Introduction to project finance

There is no one single universally accepted definition of “project finance”. Generally, the term “project finance” refers to the debt element of the funding for a project.

This guidance note provides examples of definitions of “project finance”, outlines specific advantages of project finance, considers what a typical project finance transaction involves, and lists the common uses of project finance.

See Introduction to project finance.

Common features of project finance transactions

The guidance note provides a list of five common features of project finance transactions. It is useful to remember that, due to (for example) the international character of the project finance industry, not every project finance transaction will have every feature, and some may have characteristics not noted in this preliminary list.

The five common features are:

• • the establishment of an independent entity;
• • having a considerable number of participants;
• • having a significant level of debt and a high expected return;
• • non-recourse or limited recourse financing; and
• • allocated risk.

See Common features of project finance transactions.

Regulatory framework that governs project finance in Australia

This guidance note considers the regulatory framework that governs project finance in Australia.

Relevant regulators that legal practitioners need to be aware of when working on project finance transactions include the Australian Prudential Regulation Authority (APRA), the Australian Securities & Investments Commission (ASIC), the Australian Competition and Consumer Commission (ACCC) and the Australian Securities Exchange (ASX).

It is also important to be aware of the role of the Foreign Investment Review Board (FIRB), as its approval is required for a wide range of transactions.

A project finance transaction is typically governed by the laws of the relevant Australian state or territory in which the project or the borrower is situated. Federal laws are also relevant. Important ones include Native Title Act 1993 (Cth), Environment Protection and Biodiversity Conservation Act 1999 (Cth), Foreign Acquisitions and Takeovers Act 1975 (Cth), Corporations Act 2001 (Cth), Personal Property Securities Act 2009 (Cth), and Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth).

This guidance note also explains the relevance of the work of the Asia Pacific Loan Market Association (APLMA). Legal practitioners may find APLMA’s documents a useful resource when completing a project finance transaction.

See Regulatory framework that governs project finance in Australia.

Recourse in project finance

Project financings are typically structured on a non-recourse (or limited recourse) basis, meaning that the lenders lend not to the sponsors of the project (typically, highly experienced market participants) but rather to a project company, being a special purpose vehicle established solely for the purpose of the project with no assets other than the project assets. As such, it is not uncommon that project finance is also referred to as “non-recourse finance” (or “limited recourse finance”).

This guidance note explains the concept of recourse in a project finance setting, including the relevance of “creditworthiness” and “bankability”.

See Recourse in project finance.

Structuring a project finance

This guidance note:

• • considers what is meant by “structure” in the context of a project finance transaction; and
• • identifies key issues that inform the approach to structuring a project finance transaction.

This guidance note includes a step-by-step guide in building up a project’s risk matrix, and explains the basic structure of a project finance transaction. Armed with this knowledge, legal practitioners can then successfully implement solutions in order to overcome certain identified risks and challenges.

See Structuring a project finance.

Types of projects

Project finance is a flexible financing technique. It can be used to finance almost any asset as long as the asset has a predictable revenue stream. This is because in a typical project finance transaction, the lenders rely heavily on the revenues generated by the project for repayment of the loan.

This guidance note explains some of the more common uses of project financing, with a brief description of a few notable issues involved in each type of project. The common uses include transport projects, power projects, oil and gas projects, water projects, and mining projects. International and Australian examples are used to aid understanding.

See Types of projects.

Understanding PPP and joint venture

A typical PPP (which stands for “Public Private Partnerships”) is a service contract between the public and private sectors, where the Australian Government pays the private sector to deliver services such as those relating to infrastructure.

PPPs are crucial — the public sector has a service requirement and the private sector can provide service delivery. In Australia, PPPs are vital to the development of infrastructure, as they allow governments and the private sector to work together and share resources on key projects.

This guidance note considers PPP’s legislative framework.

There are numerous forms of PPP creating a family of procurement methods. Joint venture is a newer form of PPP, and this guidance note overviews the use of an incorporated joint venture in a project finance transaction.

See Understanding PPP and joint venture.

Identifying and analysing project risks and risk allocation

Risk is a common (and defining) feature of many project finance transactions.

To decide whether or not to lend to a project, project finance lenders must identify and analyse every risk associated with the project. They will want to see that risks are:

• • shared across the project participants (and not left with the borrower); and
• • mitigated as far as possible, for example, with additional credit support or insurance.

If the risks involved in a project cannot be sufficiently minimised to the satisfaction of the lenders, this will often be reflected in the margin for the loan. In some cases, the risks associated with a project will mean that the lenders decide that they cannot lend at all. It is very important that the sponsor gets its risk strategy right.

This two-part guidance note identifies the major areas of risk that are common to many projects, and explains some of the ways in which they are usually tackled. The major areas of risk include:

• • sponsor risk;
• • construction risk;
• • permitting risk;
• • operating risk;
• • supply or resource risk;
• • off-take risk;
• • legal and political risk;
• • environmental and social risk
• • currency risk; and
• • interest rate risk.

See Identifying and analysing project risks and risk allocation part 1.

See Identifying and analysing project risks and risk allocation part 2.

The meaning of completion in project finance

Using construction financings as an example, this guidance note explains how projects involving the development of a new asset or facility are generally split into two phases, being construction and operation.

In a project finance transaction, completion marks the end of the construction phase and the start of the operating phase. This guidance note explains how completion is defined and tested.

See The meaning of completion in project finance.

The effect of completion in project finance

Following on from the guidance note “The meaning of completion in project finance”, this guidance note explains how completion typically changes a number of aspects of the finance terms for a project, for example:

• • the availability period for the project loan ends and no further drawings are permitted;
• • the margin on the project loan is reduced (known as a “margin step-down”) to reflect the reduction in completion risk; and
• • the project company gets more freedom to use its proceeds account.

Having explained what effect completion has on a project, this guidance note then outlines the key consequence of failing to reach completion of a project on time. These include trigger an event of default under the finance documents, and liability relating to liquidated damages.

See The effect of completion in project finance.