Financial Station

Introduction
F1- Hiring A Qualified Financial Adviser / Arranger
F2 - Corporate Structuring
F3 - Financial Structure
F4 - Understanding, Mitigating, and Documenting Project Risks
F5 - Sourcing Equity And Debt
FB - Detailed Inventory of Project Financing Sources
Annex - Selected Topics in PPI Project Financing

Introduction

The financing phase of the project cycle is often quite complex. The inherent risks, size, and long-term nature of public-private infrastructure (PPI) projects can make it very difficult to create and implement an effective financial structure. Canadian companies face some obvious challenges : (1) The relative lack of Canadian domestic experience in privatized infrastructure means that there are few natural investors in the Canadian private sector. (2) The small to medium size of most interested companies (consulting engineers, manufacturers, contractors) means that equity will probably have to be sourced from many sources, thereby resulting in the difficult task of constructing multi-faceted consortia. (3) Compared to some foreign competitors, Canadian BOT sponsors have more limited domestic financing sources for project equity and debt, such that developers must often resort to foreign financial sources for the most difficult parts of the financial package. (4) BOT projects comprise a complex array of legal, financial, commercial, and environmental risks which entail a considerable investment of sponsor time and money. Experienced project sponsors estimate that it can take up to four years from project identification to financial close, at a cost of 3% to 5% of the total project amount.

This Financing Station offers a 'building block' approach to the development and structuring of a project's financing package. Of course, the actual sequence (and number) of these steps will vary by project, depending on the complexity, risk profile, and other factors. However, most financings (regardless of whether the project cost is $5 million or $500 million) will share the steps outlined below.

d

These steps, which are discussed in detail in the following sections, can be summarized as follows:

1. Once the project opportunity has been identified and developed, sponsors begin focusing on more detailed project parameters such as:
   • the activities of the special-purpose project company, and who will manage its operations;
   • the rights and obligations of potential project equity investors;
   • the terms of the BOT concession arrangements with the host-country government, including key rights and obligations of both the concessor and the concessionaire;
   • a preliminary assessment of the project's capital requirements, including assessing the need for various equity and debt instruments.
   
   
2. Prior to launching fully into the financial structuring process, sponsors may want to engage the services of an experienced financial advisor.



3. Sponsors can now begin evaluating and documenting project parameters in a detailed manner. A business plan, prospectus, or information memorandum is a useful starting point, and various sources of public- and private-sector funding may be available to help cover some of the cost.



4. Sponsors may decide to appoint a lead arranger to help develop and coordinate the overall financing package for the project. Based on financial terms agreed with the sponsors (including project security and insurance instruments), the lead arranger will approach various investors and lenders to gauge financing interest.



5. Following receipt of 'in principle' financing commitments from investors and lenders, the lead arranger will negotiate the financing and related documentation with the sponsors, and then distribute the documentation to prospective lenders for their review and comments.



6. Once all the parties (borrowers, lenders, others) agree to the proposed financial terms and underlying financing and commercial documentation, the main agreements are executed and financial close is realized.

F1- Hiring A Qualified Financial Adviser / Arranger

It is crucial that you receive competent and timely advice and assistance when it comes to analyzing the financial feasibility of a BOT project, structuring the financial package, and sourcing the required funds (debt and equity). Even companies with in-house project financing staff may have to go outside for some parts of the expertise needed. Companies without such staff - or whose experience is limited to projects financed on the basis of sovereign guarantees or corporate balance sheets - should not hesitate to seek expert outside assistance.

A financial advisor can be useful at various stages:

• at the evaluation stage, to help determine whether the project is financeable;
• at the development stage, to help with financial modeling and analysis of project capital expenditures and operating cash flows, overall project funding requirements, optimal debt/equity capital structures, and key contacts amongst prospective investors and lenders; in this way, sponsors ensure that the project analysis is prepared in such a way as to be useful in a subsequent financing solicitation;
• during the financial structuring and sourcing stages leading to financial close; in some cases (especially if the advisor is a commercial or investment bank), the financial advisor may actually participate in arranging and underwriting the project's financing.

Various fee structures can be negotiated, including time fees, success fees, or a combination (the first and last being the most common). Your contract with the advisor should include a fees cap and a means of regularly reviewing progress towards targets.

Presented below are examples (by no means an exhaustive listing) of types of financial advisors active in Canada.

Type of Advisor	Examples	Comments
Canadian Banks and Investment Banks	CIBC Wood Gundy RBC Dominion Securities ScotiaMcLeod BMO Nesbitt Burns Toronto Dominion	Experience and contacts are generally excellent in North American markets, but less consistent in offshore markets.
Non-Canadian Banks & Investment Banks	ABN AMRO Bank Canada Bank of America Canada Citibank Canada Deutsche Bank Canada Merrill Lynch Canada	Few, if any, have Canadian-based advisory groups, but most can tap into extensive offshore networks.
Consultants	Klohn Crippen Consultants Ltd.	Compared to commercial or investment banks, these advisors often bring highly-specialized industry knowledge and typically charge lower fees. However, they generally do not bring the same breadth of financial services capability or geographic presence.
Major Accounting Firms	PricewaterhouseCoopers KPMG Ernst & Young	These firms bring an extensive array of financial knowledge and contacts in business and government. Some have particular expertise in privatization projects.

