Project Finance Concepts for Project Managers

[Music] So thank you everybody for attending today's webinar. It's one in a series of webinars that we run roughly monthly throughout the year. This one's called Project Finance Concepts for PMs. So this takes the whole entire realm of project finance. And I'm not talking about tracking the costs of your project or managing your cost control accounts for a project. That's project financial management. This is project finance itself. How do we as organizations fund projects? So this is around the business case and the funding of a project. And specifically, what is the role of a project manager in this project finance world? So we're gonna give you some of the basics of project finance and help you figure out what pieces of it are needed or of interest to project managers.

So I'm just going to proceed. We're gonna talk about a little bit about what is project finance first of all, and how project finance differs from how we traditionally finance projects, corporate finance, right? When companies fund their projects versus going into a project finance world. Remember the roles and participants of the project finance process. We're talking about the different stages, what are the benefits and risks. And lastly, we're gonna get into a little bit of history and a little bit about what is the PM's role.

So, um, before I get too deep into project finance, I'm just gonna ask you a little bit of interactivity here to make a potentially dry topic a little more interesting. On your web interface, you're gonna see a chat window. If you're joining by telephone, you can't chat. But if you're joining by a computer, you'll be able to chat. I just wanted you to type in the chat window, and that's different from the questions window. In the chat window, please type in what do you think project finance means to you? What do you think project finance is?

So on your web interface, you'll see a little orange arrow. If you click on that, this is the hovering little control panel on the screen, usually in the top right corner. If you click on that arrow, it expands the panel and you'll see a number of tabs. Look for the questions/chat tab. Make sure you've clicked on chat and then type a message into the bottom. I want to hear what do you think project finance means to you. Now, if you're on a telephone or you can't see the chat panel, just click your raised hand icon and I will unmute your line and you can share a couple thoughts on what you think project finance means to you.

Okay, so Kim answered. Kim says, "How a project debt is funded." Certainly, that's one part of it. Absolutely, Kim. Good answer. Kate says, "A project's ability to raise sources for required uses of the project." One says, "It means different alternatives to fund a project." And Erin says, "Securing funding for projects, cash flow, interest rates, and return on investment." Excellent, all excellent answers. It sounds like you guys get it, right? So this is quite different from traditional financial management inside the project.

Okay, so let's get into some of the details. So what is project finance? The International Project Finance Association, or IPFA, defines project finance as the financing of long-term infrastructure, industrial projects, and public services based on a non-recourse or limited recourse financial structure. We'll talk more about that a bit later, where project debt and equity used to finance the project are paid back from the cash flows generated by the project. The key elements we want to look at here are the terms non-recourse versus limited recourse, and the fact that debt and profit for equity investors must be covered from project cash flows. So we're going to spend some time talking about that.

Project finance really involves obtaining finance for the project from two key players. The first is investors, Mr. Buffett, Warren Buffett investors, those who are looking for equity investments that have large payouts and they're willing to take on a little bit of risk to obtain them. And the second group are lenders, those who provide funding but who are willing to take a lower payout in exchange for lower risk. They are typically quite risk-averse. So there's two different players with different risk tolerance, and they're looking for different things out of the project finance.

The second thing we wanted to look at was non-recourse versus limited recourse finance. Now, there's two types of project finance. Let's define those key terms. Non-recourse finance is finance where, in the case of default, the lender cannot go after the assets of the sponsor. So that's non-recourse. They can only go after the, basically, if the project fails, they get nothing, right? But with limited recourse finance, some assets may have been pledged or guaranteed by the sponsor, but there's a limit to the sponsor's liability in case of defaults. Of the two, non-recourse, believe it or not, is the most common type of project finance.

Let's talk about where it's used. Project financing is so attractive because it's a good way to use private capital to achieve private ownership of public services such as transportation, energy, and large infrastructure development. Project sectors where project financing are commonly used are energy. Right? Project finance is used to build energy infrastructure in both developed countries and in emerging markets. Development of new refineries and pipelines are also successful uses of project finance. Large natural gas pipelines and oil refineries have been financed with this model. Right now, even out in Western Canada, before the use of project finance, such projects were financed by the internal cash generation of oil companies, or they had to wait for loans by governments.

Project finance is used to develop the exploitation of natural resources such as copper, iron ore, and gold all around the world. New toll roads are often financed with project finance techniques since they lend themselves to the cash flow-based model of repayment. Projects to produce new or refurbished rail infrastructure also often use project finance. The burgeoning demand for telecommunications and internet bandwidth in developed and developing nations necessitates these two project finance strategies. And there's many other sectors targeted for private takeover of public utilities and services via project finance, include pulp and paper projects, chemical plants, manufacturing, hospitals, retirement homes, prisons in the US, schools, airports, and ocean-going vessels. So pretty much project finance can be used almost anywhere throughout projects, usually large, complex projects.

