most of the time a non-recourse situation is unrealistic. Limited recourse is the general rule which means that the Sponsor has to assign a portion of his assets as security to the lenders (e.g. by making additional cash contributions in case of cost overrun). (OeKB (2006b); p.15)
A Lender is typically a financial institution that provides the necessary financing to a PF undertaking. However, usually the sizes of projects are considerable, indicating that one single Lender often times does not have – is not willing to provide – the balance sheet capacity to finance the project himself. To counteract this situation the financing of a project is most often taken out by various Lenders at once. This so-called “syndicate” combines individual funds to finance the project under one loan agreement. Members of the syndicate can be chosen from a variety of geographic regions and are not limited to the location the project is placed in. (Fight (2006); p.13)
Without going into detail about their various responsibilities, there are different forms of Lenders in a PF undertaking: Arranger or Lead arranger, Manager, Facility agent/Agent bank, Technical/Engineering bank, Account bank, Insurance bank, and the Security trustee (ibid; pp.13-14).
An Export Credit Agency (ECA) is an entity, often publicly owned, that provides loans, guarantees or insurance to corporations that try to pursue business interests in other countries. (ECA Watch (2007); n.p.a.)
ECAs provide services to projects that are unlikely to be offered by other financial lending parties (due to the financial size or risk involved). ECAs provide guarantees to the project whereby the beneficiary is the lender. The rationale here is that when lenders know that the project is backed by an ECA, they could be more willing to provide the financing and/or assume bigger financial risks. ECA insurances are different from normal insurances found in the market to that extent that ECAs cover so-called “non-insurable” risks; risks that the market is not willing or able to insure. An example would be political risk insurance: In case political risk (e.g. revolution or forced expropriation) materializes the lenders will be indemnified for their losses.
Furthermore, ECAs also provide pre-export working capital (capital needed to manufacture goods and/or produce services before they are sold), short-term export receivables (short term loans) and long term financing (long term loans). (Fight (2006); p.19)
According to ECA Watch (2007, n.p.a.), ECAs are today one of the largest sources for foreign involvement in projects in developing countries, superseding the involvement of Multilateral Development Banks.
The next section highlights a typical PF cycle within an ECA.
This section discusses how a PF appraisal is processed within an ECA institution, the representative example being the OeKB. The information was obtained in course of an interview with a senior manager for project and environmental analyses at the institution (Hanzlik (2008); n.p.a):
Step 1: By handing in an Application Form, the Austrian exporter or a financial institution (sponsor or lender) approaches the OeKB requesting assistance in their PF undertaking. In this “Application Form” project relevant information (sponsor’s name, project location, project size, underlying business, and so on) is stated.
Step 2: The application is evaluated by the OeKB concerning the financial feasibility of the project. Further steps depend on the result of this evaluation and the amount of risk involved.
If the project shows little risk, i.e. enough securities are available, the payment risk is low, further evaluation is limited in scope.
On the other hand, if the level of the risk is significant, the OeKB demands additional information to screen the project (e.g. business plans, existing feasibility studies, sponsor information, and so on) and might also commission new studies being made by independent experts.
Step 3: Simultaneously to the feasibility study and the commercial viability of a project, its environmental sustainability is assessed. If the project has a repayment term of more than two yeas and is above EUR 10 mn the OeKB guidelines request an environmental review. If not, an environmental review is not mandatory.
Step 4: For the environmental review the project is preliminarily assessed and grouped according to the severity of its impacts: Category A (significant adverse environmental impacts); Category B (less adverse environmental impacts than Category A); Category C (minimal or no adverse environmental impacts). Only in cases of Category A projects, a full environmental assessment (including an environmental impact assessment) is required.
Step 5: After the project is assessed as to its financial as well as environmental feasibility the OeKB makes a recommendation if it would issue the requested guarantee(s) or not.
In Austria the final decision is made in the “Garantiebeirat” which is a committee chaired by the Austrian Ministry of Finance. If the committee approves the project OeKB issues the requested guarantee(s).
According to the WB, MDBs are “[…] institutions that provide financial support and professional advice for economic and social development activities in developing countries.” (World Bank (2003); n.p.a.)
Generally speaking, MDBs differ from ECAs in the sense that they not only provide financial support but also technical expertise to the project. MDBs finance their loans with the contribution of the individual members as well as by borrowing on the capital markets (via bond issues). MDBs are characterized by a large number of members from developing as well as from developed countries and are not limited by demographics and territory. (ibid.)