F2 - Corporate Structuring

A PPI project is normally operated by a Special Purpose Entity (SPE) (also referred to as "special purpose vehicle" (SPV), "special purpose company" (SPC), "project company", or "BOT company"), sometimes established offshore, formed for the sole purpose of that particular project (and possibly for others like it, in the same jurisdiction). The preference for this approach has developed out of a desire to limit the financial exposure of investors and lenders to the significant commercial, political, and legal risks that often attend such projects carried out in foreign jurisdictions.

The project company can help insulate the investors' own balance sheets from project risk and, in some cases, make negotiations with the host government a more manageable affair. On the other hand, the "cold start" limited-recourse nature of a project company usually means that the raising of capital will be a difficult and relatively expensive matter.

There are two critical areas in putting together the special purpose entity:

• Organization and Capital Structure
• Management and Control

Organization and Capital Structure

The actual legal form for the company will depend on many factors, including what the local authorities, investors, and lenders are likely to accept, as well as some important liability issues. The form of the company will also be driven by the nature of project sponsorship. In cases where a single entity (say a utility or other natural investor) controls the project company, the corporate form will reflect the preferences and judgments of that entity. In cases where there is no majority shareholder and control is shared through the stitching together of the interests of a variety of equity investors, the corporate structure will reflect a balancing of a wide variety of interests.

Project finance deals draw capital as equity, debt, or quasi-equity. The mix and terms of these forms of financing will determine the cost of capital to the project. The capital structure is commonly expressed in terms of the relative amounts of debt and equity (i.e., the "debt/equity ratio",) as well as the particular characteristics demonstrated by each of these sources.

Investors normally prefer a high debt/equity ratio, which helps to maximize returns since debt is generally less costly than equity. The most important factors in determining the amount of debt that a project should carry are (i) the ability of the projected cash flows to service debt (both principal and interest payments), and (ii) the risk appetite of the lenders.

By nature, lenders are relatively risk averse. Given the political, legal, commercial, and other risks perceived in non-OECD markets, lenders often demand high levels of project equity. Also, host governments, which sign the BOT concession contracts, may set minimum equity requirements in order to weed out weak contenders. A power project that may be feasible at 25% equity in the USA may require 40-50% equity in certain non-OECD countries.

The following factors, based on an article by Vives and Beato, 1996, may be helpful in determining an appropriate debt/equity ratio :

Cash Flow Level and Variability: Because debt must be serviced first to avoid default, the more variable the project's cash flow the less debt can be carried. For example, a power project that has a guaranteed price and output contract with a public utility can carry more debt than a project selling to a spot market where both price and demand fluctuate. As well, the financial correlation among inflows or outflows will influence the amount of debt a project can support.

Debt Maturity and Cost: Although total interest payments are greater for long-term debt than for a similar amount of short-term debt, yearly amortization payments are lower. Since projects tend to build up cash flow slowly, this makes it preferable for debt to be long term and to have a grace period covering at least the construction phase.

Availability of Risk Hedges: If a project can hedge some of its risks (i.e., reduce the variability or the harmful correlations), it may be able to increase the level of debt it carries. For instance, guaranteed input prices, forward sales of output, or currency swaps (to make inflows and outflows denominated in the same currency) and interest rate swaps (to convert floating into fixed) will increase the debt capacity of a project by lowering risk.

• A viable organization and capital structure for the SPE that will be solely responsible for the project's debt repayment, and an operating climate of predictability, transparency, and enforcement of host country legal and regulatory structures governing its performance.



• The ability of private investors to provide independent management and control of the project, and to work out acceptable agreements with host country governments regarding matters that could affect project profitability, such as locally-sourced procurement contracts and taxation.



• Provision of adequate exit mechanisms for sponsor equity via future public offerings on local capital markets, sale to third parties, or other means. (Wright, Directory of Innovative Financing summary: Financier 1996)

Sources of equity can be found at F5.

Management and Control

Private and public sector relationship
PPI projects are realized through private-sector vehicles, but in the end must meet important public-sector requirements (e.g.: quality and quantity of water supply, extent of distribution, limits to tariffs, etc.). Thus the need to describe very clearly the basis of the relationship in the Concession Contract (also called "Public-Private-Partnership (P3) Agreement"). A number of different issues should be anticipated in that agreement, such as the effects of eventual changes in law during the concession period (corporate tax, ownership rules, withholding tax, etc.). An agreement might be made, for instance, that laws at the commencement of the project must be kept in place until project completion. Another important aspect may be a requirement that the government buy out (under some agreed formula) the private-sector participants if the government does not respect its obligations.

Private partnership issues
The SPE needs to outline the management and control mechanisms in the development of the project. The participants in the venture should outline the issues that are deemed important enough to require agreement by all the participants. These issues, normally dealt with in the shareholders agreement, might be the hiring of a new CEO, the inclusion of a new partner, quorum at meetings, shareholder rights, voting, and so on.

Share Transfer
To minimize the risk of disputes later on, it is important to ensure adequate share transfer mechanisms are in place. There are different types of strategies that could be used, like the "buy-sell" or the "put-call" agreements. The buy-sell agreement is often a "shot-gun" system whereby a partner can offer to buy another partner's share for a certain price; the partner may agree and sell the shares or refuse and have to buy the offeror's shares. The put-call agreement is used when a partner is in default. The other partners then have the right to purchase the defaulting partner's shares or have the defaulting party buy their shares.