So why do we use it? Project financing is a good option for those who wish to eliminate or reduce a lender's recourse to the sponsor's assets. If you want off-balance-sheet treatment of the debt financing, as we saw in companies such as Enron, right, is one example. I mean, it didn't work out so well for them, but lots of companies are doing this regularly now. Maximize the leverage of the project. Avoid restrictions or covenants binding the sponsors under their individual financial obligations. Avoid any negative impact of a project on the credit standing of the sponsors. Allow creditors to appraise the deal on a segregated and standalone basis, that is, on its own merits. This allows the sponsor to access money at better rates when the credit risk of the project is better than the credit standing of the sponsors. Take advantage of lower tax rates for the project, the sponsor, or both. And even to reduce political risks. So those are some of the reasons why we do it.

Let me give you a little bit of a couple examples and a little bit of history. The use of project finance can be tracked all the way back to ancient Rome and Greece. It was used as a viable solution to raise funds in order to export goods around the world. It was also used in large infrastructure projects such as the development of the Panama Canal. No single company would have had the funds to be able to pull this off. During the 1990s and 2000s, project finance gained momentum as governments saw the opportunity to allow the private sector to assist with the development of assets and services under the Private Finance Initiative or the Public-Private Partnership umbrella.

In Canada, the Ontario provincial government partnered with a consortium of businesses to create the 407 ETR toll highway, and it partnered with IBM to release the Service Ontario kiosks, which were piloted in 1993 and rolled out in 1996. Both of these were project finance initiatives. In the 407 case, the Ontario government funded the construction of the highway for $1.5 billion, and when it was completed in 1999, leased it for 99 years for $3.1 billion to a private consortium who would be responsible for operations and maintenance in exchange for control over the revenue stream of tolls. At the time, it was the largest privatization of a public asset in Canadian history and actually generated surplus cash on the books of the province.

In the Service Ontario kiosk case, IBM partially funded the development of the kiosks in exchange for an ongoing residual fee for each transaction performed by the public using the kiosk. Currently, project financing has become an integral tool used in various sectors, including agriculture, telecommunications, and transportation, as we talked about a little bit earlier. Project financing is an essential service provided by development banks and plays a crucial role in developing the economies of less developed nations.

So how does it differ from traditional finance? With traditional finance or corporate finance, the primary source of repayment for investors and creditors alike is the sponsor. The sponsor, by strength of its credit and reputation, obtains desired funding by assuring lenders that it can afford the loan. If ever the loan were to go into default, the sponsor's company alone would be at risk of losing its assets or for foreclosure. Under the project finance model, projects can be structured as separate entities. In other words, repayment of the funding depends on the income and therefore the assets of the project itself. The risks and returns do not solely belong to the sponsor, but are shared between several roles, such as equity holders, debt suppliers, and quasi-equity investors. Since the risks are shared, before qualifying for funding, a project must be able to stand alone as a definite legal and economic entity.

So a quick question for you guys, just to see your level of experience on these projects. Have you ever been involved in a project finance project such as this, where there is shared risk and where funding comes from banks and investors, not from the sponsoring company itself? Do you have any examples? If you want to type them in the chat window or in the questions tab, let me know. Do you have any background or experience with project finance? Have you ever worked on one of these projects? I'd like to hear a little bit about it. Anybody?

Okay, so we have Erin says, "Yes, wastewater reclamation facility." Erin, I've unmuted your line. If you just want to tell us, you know, in 30 seconds or less, a little bit about this project.

Yeah, so the utility here needed a new wastewater facility, and I actually worked for the contractor at the time. We did a design-build-finance for Liberty Utilities, and that project used bank financing as well as, you know, other investor financing. I'm the contractor at the time, and you know, had a had a financial wizard at the height of the firm, and they made all of that work out so that Liberty wasn't financing that project, which was very large.

Excellent. You know, honestly, sometimes the only way you can do a large project is with external investors and partners because one single company just can't possibly afford all of the actual cost. There's companies working in the oil patch out west where these projects cost several billion dollars to implement and may take ten years before they start seeing a financial return. There's not too many companies that can throw out billions of dollars, billions with a B, and then wait 10 years to start seeing a return on investment. That's just too much for any individual company to take that risk. They just don't have the cash flow to cover it. So you have to look at consortiums of lenders and investors who can each put some of the money upfront and create these more complex deal structures.

Kim, you said, "All our new wind and solar sites are based on project finance." I'm gonna unmute your line if you just want to tell us a little bit about this. Go ahead, Kim.

