Banking on project finance

Mark Bull from Illumine Middle East FZE argues that project finance sidesteps the snares posed by the use of sovereign or governmental funds.

In late November 2009, the Dubai government announced it would not, despite common belief, underwrite State-controlled holding companies. Thus Dubai World, having declared corporate debt of US$59 billion, stood firmly on its lone two feet, fully exposed to a string of creditors queued up at its door. The upshot was to be expected: mass international criticism and, worst of all, mass panic on the part of investors.

Dubai is not alone. Each and every world economy, notwithstanding its home policy and financial practices, has to a greater or lesser extent been paralysed by the global financial turmoil rooted firmly in the collapse of Lehman Brothers of the US.

The simple reality is this: the scope of modern economic development goals translate into project requirements that are by and large far in excess of any single hegemony’s financing mechanisms.

Extensive and often very complicated domestic commercial debt market vehicles encouraging the pooling of project credit risk transnationally through infrastructure banks and private corporate financers provide a means to an end, altogether safeguarding governmental agencies from the requirements of financial accountability.

What is needed is the upheaval of domestic practices and the positive promotion of mutually beneficial international project financing arrangements such as Public-Private Partnerships (PPPs).

The concept of project finance is celebrated for stepping away from the use of sovereign or governmental funds.

The debt terms are not based on sponsor’s credit support or on the value of the physical assets of any one party. Instead both the technical and economic project performance of any one venture is the nucleus. The measure is the asset of the facility, including the revenue-producing potential of any contracts or any other cash flow revenue generated by the facility. In the UAE, this tool is still in its infancy. Comprehensive legal reform facilitating such a financial vehicle, together with specialist contractual legal expertise, will determine the speed of project implementation and indeed the pace of market recovery.

Alternative project financing will not eliminate age-old construction risks. Development risks (including the failure to obtain permits or governmental approvals, public opposition, weaknesses to the business framework of the deal), design engineering and construction risks (including changes to the scope of work necessitated by technical design requirements, price changes caused by currency fluctuation or inflation, construction delays, material shortages, regulatory changes and other fluctuating market conditions), start-up risks and general operating risks will, as always, still persist.

Tight drafting of commercial arrangements can overcome deal breaking impediments and ensure the allocation of risk to the project participant most suited to shoulder it. What international project finance will do is afford Dubai a viable alternative to current custom practices banking on over-waged sovereign funds. Legislative reform provides a route map. To secure a safe journey, contractors will need to stop signing up to ad hoc top-down heavy commercial conditions of contract, and place greater weight on (i) project finance credit arrangements, (ii) project finance debt commitment letters and collaterals, (iii) the detail of the contracting arrangement, (iv) contractual risk allocation between the project participants, and (v) commercial insurance and reinsurance. Similarly, investors will need to take advice on international law – in particular:

• The integrity of domestic laws governing debtor-creditor relations, the creation and perfection of security interests, the granting and registration of mortgages, creditor rights, bankruptcy laws and its enforcement;
• Laws that regulate international transactions or disputes which apply to conduct within the UAE and extraterritorially;
• Cross-border risks, conflicts of law. Laws of foreign countries and public international law; and
• Dispute-resolution mechanisms. Procedures of various arbitration organisations such as the International Chamber of Commerce that may be nominated in priority.

In conclusion, international project financing paves the way to a brighter future in a time of fierce commercial instability.