However, usually the involvement of MDBs will not be unconditional, meaning that they require the project to adhere to certain guidelines. This could result in higher usage of administrative resources from the side of the SPV which is in charge of the project.
As identified by the WB the term “MDB” typically refers to the following institutions:
- World Bank Group
- African Development Bank
- Asian Development Bank
- European Bank of Reconstruction and Development
- Inter-American Development Bank Group
Besides the MDBs there are other Multilateral Financial Institutions (MFI) that differ from MDBs in their limited regional scope or industry focus as well as in the smaller numbers of members. Without going into further detail, some examples of MFIs include (ibid.):
- European Investment Bank (EIB)
- European Union (EU)
- Islamic Development Bank (IDB)
- The Nordic Development Fund (NDF)
- The Nordic Investment Bank (NIB)
- The OPEC Fund for International Development (OPEC Fund)
Besides the MDBs and the MFIs there are also other commercial lending institutions and agencies, such as:
- International Financial Corporation (IFC)
- Multilateral Investment Guarantee Agency (MIGA)
The IFC is part of the WB Group and promotes the development of the private sector in developing countries. IFC is fulfilling this mandate by providing loans and other financial services as well as advisory services to the project. Additionally, the IFC can also take equity stakes in projects. (IFC (2007a); n.p.a.)
MIGA is also a part of the WB Group and its mission is to ensure Foreign Direct Investment (FDI) into developing countries. It achieves this by providing guarantees as well as insurances to project lenders so that they are willing to support the project. Additionally, MIGA is also providing advisory services such as technical expertise to the project. (MIGA (2007a); n.p.a.)
The following subsection highlights the PF cycle of the WB. Appendix 2 entails the appraisal process of the IFC.
In this section the standard procedure for PF with an MDB is outlined. The sample institution is the WB (World Bank (2008); n.p.a.):
Step 1: In the very beginning, the respective country develops a strategy how to boost development and sets priorities and target measures that should lead to the desired increase. These targets are then stipulated in a report (the Poverty Reduction Strategy Paper). The WB then aligns its efforts according to those strategies.
Step 2: Knowing what the country wants to achieve, the WB then forms their own strategy of assistance. Thereby, the WB tries to align its lending program according to the country’s needs. If the WB is approached with a project that meets the country’s strategy, the bank compiles the Project Concept Note (PCN), outlining the basic characteristics of the project, which is the basis for the first review. After this review, the WB produces the Integrated Safeguards Data Sheet (ISDS) that identifies possible environmental and social issues and measures how these issues can be addressed.
Step 3: In the next stage, the Environmental Assessment (EA), a project’s economic, environmental, financial, institutional and technical issues are identified and ways to mitigate those are analyzed. This assessment is primarily the host government’s responsibility and the WB provides necessary know-how if needed. The assessment is needed by the WB to determine a project’s compliance with the WB’s environmental sustainability guidelines.
Step 4: Afterwards the WB reviews the findings of the EA and prepares the Project Appraisal Document (PAD) together with the Program Document (PGD) as a basis for the decision making and determines the financial aspect of the project (e.g. necessary financing).
Step 5: Then the final terms and condition of the loan are negotiated between the country wanting the financing and the WB. Then PAD, PGD and an executive summary are sent to the Board of Executive Directors at the WB for a final decision. If the government has confirmed the final terms and conditions and the Board approved the loan, a formal loan agreement is signed and after relevant conditions are met, the money is disbursed.
Step 6: Then the project is implemented (responsibility of the country borrowed the money) and supervised (task of the WB).
Step 7: After the loan has been disbursed completely, an Implementation Completion Report (ICR) is written, outlining goals, problems, and lessons learned.
Step 8: Thereafter, the WB conducts an audit measuring the level of achievement of the original objectives.
The Host Government is the government in whose country the project is located. As most (but not all) PF projects are infrastructure related the interest of the government in the project is evident. However, even if there is no direct benefit to the public, the government might still be interested in the success of the project as it increases the government’s income (taxes, fees, etc.). (Delmon (2005); pp.67-70)
The Host Government’s involvement in the project can be manifold: It can act as a sponsor or it is involved in the issuance of permits, licenses, authorizations and/or concessions. Furthermore, it can grant foreign exchange availability, tax abatements or it can also be involved as a supplier of raw materials or a purchaser of the project’s final product. Usually, the government has a special interest in the success of the project. (ibid.)