Okay, I can't talk too much about it just because I sort of stay on the fringe a bit being in the engineering group, but that's why I'm attending this meeting here. This says, so far, excellent. I've learned a bunch of stuff already. So it's the same concept that the projects are very expensive, ranging from even just a couple of hundred million dollars to $400 million. And so we end up doing arrangements where the developer might have developed a project up to a certain point, and then we enter into a sort of a joint venture where it's split between us and the developer up into a certain part, usually when we hit commercial operations. Along the way, we go out for construction loans as well as enter into tax equity partnerships where we raise the extra capital that's needed to fund the project essentially.

Excellent. That's an excellent example of project finance in action. Thank you very much.

Okay, so let's move on. Now we can see that in project finance, it's all about managing the risk. And so one company doesn't want to necessarily take on the full brunt of the deal. So we need to spread it around a little bit, and that's where project finance really starts to come into play.

Okay, so let's look at some of the roles and participants. There's a number of roles involved in project financing. Which roles and participants depend on the type, the scope, and size of a project. And let's look at the usual parties involved. There's many possible roles in a complex finance deal. Let's look at some of the more common ones.

A private sector partner or owner is usually a corporation or limited partnership created for the sole purpose of the particular project, again, to limit the risk to the main company behind them. This party is at the center of all contracts, borrowings, and the construction and operation of the project. So if you're working for an engineering firm, for example, and you are taking on this project, that's probably a bad example. If you're a business entity that wants to take on a project and hires engineering firms and others to work on the project, you may not, if that project fails, you may not want that project to impact the rest of your business. So you may create what's called a special-purpose entity that's going to own that project until all the risk is done with. Once the project's done and in full operation and running smoothly, then you may merge it into your main company. But you may create this entity just for the purpose of this project. That's what we're talking about. So it's this entity that takes on all the risk and signs all the contracts with the various partners, like the engineering firms.

The project sponsors, the person or entity who takes on the active role of managing the project. The sponsor owns the project entity and will receive profit from the successful project, either as a result of ownership through equity or by managing the contracts. The sponsor is usually responsible for covering certain liabilities or risks of the project. There may be some guarantees, for example, or by entering into management or service agreements.

Lenders, such as commercial banks, investment banks, or other institutional investors like insurance companies, pension funds, may provide the debt portion of the project financing. And one of the lenders may be appointed as an agent acting on behalf of the other lenders to administer a syndicated loan. So the project doesn't have to deal with 30 lenders; they just deal with the one agent who handles all those lenders in the background. A single lender is often chosen to hold the accounts of the project, the finances of the project, through which all the cash generated by the project will pass, called the account bank. Lenders or project sponsors who do not expect to have an active role in the project may be classified as equity investors. In the case of lenders, they may have a shareholding in addition to lending by way of debt as a way of receiving an enhanced return if the project is successful, a way of sweetening the deal. In most cases, any investment by way of shares is coupled with an agreement to allow the equity investor to sell its shares to the project sponsor if the equity investor wishes to exit the project, a buyback provision. Similarly, the project sponsor may have the option to repurchase the shares or to force the sale of those shares.

Other stakeholders include the suppliers of materials for the project, the contractor responsible for designing and building the project, and the customers of the project. All of these may have special financial interests in the project other than the obvious through negotiated payment terms, including special interest rates for deferred payments, balloon payment clauses, and other similar financial tools. Some projects, particularly in developing countries, are co-financed by the World Bank or its investment bank, this division, the International Finance Corporation, or regional development banks, such as the European Bank for Reconstruction and Development or the Asian Development Bank. There's lots of examples. Multilateral agencies such as these are able to ensure the bankability of a project by providing commercial banks with a degree of protection against political risks, such as the failure of a government to make agreed payments or to provide the necessary regulatory approvals. So you see a lot of these on these foreign aid programs, for example.

The government of the country where the project is based is likely to be involved in issuing consents and permits, both at the start and for the life of a project. The awarding authority is the contracting local authority which enters into the project agreement with the project entity. In infrastructure projects, the project entity will normally contract in advance with a third party who purchases the project's output on a long-term basis. Insurers are vital to a project. If there's a catastrophe affecting the project, then the sponsors and the lenders will look to insurers to cover the losses.

So just a few of the more common roles in project finance, and not necessarily a complete list either. Let's take a look at the stages of project finance. So project finance is divided into two phases: the construction and development phase, where the project is actually built, and the operations phase, where it's actually running and generating the revenue. So we're going to talk about each of those separately next.

During the construction and development phase, loans are extended, and debt service may be delayed, either by rolling up interest or by allowing any drawdowns to finance interest payments prior to the operations phase. This is sometimes called capitalizing the interest. This phase is the period of highest risk for lenders, since resources are being committed and construction needs to be completed before any inbound cash flows can start. And margins may vary throughout the different times during the project to adjust for the varying risk profiles of each period. Risks may be managed by taking security over the development contract and connected performance bonds. During the operations phase, lenders may receive securities tied to inbound cash flows. Debt service can normally be tailored to the actual cash flows generated by the project, typically a dedicated percentage of net inbound cash. Loans can, via security structures such as blocked accounts, be held by the lenders automatically, with the rest transferred to the project company.