Operations Phase
Given the importance of the operations phase for the lenders (their repayments depend on successful operation) it will be important to foresee how the plant will be operated and by whom. Controlling investors (e.g.: utilities or major corporations) will take this decision themselves and may even be the operator. Typically, these matters are addressed in an operation and maintenance agreement.

F3 - Financial Structure

A project company starts out as a small entity, virtually without assets. It is a company "waiting to happen". Within a short period, and long before it is in a position to earn revenues, it will acquire significant assets and liabilities.

The diagram below shows how the financial structure, comprising equity and debt in a workable combination, is built in stages as the project's risk and cash flow profiles change. Obviously, there are no hard rules for when project funding can be sourced; it will vary considerably depending on project specifics, financial market liquidity, and financier interest.

At the outset, equity providers have to demonstrate their commitment and financial capability by being the first to put funds into the project company. This equity step will first be taken by the sponsors putting up "new money". As shown in the diagram, the sponsor's project risks are greatest during the project's development/pre-construction stage. Issues like market opportunity, host government support, local partners, and competitive threats are still unclear. In evaluating financing sources at this stage, sponsors may be able to tap government programs such as PEMD and CIDA-INC. If and as the project advances, there may be opportunities to source financing from IFIs or DFIs, as well as domestic and offshore project equity funds.

The degree of difficulty in raising non-sponsor equity will depend very much on the financial and technical credibility of the sponsors in relation to the size and inherent riskiness of the project at hand. For example, it may be easier to source equity if the sponsor is a natural investor (utility or large corporation) willing to put up enough money to control the project, as opposed to a number of smaller companies stitched together such that no single firm is able to exert control.

Once the equity picture has become more clear (but often before it is fully finalized and committed) sponsors may approach one or more ECAs to provide financing in support of their national supply to the project. (Sponsors will find it easier to attract commercial lenders (i.e.: banks) once official lenders have declared their interest.) By this time, sponsors should have produced a preliminary business plan, and key financial determinants such as project payback, optimal capital structure, investor internal rate of return, and debt service ability will be established. Non-bank financial institutions may also be approached in order to capitalize on their specialized financing expertise (e.g., their ability to source investments from insurance companies).

An investment or merchant bank may be appointed to provide some of the financing, as well as arranging or advisory services for the debt funding package. The advisor will recommend and implement an overall capitalization strategy, possibly including financing from commercial banks, public capital markets, and institutional investors such as pension funds. (Lenders, however, will not commit until sufficient equity has been committed, or at least clearly identified.)

Once the project is fully operational and generating increasing net cash flow, some of the original costly project debt may be retired and replaced by internally-generated funds.

d

Of note, given the expectations of investors, the demands of lenders, and the considerable political and commercial (and sometimes market) risks involved in PPI projects, the anticipated (pre-finance, after tax) Internal Rate of Return (IRR) must be sufficiently attractive to permit the project to move on to financing. Whereas in the U.S. a project may be attractive at an IRR of, say, 15%-20%, the necessary figure for a project in a non-OECD country is likely to be over 25% and perhaps as high as 30%-35% or more.

In addition, BOT structures give rise to a diverse array of financing issues which must be resolved through a combination of provisions in the concession, loan, and security documentation. For example:

• The financing of the project is largely based on estimates of construction cost. Estimates can go wrong. Both equity and borrowing requirements should take this into account through what amount to "stand by" arrangements.
• Lenders and project sponsors will have to agree on the pace at which their respective funds are put into the project. Normally, a significant amount of equity will be advanced, after which debt and remaining equity will go in at roughly similar rates.
• Lending during the construction period will usually comprise a grace period roughly mirroring the period up to commissioning, and a repayment term that goes beyond predicted project pay-back (although there are limits depending on the lender's risk appetite).
• At some point, it may be possible to refinance some or all of the costly early-stage debt with a cheaper long-term bond issue. While this has the advantage of extending the amortization period and increasing returns to shareholders, bond issues normally require an investment rating for the country and the project, as well as numerous risk mitigation instruments. Failing this, pension funds, insurance companies, and other institutional investors are reluctant to put their money at risk

Exit Strategy

One important step in the financial structuring process is to foresee means by which investors, according to their inclinations, can sell their holdings in the project company. This may be affected by whether or not project ownership transfers to the host government at the end of a concession period. In such cases, it is less likely that investors can achieve substantial capital gains on sale of shares: most financial payback will have to be realized by way of annual returns on the investment (i.e., dividends, etc.).

This issue, broadly defined as the project's liquidity, may be viewed quite differently by various players. For example, owner-operators may intend to hold shares indefinitely, with a view to earning profits from the project's operation. Pure financial investors may wish to sell their shares as soon as feasible once the project is operational. If there are any plans to make an initial public offering (IPO) of SPE shares at some point in the future, the means for accomplishing this must be carefully reviewed. Despite these differing (and possibly competing) objectives, the issue of "exit" must nevertheless be addressed up-front to the satisfaction of all equity investors.