The Construction Company is hired in order to realize and construct the project and its facilities. With a construction contract the SPV hands the responsibility of constructing the facility over to a specialized company. Ideally the Construction Company has a successful track record of project management and establishment. It is possible to have a group of different Construction Companies whose members assume different tasks and responsibilities – a so-called “Construction Consortium”. This can be triggered if a single Construction Company lacks experience of all the different aspects of the project; or it prefers the possibility of joint and several liability between a couple of Construction Companies. However, it is more common to structure projects on the basis of one contractor which will then appoint various sub-contractors. This eases the coordination and streamlines the reporting lines of the project. (Frame (2003); pp.37-40)
Suppliers are the parties that provide raw materials to the project which are needed for producing the output of the project (e.g. coal for a coal-fired power plant). Additionally, raw materials can also be products that are needed at an earlier stage of the project. These raw materials can be products that are needed in constructing the project (e.g. concrete and steel for facilities). However, sometimes Suppliers could also act as sponsors or lenders to a project. Since supply arrangements are key to successful projects it is tried to tie the Supplier to the project as early as possible. (Hoffman (2007); pp.52-56)
Purchasers on the other hand, are those parties that are located on the other side of the project’s production line. They are the parties that receive and pay the goods produced by the project. Depending on the project, the number of Purchasers can either be limited (e.g. oil pipeline projects) or indefinite (e.g. toll road projects). Where appropriate, the Purchaser will be linked to the project via long term off-take contracts to ensure a steady purchase amount and so decrease an SPV’s market risk. (Fight (2006); p.33)
Where the sponsor has limited knowledge or lacks technical expertise and experience, a Technical Advisor will be hired to assess or evaluate the technology used in the project, advise on environmental issues and forecast operational costs. (OeKB (2006b); p.43) These companies and/or individuals usually assist in conducting tests necessary for the feasibility study, will help in writing the feasibility study, prepare reports and monitor the technical performance and progress of the project. Furthermore, Technical Advisors might also fulfill the role of an arbiter in disputes in technical matters. Disputes can arise between the SPV and the contractor (e.g. over the satisfactory fulfillment of contract obligations) as well as between sponsors and lenders (e.g. satisfactory performance of the project as specified in the finance documents). (Fight (2006); p.15)
Most projects in PF require the expertise of international law firms as well as the knowledge of local lawyers or law firms due to the complexity and demographic scope of the projects. Lawyers can assist the project in many different legal aspects. The services can range from organizing the project entity, draft debt and equity documents, advise on legal aspects of credit enhancements and international transactions as well as drafting different kinds of contracts (operation, maintenance, supply, sales, etc.). Furthermore, lawyers can assist in advising on the following subjects: tax, bankruptcy, laws and regulations, permits, etc. There is usually a contractual relationship between the SPV and the lawyers, regulating the relationship, tasks and duties as well as the compensation of the lawyers. (Hoffman (2007); pp.114-15)
Generally speaking, a Financial Advisor has great influence on the project’s financial structure. The method of deciding on the appropriate financing method is called financial engineering. (OeKB (2006b; p.43)
Ideally, the Financial Advisor is familiar with the region and the industry the project will be placed in. (Fight (2006); pp.12-13)
Considering a PF undertaking from a Financial Advisor’s point of view, the project consists of four major tasks (based on Nevitt/Fabozzi (2000); pp.29-31):
- Task 1: Preliminary feasibility study
- Task 2: Planning
- Task 3: Arranging financing
- Task 4: Monitoring and administering the loan agreement
Task 1: Ideally, the Financial Advisor is consulted at a very early stage in the project development in order to execute a financial feasibility study to find out if the project has sufficient financial incentives to justify further investments in it.
Task 2: If the project has sufficient financial merit then the financial planning process starts. This includes: making appropriate assumptions about various financial factors (e.g. interest, inflation risk, exchange rates and so on), finding the most financially beneficial location for the project (considering currency, inflation and tax issues), determining the optimal debt to equity ratio and thereby calculating the amount of needed capital.