So the two main phases, but let's actually look at the stages of project finance. It's broken into a number of sequential stages. The first is the bidding stage, where the host company announces a project, solicits proposals from interested private bidders. Commercial banks, investment banks, and others compete to win these deals for work. In developing nations, multilateral banks such as the World Bank get involved to guarantee payment to the private bidders. And when organizations such as this get involved, they typically impose a very tightly defined tendering process, referred to as the International Competitive Bidding, ICB. Offering analysis and awards of contracts are conducted according to these strict rules throughout the tendering process. That's the bidding stage.

The second is the feasibility study phase. This is one of the first steps in a project financing life cycle. The sponsor, or a technical consultant hired by the sponsor, will prepare a feasibility study showing the financial viability of the project. Frequently, a prospective lender will hire its own independent consultants to prepare an independent feasibility study before the lender will commit to lend funds for the project. They don't always believe what they read; they may want to double-check things themselves. The feasibility study should analyze every technical, financial, and other aspect of the project, including the time frame for completion of the various phases, and should clearly set forth all of the financial and other assumptions upon which the conclusions of the study are based. While these agreements can be quite long and complex, sometimes running a thousand pages or more, indeed, developing these studies may be a whole project by itself. The more important items contained in a feasibility study include a description of the project, details of the sponsors, copies of the sponsors' legal agreements, a link to the project website, details on any arrangements with governments, the sources of funds, feedstock agreements, offtake agreements, construction contracts, details about the management of the project, the required working capital, equity sourcing details, financial projections, and maybe even a market study. I'll talk more about these in an upcoming slide.

The third stage is the contract negotiations stage, during which all the necessary contracts and agreements are signed. The sponsor will structure the project vehicle in such a way as to insulate itself from the risk and liabilities inherent in the project. On the next slide, I'll take a more detailed look at some of these agreements. A few of the principle agreements during a project financing deal include the construction contract, the feedstock supply agreements, product offtake agreements, operations and maintenance agreement, the management agreement, and any loan or security agreements, and the site lease agreement. In an emerging market country, some of these documents are entered into with the central government or its agencies, as each counterparty to the project agreement will support the sponsor's credit in one way or another. It's necessary for each of the counterparties to be creditworthy in its own right, and that's why we get World Bank guarantees and stuff coming in.

So let's take a look at some of the typical agreements that we'll find in a bit more detail. The construction contract should set forth a detailed description of all the work necessary to complete the project, and it should discuss several elements. One element is price. Most construction contracts are fixed-price contracts, although the project may be built on a cost-plus basis. If the contract is not fixed-price, additional debt or equity contributions may be necessary to complete the project, and the project agreements should clearly indicate a party or parties who are responsible for such additional contributions.

Another element is payment terms. Payments are typically made on a milestone or a completed work basis, with a holdback for the owner and the lender. This payment procedure provides an incentive for the contractors to keep on schedule and provides useful monitoring points for the owner and the lender. The expected completion date is another important element. This date, together with any extensions resulting from an event or events of force majeure, must be consistent with the parties' obligations under other project documents. If construction is not finished by the completion date, the contractor typically is required to pay liquidated damages to cover the debt service for each day until the project is completed. On the other hand, if the construction is completed early, the contractor is frequently entitled to an early completion bonus.

The construction contract may also include performance guarantees, where the contractor guarantees that the project will be able to meet certain performance standards when completed. Such standards must be set at levels to assure that the project will generate sufficient revenues for debt service, operating costs, and a return on equity for investors. Such guarantees are measured by performance tests conducted by the contractor at the end of construction. If the project doesn't meet the guaranteed levels of performance, the contractor typically is required to make liquidated damages payments to the sponsor as well. However, if project performance exceeds the guaranteed minimum levels, they may even be entitled to bonus payments.

The next agreement type is product offtake agreements. In a project financing, the product offtake agreements represent the source of revenue for the project. Such agreements must be structured in a manner to provide that project company with sufficient revenue to pay its project debt obligations and all other costs of operating, maintaining, and owning the project.

Operations and maintenance agreements. The project company typically will enter into a long-term agreement for the day-to-day operations and maintenance of the project facilities with a company having the technical and financial expertise to operate the project in accordance with the cost and production specifications. The project company will enter into one or more feedstock supply agreements for the supply of raw materials, energy, or other resources over the life of the project. It's a way of securing costs or insuring costs are stable.

