Project Financing


Project Financing (PF) has emerged as an innovative and timely financing technique and is being used in many high-profile infrastructure projects. Employing a carefully engineered financing mix, it is used to fund large-scale projects, from communications, to telecommunications, and power to energy projects. It is a preferred alternative today. It will be foremost option of future.

PF holds great promise, which is just beginning to be realized as a means of financing projects designed to help meet the enormous infrastructure needs that exist in a developing countries.

Most infrastructure projects in developing countries are being funded by exchequer and thus in nearly all cases the construction of much desired projects are delayed due to lacking funds and deficient resources. Particularly when local governments are functioning full swing developing countries need to consider PF as a preferred choice.

PF can be arranged when a particular facility or a related set of assets is capable of functioning profitably as an independent economic unit. City governments (sponsors) of such a unit may find it advantageous to form a new legal entity to construct, own, and operate the project. If sufficient profit is predicted, the project organization can finance construction of the project on a project basis, which involves the issuance of equity securities (generally to the sponsors of the project) and of debt securities that are designed to be spell-liquidating from the revenues derived from project operations.

The intricacies of PF are formidable, and can easily be misunderstood and consequently, misused. While PF structures share certain common features, by necessity, they require tailoring the package to the particular circumstances of the project. That is where both the benefits and the challenges lie.

What distinguishes PF from conventional direct financing is that in PF, the project is a “distinct legal entity” and the financing is tailored to the cash flow characteristics of the project assets. Such a structure can yield a more efficient allocation of risks and returns than conventional financing, but careful financial engineering is critical.

It is a form of asset-based financial engineering. It is asset-based because each financing is tailored around a specific asset or related pool of assets. It involves financial engineering because, in so many cases, the financing structure cannot simply be copied from some other project. Rather, it must be crafted specifically for the project at hand.

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 at the source of funds to service their loans and provide the return and a return on their equity invested in the project. The terms of the debt and equity securities are tailored to the cash flow characteristics of the project. For their security, the project debt securities depend, at least partly, on the profitability of the project and on the collateral value of the project’s assets.

PF is not a means of raising funds to finance a project that is so weak economically that it may not be able to service its debt or provide an acceptable rate of return to equity investors. In other words, it is not a means of financing a project that cannot be financed on a conventional basis.

At the center is a discrete asset, a separate facility, or a related set of assets that has a specific purpose. This can include trash collecting trucks, toll roads, water supply and sewer projects, or some other item of infrastructure. This facility or group of assets must be capable of standing alone as an independent economic unit. The operations, supported by a variety of contractual agreements, must be organized so that the project has the unquestioned ability to generate sufficient cash flow to repay its debts.

PF can be advantageous to Pakistan when it has a valuable resource deposit, other responsible parties would like to develop the deposit, and it lacks the financial resources to proceed with the project on its own.

Commercial banks and life insurance companies have traditionally been the principal sources of debt for large projects. In the typical financing structure, commercial banks would provide construction financing on a floating rate basis, and life insurance companies would then provide “permanent financing” on a fixed rate basis by refinancing the bank loans following project completion. For infrastructure projects have become a high priority, commercial banks, having adjusted to the tighter capital standards, have expanded their role in PF. They advise as well as lend.

Multilateral agencies, such as the World Bank and IDB, and various agencies, such as Eximbank and OPIC, have also stepped up their funding of private infrastructure projects. Developing countries’ capital markets can also be a useful source of funds. Raising funds locally can reduce a project’s political risk exposure.

Most recently, through the financing of hundreds of independent power projects, it has become evident that PF is suitable for relatively low-risk projects that involve standardized nonproprietary technology.

PF has attracted growing interest as a means of obtaining capital. Its potential is perhaps greatest for the many large infrastructure capital investment projects that are on the drawing boards of many local governments. The projects are large and expensive, and the risks are great. But the potential benefits are enormous. Project financing could be the answer to the financial needs of such local governments.

My Consultancy–Asif J. Mir – Management Consultant–transforms organizations where people have the freedom to be creative, a place that brings out the best in everybody–an open, fair place where people have a sense that what they do matters. For details please contact www.asifjmir.com, Line of Sight

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