Task 3: After the planning process, the Financial Advisor approaches lending institutions to obtain financing. This is done by presenting project relevant information in an Information Memorandum. The memorandum typically contains information about the sponsor and identifies other project relevant parties (suppliers of equipment or raw material, off takers, contractors, and so on). Additionally, the project’s location, the estimated costs, the project’s working capital and future cash flows are outlined together with plans how the generated income is used. Amongst others, also the project’s equity contribution, other sources of debt and contingency plans are outlined to provide lenders with a comprehensive picture of the current and future financial situations of the project. Ultimately, the proposed terms and conditions of the desired financing are stated.
Task 4: After the loan agreement is negotiated, the Financial Advisor monitors that the financial projections of the Information Memorandum are adhered to, monitors the cost development (project related cost overrun, unexpected tax payments), reacts to currency fluctuations, and ensures that debt and principal payments are timely made.
To sum up, Financial Advisors help to sell the project to the lenders and make sure that the financial obligations are favorable and that they will be met in a timely manner.
An O&M Company is an entity specialized in providing operation and maintenance (O&M) services. Depending on the project’s nature and its requirements, there are different companies that have the specialized skill sets needed to perform these tasks. For example, a pipeline project will require different O&M skills than a mining project.
Besides O&M companies also the sponsor could assume O&M functions if he has the appropriate experience for doing so. (Hoffman (2007); p.111)
Some PF literature does not differentiate between “sponsor” and “developer” but uses the terms interchangeably. However, there is an important difference between the two parties.
EDC defines a sponsor as “[..] an entity owning, either directly or through an ownership interest in a project company, the assets of a project.” (EDC (2007); n.p.a.)
“Developers” are seen as having similar responsibilities as sponsors in course of a project, which includes planning of the project, authorization of feasibility studies, development of a project as well as finding financiers for the initiated project. However, although the responsibilities are similar, the main difference between sponsors and developers lies in the ownership interest of the project. Developers are usually present in the planning and development process of a project but drop out after the project has been structured or completed. This means that developers do not maintain ownership in a project. (OeKB (2006b); p.29)
Note: Developers could be companies, small agencies or even individuals. It is also possible that a developer becomes a sponsor during the course of a project. This thesis does not differentiate between sponsors and developers, because the main focus lies on highlighting the responsibilities of each party in a PF structure; hereby, the obligations of both parties are fairly similar.
After this discourse, the next section graphically summarizes the core parties of a typical PF undertaking.
Figure 1: Core Parties in PF
Abbildung in dieser Leseprobe nicht enthalten
Source: Graphic developed by the author
This chapter outlined the core parties in a PF undertaking, who they are and what functions they have. The next chapter will deal with contractual frameworks in PF.
The following chapter of the thesis discusses various important contracts and agreements used in a PF undertaking. The reader will be made aware how the different parties in a PF transaction correlate and how they are connected to each other. The main goal of this chapter is to highlight the purpose and features of each core contract.
The structure of the chapter is a modified outline based on (OeKB (2006b); p.4). The following contracts will be dealt with in more detail in the subsequent sections:
1. Joint Venture Contract
2. Government Support Agreements
3. Construction Contract
4. Input Supply Agreement
5. Loan Agreement and Securities
6. Off-take Agreement
7. Operation and Maintenance Contract (O&M Contract) and other Service Contracts
8. Insurance Contract
It should be noted that this chapter does not aim at providing detailed or exhaustive information on the contents of the contracts but should provide a limited insight into possible information that can be found in contracts and agreements used in PF.
The Joint Venture Contract is negotiated between the sponsor(s) of a PF venture. It provides the basis of the project as it clarifies the following issues: the sponsors of the project, their responsibilities, contributions to the SPV, the relation between lender and sponsors (non-/limited recourse), issues concerning the management of the SPV, dispute settlement and litigation procedures as well as other statutory provisions. (ibid.; p.69)
Additionally, the provisions of the contract could deal with payment modalities of the contributions, share of debt and losses, major technology used, marketing methods, liabilities, termination of contract and amendments thereof, and so on. The contract outlines the underlying framework of the entire project. Therefore, it is of particular importance to the lenders because the contract informs about roles and responsibilities of the sponsors. It describes the sponsor’s (financial) contributions and so sheds light on the financial situation of the project. (Onecle (2001); n.p.a.)