F4 - Understanding, Mitigating, and Documenting Project Risks

The diagram below gives an appreciation for the complexity of BOT projects from a documentary perspective. The documentary structure, which allocates myriad rights and obligations amongst a wide variety of project participants through an intricate array of interdependent agreements, is perhaps best conceptualized in the following order:

1. The Concession Contract is the fundamental document upon which all others rely. It sets out the SPE's and government's rights and obligations in respect of the project, and defines which risks each party agrees to assume.



2. Having established the basic project parameters, the concessor must then engage a suitable contractor to design, engineer, and construct the project, which is effected through the Construction Contract. Often, the same contractor is hired to operate and maintain the project facility once complete; these terms are contained in an Operation and Maintenance Agreement. If requested by the SPE, the contractor may have to procure a third-party completion bond, in favour of the concessionaire, from a credit-worthy entity such as an export credit agency (ECA).



3. To ensure smooth and efficient operations and a stable project cost structure, the concessionaire will likely try to enter into Long-Term Supply Contracts with feed-stock suppliers (e.g., crude oil suppliers in the case of a petrochemical project).



4. For many projects, the concessionaire will also lock in creditworthy end-users and purchasers under long-term Take-Or-Pay Contracts, to ensure stable and predictable project revenues.



5. To begin construction, the concessionaire must first raise sufficient equity and debt financing. For project equity, the sponsors themselves are a good source. This may be supplemented by financial investors such as investment banks, project funds, and institutional investors. The investors agree on the general terms of their equity collaboration via a Shareholders Agreement, and effect the investment of equity into the project company by way of a Subscription Agreement. Depending on conditions within the host country, investors may look to mitigate certain risks by obtaining Political Risk Insurance from a third-party (such as Overseas Private Investment Corporation (OPIC), a U.S. government agency).



6. For debt financing, the SPE may look to various sources, including commercial banks and ECAs. Documentation may include joint or separate Loan Agreements, agency agreements, and extensive Security Documents including sponsor indemnities and filing/registration of creditor security interests. Lenders will typically, between themselves, execute an Inter-Creditor Agreement governing their rights and obligations with respect to sharing and enforcing security interests. Commercial lenders may also provide Hedging Contracts to the project company (e.g., floating to fixed interest rate swaps, forward foreign exchange agreements, etc.) Further, commercial banks will sometimes seek Political Risk Insurance coverage from a third party (often an ECA participating in the project).



7. Finally, the project company must secure adequate Insurance Contracts to cover risks during both the construction and operations stages of the project.

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Project Security

Lenders take security for two main reasons: (i) as protection against a borrower default, and (ii) to guard project assets against claims by third parties. In so doing, lenders are attempting to ensure that, if the borrower fails to service debt or carry out other obligations under the financing documents, the lenders can enforce their rights of possession and disposition over the secured assets and use the proceeds to retire the debt. For some projects, assets may have limited market value (e.g., cable in the ground for a telecoms project), which makes it even more critical to acquire additional rights such as the ability to step in and complete the project or operate the project company.

Security structures are unique to each project, reflecting amongst other things:

• the financial integrity of the project (i.e., cost structure, debt service coverage, etc.);
• the degree of support and risk mitigation provided by sponsors, host governments, insurers, contractors, etc.;
• the project's capital structure for equity, quasi-equity, and debt;
• political risks such as currency convertibility and transfer;
• the host-country legal environment (particularly having to do with perfecting and enforcing rights in security); and
• the contractual relationships amongst lenders and their individual and collective risk appetites.

Forms of Security

Project security can take many forms, but some of the most common are:

• first-priority fixed and floating charges (or mortgages) over the project's assets, including land, fixtures, machinery, cash and equivalents, project contracts, raw material and inventory, intellectual property rights, goodwill, uncalled capital, as well as future assets acquired by the project company;
• pledges from shareholders of their shares in the project company;
• pledges or assignments of the project company's rights under permits, concessions, licenses, approvals, contracts, and other material project documents, as well as consents and/or acknowledgements of such pledges/assignments from relevant third parties;
• assignments of insurance policies, under which the lender is named a joint insured and first loss payee;
• if available, undertakings from project sponsors to assume liability for servicing interest obligations during the construction period in the event of completion delay; and
• pledges/assignments of the project company's bank accounts.

Escrow Accounts

In some cases, lenders require the project company to set up offshore escrow accounts in order to collect international receivables generated by the project before such cash enters the host country (e.g., proceeds from the sale of output for mining projects, international toll revenues for telecom projects, etc.). Such accounts, in addition to being used to service project debt, are often pledged/assigned to lenders as security (which pledge/assignment may require host-country central bank approval). The main benefit of escrow accounts for lenders is in isolating some of the project cash flows from local legal, governmental, or regulatory issues. A number of jurisdictions, however, have enacted legislation to prohibit or restrict these offshore arrangements.

Inter-Creditor Agreements

In cases where multiple secured lenders are participating in a project financing, they will normally set out their individual and collective rights and obligations in respect of the project security under an inter-creditor agreement.