Loan and security agreements are standard in project financing. The borrower in a project financing deal typically is the special-purpose entity formed by the sponsors to own the project. The loan agreements will set forth the basic terms of the loans and will contain general provisions relating to maturity, interest rates, and fees. They're also typically provisions such as disbursement controls. These frequently take the form of prerequisites for each drawdown, requiring the borrower to report to present invoices, builder certificates, or other evidence as to the need for and use of the funds. The lender may require periodic reports certified by an independent consultant on the status of the construction progress. The borrower will covenant not to amend or waive any of its rights under the construction, feedstock, offtake, operations and maintenance, or any other principal agreements without the consent of the lender. There's also restrictions. These covenants place restrictions on the payment of dividends or other distributions by the borrower until the debt service obligations are satisfied. There could be completion covenants. These require the borrower to complete the project in accordance with plans and specs and prohibit the borrower from making material alterations without the lender's consent. Debt and guarantee restrictions that prohibit the borrower from incurring additional debt or from guaranteeing other obligations without approval from the lenders.

Lenders typically require other participants in the project to enter into subordination agreements, under which certain payments to other participants from the borrower under the project agreements are restricted, either absolutely or partially, and made subordinate to the payment of the debt service. So, in other words, think about a house. The bank wants the primary mortgage. If they have a clause, they'll give you the mortgage if they have the primary mortgage, right? They don't want to be secondary mortgages because once, if there's a default, the primary mortgage is largely covered. The secondary mortgages are at greater risk. So subordination clauses prevent creating, making a loan secondary; it has to be a primary. And the project loan typically will be secured by multiple forms of collateral, including mortgages on the project facilities and real property, assignment of operating revenues, a pledge of bank deposits, assignment of insurance proceeds, and other kinds of securities.

The fourth stage is the money-raising stage, which begins once all the project agreements are initiated and ends when the project has been commissioned. At this stage, the sponsor mobilizes the required financing and supervises the management, organization, construction, and successful commissioning of the facility or service until the financial goal is reached. The sponsor is responsible for all development costs associated with the project. Finance is the largest single cost of a project, and without financing, there is no project. On a large construction project, the materials may only be 30% of the total capital cost, the construction costs may be another 30%, and finally, design and project management, commissioning, working capital, and contingency about 10% each.

Projects that require financing tend to be complex in nature, and finance planning adds to this complexity. There are three things that need to be kept in mind when you're in the financial planning stage: First, the source of finance needs to be identified before the technical specs or equipment. To the structuring and acceptability of the financing package is different from the perspective of the lender and the borrower. Third, the availability of finance and the terms on which it's available can be subject to significant and rapid changes for reasons beyond anyone's control.

When you're discussing raising capital for a project finance project, it's important to discuss the various sources of finance. Equity is an important source of financing in a project finance project, and it's used for a variety of reasons, including it's the means to support and finance the planning study and feasibility analysis stage, up to the preparation of the business and financial plans to be submitted to lenders. So we start with equity costs. For the initial development, are recorded as project costs and so contribute to increasing the initial amount of investment for the venture. Equity also makes the project safer for lenders. The greater the equity, the higher the risk borne by the sponsors. Then this means less risk for lenders. An increase in equity improves the debt-to-equity coverage ratio required by lenders, although it has a negative impact on the sponsor's internal rate of return.

Next is mezzanine financing. This is a hybrid of debt and equity financing. It's typically used to finance the expansion of existing companies or existing operations. It's basically debt capital that gives the lender the ability to convert the debt into an ownership or equity interest in the company if the loan is not paid back in time. Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little to no collateral on the part of the borrower, this type of financing is very costly, with the lender usually seeking a return in the 20 to 30% range. I heard it what's referred to as borrowing from the mob.

Subordinated and senior debt is the third main source of funding. Subordinated debt is a loan that ranks below other loans with regards to claims on assets or earnings, like a second mortgage. We talked about creditors. With subordinated debt, wouldn't get paid out until the senior debt holders are paid in full. Senior debt is borrowed money that a company must repay first if it goes out of business. Companies have a number of options for obtaining financing, including bank loans and the issuance of bonds and stocks. Each type of financing has a different priority level in getting repaid if the company decides to liquidate. If a company does go under, the holders of each type of financing have different levels of rights to the company's assets. Senior debt is secured by collateral, and that collateral can be sold to repay the senior debt holders. As such, senior debt is considered lower risk and carries a relatively low interest rate. Even though senior debt holders are the first in line to be repaid, they will not necessarily receive the full amount they are owed in a worst-case scenario. So banks tend to want senior debt, whereas you look at hedge funds, they may look at mezzanine financing because the greater returns they'll take on some of that greater risk in exchange for the greater returns.