This non-legally binding agreement sets out to regulate specific issues of the relationship between the host government and the SPV. In cases where the project covers more than one national territory there might exist more than one Letter of Support. This agreement facilitates the completion and operation of the project and could be seen as an instrument for mitigating political risk. Amongst others, a Letter of Support could deal with the following issues: acknowledgment of the project’s existence and activities, non-discrimination by the government against the project as well as waiving the need of or granting the right to specific permits. Additionally, the government could guarantee that the construction and operation of the project as well as the operation or availability of other necessary resources needed by the project (e.g. transportation networks) is ensured. Aspects concerning tax issues as well as dispute settlement could also be addressed. (Yescombe (2002); p.126)
However, sometimes there is no need for such an agreement as the governing law of the respective host country regulates the framework of a project, meaning that in fully privatized sectors in politically stable countries there is often no need for the government to support projects in any way (ibid.; p.123).
Concession agreements, licenses and permits are concluded between the host government and the SPV. In cases where the project covers more than one national territory, licenses, permits and concessions of each different government regulatory have to be obtained (Baker Botts (2007); n.p.a.).
Generally speaking, the documents have to be obtained before construction of the project in order to be legally allowed and rightfully empowered to build and develop a project in the host country. In order not to lose control over the project after issuing the necessary approval documents, the government might impose clauses that may allow it to revoke the license or concession issued. The SPV could address this risk factor by seeking insurance (e.g. obtaining a political risk insurance issued by a MDB). (Fight (2006); p.112)
As mentioned above, Concession agreements exist between the host government and the SPV. Concession agreements specify rules under which the SPV can operate in the respective government’s jurisdiction. More specifically, it grants rights to a public or private sector partner to build, operate and financially benefit from a project for a certain period of time, adhering to a specified set of conditions (FitchRatings (2004); p.8).
Furthermore, the Concession agreement can be used to identify the concerns the host government has towards the project and should therefore be seen as an important document. It sets the limitations under which a project can operate and is the forerunner of any further agreements (ibid.; pp.4-8).
Considering the importance of the Concession agreement, the content should at least clearly state the rights and obligations of the parties, the terms and duration of the concession, possible extensions of the concession, the way how the concession can be terminated and the ability to freely transfer the concession to other parties (Fight (2006); pp.112-13).
According to Yescombe (2002, p.80), depending on the nature of the underlying project (e.g. toll road systems or public sector buildings) concession agreements can be classified according to:
- “Service” Contracts
- “Toll” Contracts
“Service” Contracts are present when the SPV is remunerated for its services by the contracting authority. A contracting authority is any party that commissioned a project. This can either be a government or government affiliated entity; however, also private entities can fall under this term. (ibid.; pp.80-81)
Contracts are referred to as “Toll” Contracts if the SPV provides a service for which the private users pay, hence making the remuneration completely dependent on usage. Alternatively, “Toll” Contracts are also present if the SPV is paid by the contracting authority but on the basis of usage by private individuals. (ibid.)
Furthermore, “Hybrid” Contracts (combining aspects of the “Service” as well as of the “Toll” Contract) also exist. For example, when the revenues created by the general public are insufficient to fulfill the SPV’s desired financial return the contracting authority can provide subsidies or guarantees that assure a minimum base revenue (if the minimum is not achieved then the contracting authority pays the difference). (ibid.)
Any contract similar to a Concession agreement follows generally the same principles as the Concession agreement. Therefore the author will not further elaborate on licenses and permits, as the nature of these agreements is greatly identical to the one of a Concession agreement.
Construction Contracts are concerned with the relationship between the SPV and the construction company. However, it is common practice that the Construction Contract also covers design and engineering aspects. Generally speaking, the sponsor and the lender of a project usually prefer to have a general contractor being responsible for the whole construction process. The general contractor can then hire sub-contractors to execute the project but the most important aspect is that the whole construction responsibility is shifted to one party other than the SPV. (Yescombe (2002); pp.105-06.)
In cases where the Construction Contract foresees that the contractor makes the project ready-to-use, the contract is also referred to as a “turnkey contract”. (Fight (2006); p.113)
Since these contracts are usually assigned for the engineering, procurement and construction of the project, turnkey contracts are also known as “Engineering, Procurement and Construction (EPC) Contracts”. These contracts set a fixed date and a fixed price to the building of the project. (Yescombe (2002); p.106)
The EPC Contract’s main clauses deal with the technical specification of the project as well as with its performance and safety criteria. They include the completion date and provide for specified grace periods, they set a fixed price for the project and contain provisions that allow the construction company to alter the price. EPC Contracts regulate payments to the construction company (i.e. frequency, timing, conditions, amount, and entitled parties and so on) and foresee penalty payments for a non-, late- or underperformance of either party under the contract. Moreover the issue of damage payments in case one party breaches the contract (i.e. liquidated damages) is addressed. Additionally, the EPC Contract deals with litigation and dispute settlement procedures which occur when failure in the construction or design do not allow the project to perform as specified (ibid.; pp.109-13).
