In an ever-changing world, infrastructure has become more critical than ever. Beyond the traditional infrastructure elements—such as ports, transport (rail, pipeline, and road), and civil and mechanical systems that have existed for many years—society has adopted a transformative approach to the development, implementation, and management of these assets.

1. Infrastructure and Projects

In infrastructure project finance, a trained engineer or developer would spot a critical piece of infrastructure around every corner. A well-versed banker would spot an infrastructure funding opportunity in every article on his/her news feed. For laypeople, however, identifying with these critical pieces of “kit” or “assets” or “the things that help us all” is not always as easy.

Think about the following questions:

  • Where does my fibre come from;
  • Where is the cloud that hosts my data;
  • Why do I have a cellphone signal wherever I go;
  • What produces my biodiesel;
  • How do wind, water and the sun to power my hybrid;
  • Who owns my children’s school/university?

The answers to the above can always be related to infrastructure. To ensure that we have enough of “the things that help us all,” the world has adopted a specific way of developing them: planning and implementing projects.

A project can be defined as “an individual or collaborative enterprise that is carefully planned to achieve a particular aim”.

In its simplest form, the development and implementation of an infrastructure set relate directly back to the definition of a project: People, Organisations and Regulatory Bodies (such as Governments) collaborate to plan and implement a project to achieve a specific outcome, establishing the infrastructure.

Not only has our society adopted a specific method for ensuring the rollout of critical infrastructure, but we also have a unique method for funding it, called project finance.

Project finance focuses on individual projects. It is differentiated from traditional corporate finance in that it aims to fund the project, instead of a business, in a way that suits the risks and circumstances accompanying it.

2. Infrastructure Project Finance Elements

Project finance follows a specific set of underlying rules or “elements” that must be implemented to work effectively. This piece aims to educate the reader on these elements and to better understand and apply this to future projects.

2.1 SPVs and Ring Fencing

Infrastructure project finance is predominantly ring-fenced in a separate legal entity, commonly referred to as a Special Purpose Vehicle (SPV), established for project implementation.

This enables separation between the project (its finance) and external variables that may affect it further down the line. In other words, project finance is raised and intended for a specific project, and ring-fencing ensures the specific allocation and usage of funds for the project’s implementation only.

2.2 Project Participants

These parties consist of a mix of the following players, all of which end up having vested interests (through the way of shareholding or contract holding) in the project:

2.2.1 Infrastructure Project Finance: Sponsors

Sponsors are individuals, organisations or a combination of the two that originate and drive project development. They often start a project’s development process and are mainly the “jockeys” backed to make it successful.

2.2.2  Implementation Contractors

This comprises a combination of Engineers, Built Environment Professionals, EPC and/or Construction Contractors. These parties are engaged throughout the Project’s development process to identify capital expenditures and implementation costs. All contractors are tied in based on contracts that are developed to incorporate the various areas of implementation and construction. These contracts can often be a deal killer in the project finance world, as details of funder requirements may be overlooked.

2.2.3 Equipment Suppliers

Equipment suppliers also play a big role during a project’s development and “construction” phases. They contribute their equipment in exchange for an economic benefit, which adds to the project’s capital expenditure. Solid contracts, which fall in line with funder requirements, should always be put into place for the supply of equipment, with specific attention given to items such as lead times on orders placed, bonds and guarantees required and possibilities of the vendor.

2.2.4 O&M Contractors

These contractors usually start delivering their services once the construction or implementation of a project has been finalised. They participate in ensuring the operations of the project are performed and may include services such as maintenance, the supply of operational capability and resources, logistical management and maintenance, etc. Again, funders usually focus on the contracts for these guys to evaluate the overall bankability of the project.

2.2.5 Infrastructure Project Finance: Others

Although the main players in a project finance environment have been listed above, SPVs often incur expenses for the services of various consultants for successful development. These may include environmental-, legal-, financial- and other advisors, insurance brokers and companies, logistical partners, clearing agents, etc. These are the essential service delivery agents required to stitch together the main elements for project finance to succeed.

2.3 Supply

Stability and supply security contribute to the effectiveness of a project, and obtaining supply at the right price and terms will almost certainly boost the project’s bottom line. Supply can take various forms; it can be the fuel which is stored and transported through a tank farm, grain which takes up capacity in a silo, electricity and fibre optic connectivity to a data centre or water, yeast, grain and hops into a brewery.

As supply is a key element in the optimal functioning of a project, financiers emphasise the terms, practicalities and circumstances surrounding supply (in the form of supply agreements) in the project. Supply is a key element not only for the implementation and operation of a successful project but also for obtaining project finance.