Perfection and Enforcement

To ensure full and timely access to the security, the lender must be confirm its ability to both perfect and enforce its security interests in the host country. As such, it is critical to ensure that the project's legal environment is acceptable, particularly with respect to:

• registration and/or notarization requirements for the creation of a valid security interest;
• bankruptcy protection laws in the host country;
• limits on the amount of debt which can be secured;
• conditions to be satisfied by the creditor prior to enforcement of security;
• stamp or registration duties payable on the security;
• requirements for service of notice to debtors;
• types of assets over which security can be granted (e.g., for many telecoms projects, operating licenses cannot be assigned);
• legal requirements (e.g., consents, acknowledgements, etc.) for perfection of security interests;
• stays on enforcement of creditor rights;
• enforcement priority vis-a-vis other secured and unsecured lenders.

Project Risk Assessment

At some point during the development/pre-construction stage, sponsors will want to develop a comprehensive risk assessment summary of their project. This will help not only themselves, but all project players (investors, the host government, the lenders, etc.) to evaluate, at a glance, the various risk dynamics at play, as well as structure and document the project appropriately to minimize certain risk factors. In many cases it is advisable to retain financial or risk management advisors to assist in this aspect of a project's conception, development, and realization. Under-protection against risks can break the project; over-zealous protection may erode the potential for profit.

These risk assessments are normally produced as part of the feasibility studies, Preliminary Information Memorandum, or prospectus, to help summarize major conclusions and findings. While the specifics will vary considerably depending upon the complexity of the project and its stage of development, any such framework should, at the very least, try to group project risks (e.g., construction, financing, political, legal, etc.) and provide risk mitigants or concerns and risk ratings. Below is a hypothetical project risk assessment for a telecommunications project in a South Asian country.

Risk Type	Risk Mittgants/Concerns	Risk Assessment
Construction Risks:
Non-Completion	Sponsor's considerable technical, financial, and management expertise Sponsor completion guarantee, backed by a third-party surety bond all-risk insurance on physical plant and equipment procured by Sponsor	Low
Completion Delay	Sponsor will manufacture the major network components liquidated damages under construction contract	Low
Cost Overruns	full turnkey contract shields investors Sponsors liable for cost overruns disbursements of equity and debt to be tied to network roll-out milestones	Low
Land Acquisition	minimal legal precedent for land acquisition procedures acquisition costs have not yet been confirmed strong project support from local population	Medium
Non-Performance of Network at Commissioning	Sponsor's extensive experience delivering similar networks use of proven technology liquidated damages under construction contract for defects in design, and performance guarantee (surety bond)	Low
Operating Risks:
Network Operating Performance	Sponsor to provide post-completion warranty and/or liquidated damages	Low
Unexpected Capital Costs	full asset maintenance and replacement cycle of 25 years	Low
Operating and Maintenance Fees Exceed Forecast	maintenance of appropriate cash reserves O&M; fees linked to cost controls	Low
Viability of Proposed Tariffs	regulatory recently approved 50% tariff increase in target metropolitan areas	Medium
Interconnection with Other Operators	telecommunications policy ensures mandatory interconnection numerous interconnection agreements between operators have been successfully concluded	Low
Availability of Workforce	Key senior positions have been identified/filled with experienced network operators/managers large pool of talent amongst host-country telecom operators	Low
Availability of Power	long-term electricity supply contract secured with state-owned utility	Low
Demand Risks:
Line Demand	extensive independent demand analysis/survey financial model assumes conservative line demand scenario financial model can withstand a 45% downward shock in demand without inhibiting capacity to service debt	Medium
Capacity to Pay	demand study indicates a strong capacity/interest amongst local businesses and private individuals	Medium
Competition	sole direct competitor is national incumbent product differentiation strategy will establish a dominant market position	Low
Country Risks:
Government Support	newly-elected government strongly endorses telecoms duopoly BOT arrangement helps secure Government commitment	Low
Regulatory Environment	independent regulator with proven capabilities clear telecommunications policy and tariff regulations exist	Low
Currency Transfer/Convertibility	enabling BOT legislation ensures unconditional transfer/convertibility of dividends, earnings, and fees for investors and creditors	Low
Economic Conditions	recent economic reform measures have reduced the budget deficit, but inflation remains a concern exchange rates are relatively stable, but suffer from downward pressure country remains in good standing with bilateral and multilateral donors/creditors	Medium
Financing Risks:
Sourcing Equity Financing	potential equity investors have been engaged Sponsors to seek arranger/underwriter for equity financing	Low/Medium
Sourcing Debt Financing	financial model sustains up to 40% of total debt in US$ Sponsors to seek arranger/underwriter for debt financing	Low/Medium
Legal Risks:
Feasibility of BOT Structure	enabling BOT legislation exists for telecom projects Government has approved the concession for the project	Low
Ability to Acquire, Perfect, and Enforce Security Interests	legal environment lacks precedents for acquiring, perfecting, and enforcing security interests on project assets	Medium/High
Foreign Investment and Employment	enabling legislation requires a minimum 51% local ownership, but permits a 15-year tax holiday	Low
Environmental Legislation	independent environmental impact assessment concluded minimal biophysical impact of project project will comply fully with the relevant environmental legislation	Low

Project Insurance

Although insurance cannot create the blanket protection from risk that many project developers seem to feel it should, it is an essential part of any BOT project. Project insurance instruments are available to various players :

• Investors: May be able to cover certain political risks that could threaten their equity.
• Exporters: Can seek coverage against a wide range of risks, from bid bonds, through pre- shipment insurance, to confiscation risk, performance bonds, the risk of non-payment and certain foreign exchange risks.
• Lenders: Can apply in some cases for third party coverage (insurance or guarantees against political risks affecting loan repayment prospects).