Additionally, clauses that set out for the following types of instruments could be found in an EPC Contract (ibid.):
- Retainage: A percentage of each installment payment is retained by the SPV until the project is completed, to the SPV’s satisfaction.
- Performance bond: A bond provided by the contractor to ensure his fulfillment under the contract. If he fails, the bond is used to pay for indemnifications and liquidated damages.
- Advanced payment guarantee: If payments have been assigned by the SPV in advance the contractor could provide a guarantee to repay the money in case the contract is terminated earlier than agreed.
The main purpose of EPC Contracts is to mitigate certain kinds of risks (construction risk and associated risks) from the SPV to another party, thereby decreasing the SPV’s risk exposure and at the same time ensuring that the project will be executed in time, at a predefined price and fulfill certain specified criteria.
Input Supply Agreements are negotiated between the SPV and the supplier. More specifically, the contract provides for supply of a pre-agreed kind, quality, and quantity of raw materials (or any other resource needed to produce the project’s final outcome) by the supplier at a fixed price, date, place and manner (Yescombe (2002); pp.117-18).
Some examples of these contracts are Fuel/Energy Supply Contracts, Water Utilization Rights Agreements, Wood/Coal/Gas/Steel Supply Agreements, and so on.
There can be more than one Input Supply Agreement in a PF undertaking, depending on the scope and versatility of the project’s needed input materials. Under the Input Supply Agreement the SPV ensures a steady and predictable supply of raw materials, which will be needed for other production and/or operational processes. Furthermore, it can decrease the uncertainty of available (adequate and sufficient) supplies and so limit the likelihood that there are no – or not enough – supplies at the right time, place, quality and price available. (OeKB (2006b); p.71)
Input Supply Agreements could be distinguished according to their obligations imposed in the contract:
- Supply-or-pay contract: The supplier has to provide the raw materials as specified in the contract otherwise he has to pay for alternative supply or make already specified penalty payments. Also known as deliver-or-pay contracts (ibid.)
- Supply-and-pay contract: The SPV pays for the raw materials needed when they are delivered as specified in the contract. (Yescombe (2002); p.118)
- Tolling contract: The raw materials are provided at no cost, but the SPV is paid a “toll” to process the raw materials. The processed goods are then either used by the supplier himself (“Pull Tolling contract”) or sold in the market (“Push Tolling contract”) whereby the supplier receives the gains of the sales. (ibid.; pp.118-19)
An Input Supply Agreement should ideally have the same duration as the off-take contract. This enables the SPV to eliminate production shortages while having to fulfill contractual obligations to provide products and/or services; which not only could lead to a loss of revenues but also to indemnification payments to the purchaser of its products and/or services. In case of absence of off-take contracts the duration of the Input Supply Agreement should be as long as the term of the loan. (ibid; pp.117-18)
To stipulate the price of the supplies reference can be taken from the market price, the SPV’s sales price of its product and/or service but it can also be a negotiated price. In cases where Input Supply Agreements and off-take agreements are present, there are commonly two ways to set the price for supplies and for the finished products/services (ibid.; p.120):
- Either the sales price of the SPV’s products/services is based on the supply price of or
- The supply price is based on the sales price of the SPV’s products/services
To sum up, an Input Supply Agreement – if properly set up – ensures that needed raw materials are available to the project at the right quantity, quality, time and price; thereby the supply risk of the project can be mitigated.
Loan Agreements regulate the relationship between the SPV and a project’s lender. More specifically, the Loan Agreement will outline the terms as well as include provisions concerning maturity, fees and interest rates and other payment modalities of the loan (Construction WebLinks (2002); n.p.a.).
With this contract the sponsor of a project secures the necessary financial funds in order to undertake the project. On the other hand, the lender tries to secure his investment and to control as many risks in the project as possible. Ideally, all risks of the project are identified and controlled in one way or another. However, where certain kinds of risks cannot be sufficiently controlled the fees and interest rates of the loan will increase proportionally (Fight (2006); p.118-19).