And last, we have the construction stage, which is usually the last phase of the project. The sponsor doesn't begin construction until all the financing is secured. So we talked about the stages that we go through in construction finance. Now let's talk about the benefits. What do you think the benefits are of project finance? What do you think the kinds of benefits we'll see are? Go ahead and type them in the question window. Go ahead and type them in the chat window.

Kim asked me to please repeat the definition of agent and account bank. Sure. So when one bank doesn't want to take on the risk to fund the whole project, it's just too big, too much money, they're gonna split the debt obligation among a number of banks. They'll get a consortium or a syndicate of banks together, and each will provide a portion of the debt funding. Those are all participating banks in a syndicate. The project doesn't want to have to deal with the consortium of 30 banks; that's just too many bankers to have to deal with one at a time. So what happens is one bank acts as the chairperson, the captain of the banking team, and the project just has to deal with that chairperson or that captain. That's called the agent. So the agent is the one essentially who takes care of the sponsor of the project and deals with their debt obligations and keeps all the various banks kind of coordinated in the background and the deal amongst themselves.

The account bank is one where, once the project is up and running, say we've built a new toll highway, the toll monies that go in are going into the account bank. One of the banks in the syndicate is determined to be the account bank. They're gonna keep all the revenues coming in, and they will handle the splits because maybe there's deals about the split of revenue, maybe a percentage goes to pay off the debt obligations, and the remainder goes to the sponsors. So that may be dealt with by the account bank. So the account bank is the one that actually holds the revenues as they come in when it's in operations and handles the split of the money, whereas the agent banks are the ones that are providing the loans. Good.

So Kim says, "Benefits including maintaining the sponsor's credit ratings." Yes, that's very true. A company may want to take on huge amounts of debt but doesn't want it to show up on its books and kill the company's financial ratios for stockholders or investors, or maybe they have covenants in place in other loans with banks for finance that say they can't take on additional debt. But running it through special-purpose entities, the debt technically is the obligation of the entity, not the sponsor. The sponsor just has an equity investment, so that debt doesn't show up on the sponsor's books. So that's a way of getting around some of those covenants.

Erin says, "It allows a firm to take on projects that they wouldn't be able to afford otherwise." Yes, absolutely, right? They don't have the financial resources, or sometimes they don't have just the reach, the marketing expertise, or the distribution relationships. But bringing partners in might be able to help. Great. Are there any other examples of benefits? Louise, you have your hand up. I'm gonna unmute your line. Go ahead, Louise. What other benefits do you think you have?

Louise, oh, she's muted herself. I guess your hand might have been raised by accident there. Okay, anybody else have a question or comment or a benefit of project financing that they can identify?

Okay, let me go through a list of ones that I've come up with. So here's some of the benefits I've come up with. It primarily benefits sectors or industries where projects are structured as separate entities, apart from their sponsors, such as special-purpose entities and joint ventures. And the primary benefits I can see are: it allows promoters to undertake projects without exhausting their ability to borrow for traditional projects. We talked about that one. It limits financial risks to the amount of equity actually invested. There may be non-recourse back to the sponsor. It enables raising more debt as lenders are sure that cash flows from the project will not be siphoned off for other corporate uses. Provide stronger incentives for careful project evaluation and risk assessment. Facilitates careful technical and economic reviews of projects. Eliminates the dependency on alternative project funding models. Project financing facilitates the arrangement of liability financing and credit improvement accessible to the project but which may be unavailable to the project sponsor. It enables the diversification of the project sponsor's investments to reduce political risk. It enables prolonged credit opportunities. It matches specific assets with specific liabilities. I mean, as you can see, there are quite a few advantages to using project finance techniques. However, this does not mean that there are no disadvantages.

One of the biggest ones is risk. Let's talk about risk and how it's managed on project finance. Project finance is focused on identifying characteristic risks, allocating them suitably, and guaranteeing that the responsible parties are adequately motivated to manage these risks with efficiency. So to make sure the right contingencies are in, we're managing them properly with varying amounts of participants, including sponsors, contractors, suppliers, host governments, and banks, it's not hard to imagine that a typical project finance deal can take years to come to fruition.

Here's a few of the more common risks associated with project financing. Deals can take longer to structure and execute than equivalent size corporate finance deals because of the complexity of pulling together various partners. Non-recourse project debt is more expensive due to a greater risk and higher leverage. There are higher transaction costs through the creation of independent entities and the complex contractual structures. And project finance requires a greater disclosure of proprietary information to lenders.

Let's talk specifically about some of these risks and how they're managed. Financial risks can be reduced through a number of means. One of them is futures contracts. This is where interest rates can be used to protect against foreign exchange rate changes. Options: call options give the buyer a maximum price, and put options give the buyer a minimum price at which the product can be sold. Sponsor companies can use these options to control input and output prices. The cost of this protection is equal to the option price. Another is called swaps. They are currency and interest rate and currency interest rate and commodity swaps. An interest rate swap can create a source of lower-cost debt or higher-yielding assets and provides access to an otherwise unavailable source of funds. A commodity swap can be used to manage the price risk of the outputs or inputs of a project.