A critical step is determining which project insurance instruments are needed. (For these purposes, the term 'insurance' does not refer to the various warranties, liquidated damages, indemnities, etc. which may be offered by contractors, operators, host governments, or others. Rather, it means the contractual undertakings by third-party insurers to indemnify project participants for certain types of risk.)

Some types of project insurances are standard, while others are specialized or optional, depending on the nature, complexity, and risk profile of the project. Typical insurance instruments are as follows:

Type of Instrument	Coverage
Third-Party Liability (sometimes referred to as Casualty)	Third-party liability protects the project against legal liability for injury, loss, or damage suffered by an unrelated person or entity arising out of the project's activities.
Property All-Risk	Covers physical loss or damage to the project's buildings, structures, equipment, materials, etc. Coverage is typically effected under one or more all-risk insurance policies during each of the construction and operations stages. Coverage should be sufficient to repair or replace damaged facilities to a level similar to that existing prior to the insurable event.
Business Interruption	This covers the insured for expenses incurred while the project is not operating or construction has ceased, owing to physical damage to the facility. Examples of coverage include interest and principal payments on debt, fees, wages, etc. This coverage is sometimes included under property insurance policies.
Employer Liability	This is usually a statutory obligation to cover liabilities in respect of injury, death, or illness of project employees suffered in the course of employment on the project.
Political Risk Insurance	For projects in non-OECD countries, lenders (particularly commercial banks) often seek insurance for non-payment of project debt due to certain host-country political risks. Political risk insurance is provided by various multilateral agencies (e.g., MIGA) and export credit agencies (e.g., EDC), as well as some private institutions. Coverage normally includes: expropriation, nationalization, or confiscation of project assets by the host country government; restrictions on the convertibility and transfer of funds by the project company; war, rebellion, and insurrection.
Performance Bond (also referred to as Surety Bond)	While not technically insurance, this coverage acts in a similar manner by guaranteeing a project company, sponsor, lender, or other third party that the contractor (or other party) will complete the construction as specified. In some cases, these bonds will also provide for payments to sub-contractors in the event of default/insolvency of the general contractor. A performance bond is more likely to be required if the contractor is small, not well-known, or has a limited track record in projects.
Other Insurances	In addition to the above, other types of coverage may be required depending on the nature of the project and the financial strength and technical capacity of the parties responsible for various aspects. Examples include cost overrun or completion delay insurance to protect parties during the construction stage, and operating performance insurance to ensure that the project satisfies pre-determined standards during the operations phase.

Lender Considerations

Whatever the overall insurance package, project lenders will try to ensure they are assigned the benefit of these insurance contracts, either by way of assignment, pledge, or being named as a joint insured party and a first (or sole) loss payee under the policies. Lenders may also seek:

• a requirement that the insurers are acceptable to the lenders;
• notification prior to cancellation of a policy;
• the ability (but not the obligation) to step-in and pay the insurance premiums.

Insurance Sources

In the past, medium and long-term risks could be covered only by ECAs and certain IFIs. Shorter term coverage (under 18 months) has long been available from both ECAs and private markets. Increasingly the private market is developing capacity for certain longer-term risks. A financial advisor or insurance broker can help decide which market you should go for your project or, indeed, whether you should have them compete against each other. Premiums are not the only important factor: extent of coverage and waiting period for payment of claims are examples of other crucial considerations.

Potential sources of project insurance instruments and guarantees:

• IFIs: Particularly MIGA, IBRD, IFC and EBRD.
• ECAs: Short, medium and long term Bonds (bid, performance, etc.); equity investment; confiscation; payment, etc
• Private sector insurers: London and New York are the most important markets, though the partial privatization of certain ECA insurance services is creating opportunities elsewhere.
• Specialized brokers: They do not insure but they can help you test the market and negotiate your deal. Some brokers are more independent than others.
• Risk Managers: A fairly recent development - There are independent advisors (not brokers) who charge fees for advice on risk identification and coverage. To some extent these services can be provided by your financial advisor.

F5 - Sourcing Equity And Debt

In sourcing financing for projects, Canadian sponsors and equipment vendors are faced with a vast array of public-and private-sector financiers, both domestic and international. The choice of financial partner(s) will be driven by many different factors, not least the stage of project development, the location of the project, and its risk profile. In evaluating financing sources, a useful starting point is to compare and contrast the various players in Canada. While the comparative listing below is by no means exhaustive, it is helpful in drawing some broad comparisons between the types of financial services available.