Those uncontrollable risks could be of economic or political nature. To prevent the terms of the loan to alter and thereby increasing the loan payments, the SPV can seek risk insurance. If it is not possible to obtain insurance from the market, a possible solution could be to address multilateral institutions or ECAs.
Due to the credit exposure of the lender, it is common practice that the loan is not undertaken by one lender but by a multitude of parties, which is also called loan syndication. The term “Syndicated Loan Agreement” is used, if more than one party acts as a lender to the project. (OeKB (2006b); pp.34-35)
According to Construction WebLinks (2002, n.p.a.) additional aspects of a loan agreement could be: disbursement controls (also called “conditions precedent”), provisions for progress reports, covenants (incl. pari passu and negative pledge), dividend restrictions as well as debt and guarantee restrictions. Furthermore, subordination as well as covenant issues are addressed.
Accompanying the Loan Agreement the lender may demand additional securities to ensure the loan. This is usually done via collaterals that can be of the following kind: a mortgage on the project facilities, a pledge of bank deposits, liens, assignment of insurance proceeds, assignment of the agreements within a project, assignment of intellectual property ( e.g. patents) and so on (Construction WebLinks (2002); n.p.a.)
Summarizing, a Loan Agreement is set up between the lender and the SPV to receive the necessary financing for the project. The agreement does not only outline the loan amount, disbursement schedule and payment modalities, but also covers restrictions and obligations that ensure the lender’s security interest.
Off-take Agreements govern the relation between the purchaser(s) and the SPV. There are generally two different kinds of agreements, “take-and-pay contracts” and “take-or-pay contracts”:
- Take-and-pay contracts: The buyer has the obligation to pay contingent on delivery or on acceptance of the project’s goods (BusinessDictionary (2007a); n.p.a.).
- Take-or-pay contracts: The buyer assumes an unconditional obligation to pay whether or not the project’s goods are delivered or accepted (BusinessDictionary (2007b); n.p.a.).
Those agreements are used to secure the SPV’s ability to sell products on a pre-agreed basis to a known purchaser. More specifically, Off-take Agreements not only guarantee that there will be a purchaser for the SPV’s products/services once normal operation starts but already stipulate the quantity sold at a certain price. Both, quantity and price of the product could be fixed, based on minimum prices or can range between certain predefined limitations as defined in the contract. (IPFA (2007); n.p.a.)
The advantage for the SPV hereby lies in already having secured sales conditions of their products with specified parties which decrease the risks and efforts of having to find off-takers for the products (Hoffman (2007); p.104).
Therefore, Off-take Agreements can be seen as the basis of revenue for the SPV as well as an instrument to decrease or mitigate market volatility and serve as security to the lenders, ensuring that there will be sufficient cash flow to serve the repayment of their invested funds (Fight (2006); p.115).
Off-take Agreements are considered to be one of the key agreements in a PF undertaking, as they could guarantee – with some level of confidence – future returns of the project and so serve as a basis for calculations of future cash flows. (IPFA (2007); n.p.a.)
Off-take Agreements, amongst others, usually contain clauses concerning quantity, quality and the price of the SPV’s products/services, stipulate delivery specifications and regulate payment modalities as well as warranty issues for the goods/services. (OeKB (2006b); p.71)
Depending on the industry, the agreements could be named differently: An Off-take Agreement in the mining industry could be called a “Coal Off-take Agreement” whereas in the electricity generating industry an “Electricity Off-take Agreement” could also be known as a “Power Purchase Agreement” (LawVantage (1999); n.p.a.)
To sum up, an Off-take Agreement secures future sales of a SPV’s products/services whereby quantity, quality, price, delivery modalities and so on are already agreed upon. Those agreements mitigate the market risk and secure that the project generates cash flow with which to reimburse lenders and satisfy sponsors.
O&M Contracts are considered by some experts to be one of the key contracts in PF (IPFA (2007); n.p.a). These contracts are implemented between the SPV and the entity responsible for operating and maintaining the project once construction is completed.