Governments can play a critical role in project finance. Project financing is usually a long-term investment for which political motivation and long-term political support are needed. Project financing may also form part of the government policy for privatization or for the provision of public infrastructure through public-private partnerships, whose success or failure has significant and considerable political consequences. Very few projects have been structured and financed without any political support. Political support from a high level is often necessary to enable a project to be completed successfully. Support is not only needed at the beginning of a project but all the way through the construction phase until completion, and also sometimes during operations.

Political risk is one of the major issues that needs to be mitigated before providing any finance. Some ways to reduce political risk include private market insurance, political insurance, and assurances from relevant government bodies. And then we have joint ventures. A joint venture or a joint development company is when two or more parties join to develop a product, a project, or a series of projects. This could include different entities whose skills complement each other. Joint ventures can provide risk enhancements, thereby rendering the loan facility more attractive to the financial markets. When these joint ventures create a new company, sometimes they're called special-purpose entities or special-purpose vehicles. Have you ever worked for or have been involved with a joint venture company or special-purpose entity? Does anybody have an example they can share? Just click your raised hand icon and I can unmute your line, or type something into the chat window.

Question: Involved in a joint venture or special-purpose entity and that you would be willing to share a few words on? Okay, Kim has her hand up. Kim, I'm unmuting your line. Go ahead.

Thanks. So just for the group, Maverick Creek is a 100 and sorry, 492 megawatt wind farm in Texas that Libby's developing right now, and it is currently a joint venture with our development partner, which is RES Americas. So right now, it's a 50-50 joint venture with the intention later on in the project to come fully that we will buy out to the resolution at one point in time. I think it's closer to commercial operation date next year. Not very good.

Excellent example. Yeah, sometimes you partner with another company to help spread the risk during the construction phase. Sometimes it's a partner who has extra financial resources or who may have some regulatory control or some influence over the governance of the project. Right? So we may partner with a government to get a large project done, and at the end of the project, we'll buy out the government once the risk is gone. You know, that may be an option as well because the governments have deep pockets and can actually affect the success of the project. So if they have an equity role, they can bypass some typical bureaucracy that may impact our project, and then once we're through, we can buy out that portion. So that's a good example. Thank you.

So one of the things we talked about with this is also another way of managing is guarantees. The most popular, most common way used to mitigate risk is through the use of guarantees. Guarantees are a critical element of project finance because they enable promoters to move the financial risk of a project off the balance sheet to one or more third parties. Overall, they allow the shifting of certain financial risks to interested parties who do not want to take a direct financial commitment or to provide funds to the project. And there's several kinds of guarantees. As with traditional guarantees, limited guarantees represent unconditional commitments by the guarantor to perform all the agreed-upon obligations of the third party, but they're limited in the fact that they can also provide credit enhancement without considerable impact on the guarantor's credit standing. Unlimited guarantees are open-ended and are more uncommon, as they create unlimited liability for the guarantor. Indirect guarantees exist to ensure a steady stream of project revenues. Implied guarantees offer a way to assure the lender that the guarantor will provide necessary support to the project. Implied guarantees are not legally binding and do not require financial statement reporting. Sometimes these are called moral obligations. Contingent guarantees are contingent upon a particular event occurring. So if this happens, then you will step in and help us. Government assurances are extended by the government and are generally used on projects of national interest. And lastly, there's something called sovereign guarantees. The host government guarantees to the project that if certain events do or do not occur, the government will provide compensation to the project company.

So we've talked a little bit about project finance, what it is, what the stages are, how it works, what are some of the common mechanisms, what are, you know, how do we manage risks, what's the role of the PM in all this? PMs may be needed to run feasibility study projects. PMs are needed to help coordinate the preparation of project timelines and costs that feed into the feasibility study. And important project finance agreements, PMs will be working with both suppliers, sponsors, and possibly end users or customers and need to understand their roles and their overall relationship. Having an understanding of advanced risk management strategies, using derivatives such as interest rate and commodity swaps, plus looking at higher-level risks such as political risks, puts the PM at the table with the senior executives to help come up with strategies for success. I've used this in my career when I was working with IBM, and by taking these higher-level approaches, seen as being a leader rather than just a project manager, you're seen as a peer, as a partner in helping achieve business value, and that leads to rapid career progression. Project management decisions may impact the timing of cash flows, and a deeper understanding of the project finance model helps the PM make the best choices for the organization overall. So the project manager does have a role in project finance, certainly while we're trying to come up with the financial details and packages, getting involved in some of those estimates and plans and negotiations, but also once the project starts in steering the project to help maximize the value we're hoping to get out of this finance model.