Type of Financier	Examples	Comments
Schedule A Banks	CIBC Royal Bank Bank of Montreal Bank of Nova Scotia Toronto Dominion	Most focus on arranging and underwriting senior project debt, but some may consider equity investments, typically through their investment/merchant banking subsidiaries.
Schedule B Banks	ABN-Amro Barclays Citibank HSBC Chase ING BankAmerica	Most focus on arranging and underwriting senior project debt, but some (e.g., ING) may be more aggressive in considering equity and quasi-equity investments.
Project Funds	Latvia Energy Efficiency Fund IFC Asian Mezzanine Infrastructure Fund Polska Energy Efficiency Loan Facility	Typically, funds specialize in either debt or equity, although some may provide both. Debt and equity placements are subject to pre-defined investment criteria.
Non-Banks	CIT-Newcourt	Focuses primarily on project debt, often selling down financial risks to third-party institutional investors.
Export Credit Agencies	Export Development Corp.	Extensive experience in providing debt financing for offshore projects. Will consider equity investments in projects, subject to certain regulations and investment criteria. Debt and equity support is subject to, inter alia, acceptable Canadian benefits.
Institutional Investors	Ontario Teachers Pension Fund Caisse de dépôt Fonds de solidarité OMERS Manulife	The longer-terms and fixed financing costs sought by project borrowers coincide with the types of investments desired by many institutional investors. However, many of these investors lack the financial expertise to participate directly in projects, thus preferring to invest through sophisticated third parties (e.g., investment funds, non-bank financial institutions, etc.).

The Role of Vendor Financing in Projects

As competition intensifies for project procurement contracts, sponsors find themselves in an increasingly strong position to request risk-sharing commitments from contractors and suppliers, often in the form of fully-underwritten vendor financing commitments. (This is over and above the normal requirements for full turnkey fixed price contracts with appropriate bonding, insurance, and liquidated damages undertakings.) This has heightened the importance among Canadian project developers and suppliers of developing in-house vendor financing capabilities.

Vendor financing can be described as any financial instrument related to the sourcing of goods or services from one or more vendors, for the purpose of helping the buyer pay the vendor(s) for such goods or services. These financial instruments include term loans (often subordinated to commercial lenders), operating and financial leases, conditional sales, financial guarantees, third party-indemnities, interest rate make-ups, equity investments, assignments and pledges of assets or rights, and supplier credits (e.g., by way of promissory notes). While vendor financing can be provided by third parties such as commercial banks or export credit agencies, this section focuses on financial commitments provided by the vendors themselves.

Market Trends

The growth in vendor financing is driven by a number of factors, including:

• deregulation and privatization trends, which create new market players with immediate capital requirements;
• the limited financial track record of these new players, which makes traditional financiers (e.g., commercial banks) more cautious in considering financing;
• intense competition and convergence of technologies in many industries, which makes financing a key differentiator amongst vendors;
• in many cases, vendors are in a better position than financial institutions to understand the risk/benefit profile of a project.

Skill-Set Development

This growing emphasis on vendor financing has compelled major equipment suppliers to devote significant financial and human resources to the development of entirely new skill-sets and management functions relating to:

• assessing and mitigating project financial risks;
• developing appropriate financing structures to accommodate project risk profiles;
• arranging financing between their customers and third parties such as investment banks and ECAs;
• issuing up-front underwriting commitments for project financing, with a view to subsequently selling down the financing to third parties;
• negotiating financing and related documentation in a form/content acceptable to eventual lenders;
• providing credit-enhancement instruments to third-party financiers (e.g., first-loss deficiency indemnities, interest rate make-ups, asset refurbishment and re-marketing agreements, partial guarantees, performance undertakings, etc.).

Strategic Challenges

In providing this financing, equipment suppliers face very different types of challenges as compared to traditional lenders such as commercial banks. This reflects the different dynamics and pressures involved in mobilizing financing in support of project supply:

• often financing is requested for the full turnkey project, which could range into the billions of dollars;
• sponsors seek fast project deployment, which minimizes the time available to arrange financing;
• most project structures have high initial capital expenditures and negative cash flows in the early years, which makes it difficult to attract traditional financiers;
• financing commitments are often required at the earliest stages of project development, even before sponsors have finalized the project's business plan and obtained the necessary approvals, licenses, etc.;
• in some cases, financing may be requested for more than the value of the goods and services being supplied (e.g., working capital, import duties, etc.);
• sponsors are in a position to play vendors off against each other to obtain the most aggressive financing terms possible (e.g., grace periods prior to loan repayment, degree of financial recourse to sponsor, interest costs, debt/equity leverage profile, etc.).

This creates a number of strategic issues for vendors:

• can the financing commitments be sold down to third parties within a reasonable time frame without recourse to the vendor?
• since balance sheet resources are scarce, what is the optimal way to strategically ration the available financing (e.g., achieve the highest possible contract amount for the capital deployed, only use financing to establish new market footholds, etc.)?
• to what degree should/can the financing portfolio be diversified (e.g., by geographical region, by asset type, etc.)?
• will the amount and types of vendor financing on the balance sheet adversely impact on the company's credit rating or share price?

There are no straightforward answers to these issues, and each vendor must carefully weigh the pluses and minuses, both in terms of immediate sales prospects and longer-term market share.

The Role of Arrangers

Once financing sources have been initially scoped out, sponsors should carefully consider the possibility of appointing a financial arranger. The arranger, usually an international commercial or investment bank, is a vital player in most large, complex project financings, responsible for developing, structuring, coordinating, and closing the project's financing package. In effect, the arranger acts as the primary interface between the borrower (i.e., the SPE) and the group of financial institutions (i.e., the lending syndicate) funding the project.