O&M Contracts exist to keep costs for operating and maintaining the project within predefined budgetary limits and to ensure that the project is operated as planned. Reasons for an O&M contract could be that the SPV has no experience with operating and maintaining the project and therefore prefers to outsource this responsibility to another party. This other party can be a specialized O&M company, the construction company as well as the project’s sponsor. However, an operator is selected according to his track record, his experience, as well as his financial standing. The higher he ranks in all three categories the more likely it is for him to become the operator, because he has not only the experience but also the financial possibility to assume the risk of operating and maintaining the project. (Yescombe (2002); p.115)
Amongst other clauses, the contract has to cover the specified services and operations the O&M contractor has to fulfill as well as performance specifications that have to be met. Additionally, the price for this service, the payment modalities as well as the topic of non-, late- and underperformance as well as breach of contract and consequences thereof (i.e. liquidated damages) have to be addressed. (OeKB (2006b); p.73)
However, the O&M Contract also serves as a risk mitigation tool, as the risk of operating and maintaining an object is transferred to another party which will assume the risk against a certain fee.
Under O&M Contracts two common possibilities of pricing exist (Yescombe (2002); pp.116-17):
- Fee based pricing
- Incentive pricing
Fee based pricing is usually done on a fixed cost-basis, whereby the prices are indexed against inflation (Construction WebLinks (2002); n.p.a.).
Incentive pricing can be done instead of or in addition to fee based pricing. Incentive pricing links payment to the performance of the contractor. Should the project operate better than anticipated (by SPV forecasts) the remuneration of the contractor will also increase. (Yescombe (2002); pp.116-17)
Other Service Contracts
These contracts cover other contracts set up by the SPV and other parties who provide their services to the project. Those other parties could include:
- Technical advisors
- Financial advisors
- Legal advisors
Service contracts foresee an exchange of services for money, whereby the SPV pays a fee for the other parties’ services.
These service contracts most likely contain similar provisions as can be found in an O&M contract, like parties to the contract, responsibilities and obligations of each party, pricing for the services, dispute settlement, and so on.
Summarizing, the O&M Contract exists between the SPV and a party that is responsible for maintaining and operating the project within budget and according to specified performance standards. This contract allows the SPV to mitigate the performance risk of the project to parties that are more suited to assume this kind of risk. Additionally, other service contracts regulate the contractual relationship between the SPV and other professionals that provide their services to the project.
Insurance affects the relationship between insurer and SPV. Generally, in an insurance contract (or policy) one party agrees to pay another party all or partial experienced damages that are caused by certain events (Farlex (2007c); n.p.a.).
According to the different insurance needs due to the state of a project, some experts differentiate between two kinds of insurance: Insurance during the construction of the project and insurance during the operation of the project. (Fight (2006); p.79)
Insurance can be obtained on the insurance market when the risks are considered “marketable”. When there is no possibility to get insurance on the market (e.g. in the case of political and/or economic risk) MDBs, MFIs, ECAs could be possible sources for obtaining desired cover.
Neglecting the insurance issue or miscalculating the cost of insurance can lead to increased costs or even prevent financing, if addressing the insurance issue was a requirement for financing in the first place. Ultimately, this situation could lead to distress in the project. (Yescombe (2002); p.127)
Note: Although the topic “insurance” is covered superficially in this thesis, the importance of insurance must not be underestimated as it is an important tool to mitigate, eliminate or reduce various project related risks.
Apart from the core contracts that are usually present in a PF undertaking, there are special contractual structures in place for PF undertakings in which the public sector is involved.
Examples of PPP projects are bridges, cultural and recreational facilities, hospitals, power plants, roads, schools, transit systems, tunnels, universities, water and waste treatment facilities and so on. (Deloitte (2008); n.p.a.)
Agreements that stipulate the basis for a PF venture between the private and the public sector could have different forms. Some of them are briefly outlined below:
illustration not visible in this excerpt
Table 3: Types of Project Agreements with the public sector
Although a SPV would prefer to own the underlying project, the real value of PPP agreements lies in the right to earn revenues from the project. (Yescombe (2002); p.11)
 A more appropriate meaning of the phrase is found in the German translation for this term, which is “Wegfall der Geschäftsgrundlage” (Dietl/Lorenz (2005); p.783)
 Note: Due to continuous development in the modern insurance market also private insurers can provide political risk insurance, thereby rendering this statement invalid.
 As all OECD member countries’ ECAs are subject to the Common Approaches, the framework of assigning export credits is standardized for all members.
 License: “Governmental permission to perform a particular act […], conduct a particular business or occupation…” (Farlex (2007a); n.p.a.)
Permit: “[…] a license or other document given by an authorized public official […] to allow a person or business to perform certain acts.” (Farlex (2007b); n.p.a)
 This contract is the most favorable one for a SPV as the payment is guaranteed in almost any case.
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