2.4 Off-take

Any business functions on revenue generated. In a project environment, revenue is derived from an off-taker. This can take the form of a tenant paying to utilise office space, a client paying to transport gas through a pipeline, or even a farmer leasing hydroponic planting space. Without an off-take/rs, no revenue will be derived. Thus, without an off-take/rs, required returns, expected for funding provided, will not see the light of day.

Project finance generally leverages off-take (viewed in conjunction with the free cash flow generation capability that originates from it) as a pillar for the serviceability of required returns. It is often the starting point of any project evaluation by a project financier, and the terms surrounding the off-take (and thus the flow of cash) often drive the investment decision.

2.5 Infrastructure Project Finance: Legislative & Environmental Impacts

Any legitimate business is governed by legislation, rules and regulations. Whether enforced by the government, local or international agencies, associations or other third parties, laws and regulations significantly impact a business’s operations. A project is no different. Compliance with laws and regulations is a must for the optimal functioning of any project. Even more so, with infrastructure Projects, compliance with environmental laws and regulations has become very topical nowadays.

Infrastructure often impacts the environment. Generally, governments and international associations have specific rules and regulations to help protect the environment, which are continuously enforced. In most instances, authorisation is required from specific bodies to implement infrastructure projects in specific areas. For this, project owners or sponsors need to do environmental impact assessments before implementing their projects to satisfy the relevant bodies and ensure that their projects will not detrimentally affect the environment.

Furthermore, other laws and legislation may significantly impact projects. Think anti-money laundering legislation, anti-competitive behaviour prohibitive legislation, tax legislation, trade legislation, stock exchange legislation, banking and credit regulatory legislation, etc.

Very often, project financiers commit to complying with relevant legislation. If they do not, they may be at risk of fines, penalties and possible retraction of committed funds from underlying investors. Compliance with relevant laws and legislation is thus a crucial element in successfully implementing projects and raising project finance.

2.6 Infrastructure Project Finance: Security & Insurance

Any business needs to be covered in the event of things going wrong. This principle applies throughout a Project Finance environment. Essential mitigation against risks that can’t be hedged on a natural or operational basis can, in most circumstances, only be implemented through insuring against losses that arise from circumstances that are out of the control of project owners. Similarly, project Financiers often require security or insurance for project investments. This protects them against unforeseen circumstances that may lead to the required returns on investment not being realised.

These types of loss inhibitors or protection can take various forms, depending on the nature of the Project. Physical security usually takes the front stage in a Project Financier’s books (as with any other funder). Thus, if you put up your owned assets (physical and non-physical) as security against non-settlement of required returns, your Project is more de-risked in a project funder’s eyes.

The aim of project finance, however, is to see whether the risks related to a project can’t be successfully mitigated through alternative forms of security. Normal insurance practices often play a big role in mitigation, i.e., insurance against theft, bad debts, etc. In more complicated circumstances, insurance for cross-border transactions (export credit insurance), the cession of income and off-take agreements, performance and operational guarantees and hedges can be put into place to bring investment-associated risks down to an acceptable level. These services and instruments usually require input from specialised service providers who understand the intricacies around them.

2.7 Funders

An array of funders exist in the project finance world. Normally, project finance consists of a combination of efforts from these funders. In general, debt and equity funders join forces to make project finance dynamics work. This means that one would usually encounter two different main kinds of funders in a project finance environment: equity funders, who buy a stake in the shares of the project (usually through acquiring an equity stake or share in the SPV), and debt funders, who borrow funds into the Project and its operations in exchange for repayments.

2.7.1 Debt vs Equity Funders

The main difference between these two is that equity funders take on more risk. This is because they stand behind debt providers when it comes to waiting in line for required returns. I.e., debt providers borrow funds into the project (usually through the SPV), have specific rates of return (interest rates and cost of debt) and usually link these returns to specific events or timelines. They get preference above any other project creditors and often take up all of the security available from the Project.

Equity providers, on the other hand, invest in the project’s share capital (or SPV) and share in the profits generated by the project. Their returns are less guaranteed than debt providers but often more lucrative if a project works. The simple economic principle of risk and return is often clear when these two kinds of funders, the risks they take and the returns achieved, are weighed against each other.

These funders use various financial instruments to structure and implement project finance, tailoring these tools to suit specific projects. Instruments such as preference shares, ratchets, and mezzanine/hybrid financing can impact the returns generated for Project financiers, which is why project finance dynamics often vary significantly across projects. These strategies help mitigate investment risks uniquely for each project, enabling effective funding across different project types.

The above elements are key considerations when developing a Project to secure project finance. While much more can be said about each element, its effects and impacts can vary depending on the specific project. Nevertheless, project owners or sponsors who rigorously address each of these elements are more likely to succeed in raising project finance provided that the project is fundamentally sound.

Read more on the EPCM topic here.

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