We are currently sitting at five minutes to the top of the hour. I do have time for a few questions. If you have any questions, please click your raise hand icon and I'll unmute your line, or you can go ahead and type them in the questions window if you're shy, and I'll just answer them that way. By the way, while I'm waiting for you to type in questions or click your raised hand icons, participants in the session do earn Professional Development Units from PMI EP to use. And you can also count this towards your professional development in some of the professional engineering associations as part of their ongoing continuing professional development practices. Ontario Association of Architects and others will also, some of the other architectural societies of the various provinces will also count this towards your recertification or relicensing as well. If you have any questions about whether this is eligible for something, just contact me directly, and I'll get you the information you're looking for.

Okay, we have a question. The question is from Erin. She's a PMP and a PE. Okay, yes, you can double count this. You can count this towards both. Very good. So you'll get one full PDU out of this, and it comes on the strategic side. And the PMI talent.

Triangle. This count says not technical PDUs, but strategic PDUs. And I'll say the details after the event to the participants. If you're listening to this later, our recording on YouTube, you would count one strategic PDU for attending the session. Any other thoughts, comments, or questions? Please type them into the questions window or click your raised hand icon, and I'll unmute your line. Last chance. We're at three minutes to the hour. I have time for one more question if somebody wants to fit one in. Chris said, "Wonderful lesson, thank you." Now, there is a question here. It says, "Is there a rule of thumb for financing a minimum that any group may actually want to approach?"

Great question. You know, I've been involved in several project finance deals of significant size. I mean, where you're talking many, many millions of dollars, tens of millions. One was over a hundred million dollars. And in these particular, and I've been evolving some smaller ones as well, but I've never seen two that are anywhere close to being alike. Every one is particularly unique. Companies are trying to figure out how to minimize risk, you know, minimize their investment to maximize their return. Companies don't want to give up too much control, so they don't want to give up equity. So they're looking at debt.

But the debt providers may have different concerns. Like, for example, this, this whole concept of interest rate swaps. You know, say you're borrowing money at, at a fixed interest rate, so you're borrowing money at 6% from the bank. But you know, your client is paying you back, and you're, you know, is paying you back for using the facility, and they're, you know, they're not paying you back immediately. They have payment terms. And say that payment terms are overdue payments have to come in at, you know, at, at prime plus, you know, two percent or something like that. Well, if prime is, you know, four percent, it's still 6%. Your client is paying you 6% interest. If they're late, you have to pay that, your, your, your lender 6%. So for you, it's, it's a wash, right? You're not really threatened.

But if you notice one of those interest rates is fixed and one is variable, and what happens is when you're getting paid in variable, it's straight that Nell has said now you're taking on risk because what if prime goes down? What if it goes down from 4% to 2%? Now you're only getting 4% from your, your customer who's late and paying, but you're paying the bank 6%. You're getting caught now in a cash flow crunch. So in those cases, we might do something called an interest rate swap where you find somebody else who's, who wants a stable interest rate or wants a variable interest rate because they are looking for maybe for some potential upside or downside, you know, or I guess the potential upside if interest rates go up or down. Now, they're, they're willing to take a little bit of risk, they're willing to gamble, they want that variability. And you can swap your loan with theirs, your interest rate with theirs to get some stability so that you know for sure your Sabae earning it, and even 6% coming in.

So we can do interest rate swaps and other kinds of derivative products to, to manage some of those cash flow risks. But it all depends on the risk appetite of the various partners and the way the specific loans are structured and the terms of the loans and the deals. So I really don't think that there is any rule of thumb here. Every single one that I've ever seen is completely unique. Even looking at some of the large project finance deals, structured financing, sometimes they call them through companies like Enron that have done interesting things to move this part of the industry forward. Now, Enron got involved in some fraud and some shady dealings, so and they eventually imploded. I'm not commenting on that part of it, but their financial engineering of how they put these deals together was incredibly complex and sophisticated, and I think they moved the bar forward in how people can creatively structure deals to get what they need without having to expose themselves to to excess risk or complexity. I'm very, I'm very impressed with some of the stuff that I learned from studying how they finance very, very complex arrangements. Now, as I said, some of them, you know, crossed a line and, and some of them may have even been illegal. But the, there were many that were done well and done properly that other companies have learned from and, and the state of the art is improved as a result.

Any other thoughts, comments, questions? Okay, I'm gonna wrap up this call. It's the top of the hour. We've been at this for our one hour time period. Thank you very much for this time together. This webinar has been recorded, and within a few days, it will be up on YouTube. If you want to look for it, it'll have the exact same title as it did when you signed up, so you can take a look at it if you're interested if you want to rewind and, and review a particular point. Thank you very much, everybody. Have a good day. [Music]