Arrangers are appointed at the earliest stages of the formal financing process, once the main project parameters have been fleshed out and the proposed capital structure has been established. Typically, the arranger will provide a number of critical functions for the borrower, such as:

• help the borrower prepare a preliminary information memorandum or business plan, including a detailed financial model for the project;
• negotiate with the borrower the main terms and conditions of the financing and security package (including the proposed loan amount), and set these out in a comprehensive term sheet;
• solicit indications of financing interest from potential lenders (e.g., commercial banks, export credit agencies, international financial institutions, etc.), based on the financing terms negotiated with the borrower;
• organize due diligence meetings between the borrower and prospective lenders;
• negotiate financing documentation (e.g., the loan agreement, security documentation, inter-creditor agreements, trust arrangements, etc.) with the borrower;
• obtain 'in principle' financing commitments from lenders (ideally for a total amount not less than the proposed loan amount);
• provide the financing documentation to prospective lenders for their comments, and reach agreement with lenders on final execution documents;
• serve as (or appoint) the financial agent for the loan facility, with the responsibility of managing loan cash flows (e.g., fees, disbursements, principal and interest payments, etc.) between the borrower and the lenders, and administering/coordinating waivers and amendments throughout the life of the loan; and
• at financial close, coordinate the underwriting of the loan and concurrent sell-down of loan participations to the various lenders (the arranger will likely hold some of the financing for its own account).

The Due Diligence Process

For BOT project financings, 'due diligence' refers to the process by which investors or lenders identify and assess the risks of providing financing to a project. Due diligence activities commonly include:

• meetings with project sponsors, financial arrangers, project consultants, and host-country officials (e.g., regulatory agencies);
• review of the project's information memorandum or prospectus;
• secondary data research; and
• analysis of the project's financial forecasting model (including sensitivity analysis of key model assumptions).

Most lenders have a standard due diligence outline that serves as a roadmap to identify and understand risks in a consistent manner from project to project. Depending on the type of project being considered, lenders will modify their basic outline to reflect the particular attributes and risks. Set out below for illustrative purposes is a sample due diligence outline for a telecommunications project in an OECD country.

Due Diligence Outline

1. Sponsor Analysis
• What types and extent of support is the sponsor providing to the project?
• Financial
• Ownership
• Technical
• Strategic
• What is the sponsor's track record in similar projects?
• Does the sponsor have sufficient technical, financial, and managerial capacity to undertake the project?


2. Market/Industry Risks
• What is the current market demand for the product/service?
• Regional demand
• In-country demand
• What factors currently affect market demand?
• What are the forecasts for market growth?
• Results of consultants' studies
• Sponsor estimates
• What are the key success factors in developing mass market appeal for the product/service?
• What are the company's market share estimates, and on what basis are these derived?
• How will the company manage/minimize customer churn?


3. Competition
• Who are the company's direct competitors? secondary and tertiary competitors?
• What are the main barriers to market entry?
• What are the current competitive issues in the market?
• Interconnection with other operators
• Distribution channels
• Subscriber acquisition costs
• How important is customer service in attracting/retaining customers?


4. Legal/Regulatory Environment
• Who are the principal governing bodies for the industry?
• What is the regulatory history of the market?
• What regulatory risks/issues have been identified?
• Broadcast spectrum availability
• Dispute resolution mechanisms
• Tariff approvals
• Licensing obligations
• What approvals, permits, licenses, etc. are required in order for the project to proceed?
• How do lenders effect the acquisition, perfection, and enforcement of their rights (e.g., in respect of asset security)?


5. Technology Risks
• Is the project deploying new/untested technology?
• What competing technologies exist in the market, and what are their advantages/disadvantages?
• Does the project's technology have any issues in respect of network capacity or coverage?
• Are there any technology licensing or intellectual property issues?
• What is the risk of network obsolescence?



6. Network Construction/Operation
• How have sponsors mitigated construction and completion risks?
• Delays
• Cost overruns
• Performance of Equipment
• How have sponsors mitigated project operating risks?
• Network congestion
• Disaster recovery
• Who will operate, manage, and maintain the network, and what are the main terms of this arrangement?


7. Financial Risks
• What contingencies exist in the event of additional equity requirements?
• Does the project's 'base-case' cash flow forecast accurately reflect the project's dynamics, risks, and proposed financial/operating covenants?
• Consultant's analysis
• Lender's own analysis
• Is the forecast sufficiently robust to withstand downside shocks of key project assumptions?
• Sensitivity analysis on key assumptions
• Shocks sustainable with no cumulative cash shortfalls or covenant violations
• Severe downside scenarios


8. Financing Documentation
• Do project documents (including commercial and financing agreements) accurately reflect the rights and obligations of the various parties to the project?
• What side agreements will lenders require in order to protect their interests and preserve/enforce their rights (e.g., with respect to security, etc.)?
• What inter-creditor arrangements are contemplated (e.g., voting, enforcement, agency, etc,), and how will lenders share security interests?

In order for the financing process to proceed as smoothly as possible, sponsors should be prepared to respond to the types of due diligence investigations that investors and lenders will inevitably wish to pursue. To the extent possible, project documentation (especially the information memorandum) should be crafted in a way that addresses these due diligence issues up-front.