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Non-traditional forms of project finance are gaining traction in the GCC

Stakeholders in the GCC construction sector are looking into non-traditional sources of project financing to bridge funding gaps caused by liquidity constraints and increasingly stringent banking regulations, Fatima de la Cerna reports

Companies in the region are becoming creative in their efforts to secure project funding, states Mathew.
Companies in the region are becoming creative in their efforts to secure project funding, states Mathew.

In Q1 2019, banks around the world will implement Basel III, an international reform framework developed by the Basel Committee on Banking Supervision that is aimed at boosting the regulation and risk management of the banking sector.

Speaking to Construction Week in March this year, Karim Nassif, associate director of infrastructure finance at S&P Global Ratings, noted that Basel III will make it harder for banks to offer long-term project financing support, likely placing further pressure on the region’s construction industry.

He elaborated: “The construction sector is feeling the strain in terms of its operational ability to deliver the GCC’s vast infrastructure pipeline. According to S&P Global Ratings’ estimates, the GCC has a funding gap of roughly $270bn. If the region is going to deliver this infrastructure pipeline in spite of the funding gap, stakeholders are going to need to secure project finance [from other areas].” 

Like Nassif, Shimmy Mathew recognises the need to pursue non-traditional forms of financing. But rather than propose it as a possible course of action for the industry, he says that it’s a practice that is already being adopted in the Middle East. 

The chief financial officer of KBW Investments tells Construction Week that in the past couple of years, a dearth of liquidity in local and international banking systems has been the biggest challenge facing the construction sector. 

“Regionally, this has been a direct result of the price of oil, which is still the primary driver for economic growth in many countries across the Middle East,” he explains. “A slowdown in government spending means that bank deposits drop and lending tends to dry up, as lenders think more selectively about granting loans. Meanwhile, the cost of lending rises at the same time. 

“This has been compounded by new international regulatory standards, such as Basel III, which have made some banks more reluctant to allocate long-term loans.”

 In an effort to weather this challenging financing climate, construction companies are reportedly becoming creative in their efforts to obtain funding for their projects. 

“Against this backdrop, construction industry stakeholders have generally had to become a little more creative when it comes to securing financing,” explains Mathew. “As well as more traditional forms of financing, companies are now looking at a variety of options, including private equity players, specialist infrastructure funds, and capital markets – through bonds and/or sukuk – to make up the shortfall.”

He clarifies, however, that the extent of the impact of low liquidity differs from country to country. “This has affected the banking sectors of some countries more than others; in the UAE, the Central Bank’s Credit Sentiment Survey for the second quarter of this year suggested that demand for credit appeared to have stabilised following a recovery registered in the previous quarter.”

While other parts of the region are struggling with liquidity, the UAE has seen an increase in budget allocation for infrastructure development, reveals Mathew. 

“The project finance climate in the region currently varies significantly, both by geography and by sector,” he says. “In the UAE, the government is […] continuing to spend on infrastructure, thus helping to drive project finance deals. The Dubai government’s budget for 2017 actually increased by 12% on last year’s, with a total of $4.5bn (AED16.6bn) set aside for infrastructure, transport, and economics.

“That is a rise of $490m (AED1.8bn) [compared to] the year before, and shows that the government here will continue to invest despite the low oil price, which is a great confidence booster for the market here. In addition, the advent of [Expo 2020] means that projects will continue to be awarded and that public spending will continue.”

Sharjah is reportedly also showing resilience and growth, despite challenging regional conditions.

“In Sharjah, where Arada – a developer formed by a joint venture between KBW Investments and the Sharjah-based Basma Group – is active, a similar story is taking place,” Mathew continues, adding: “For 2017, the Sharjah government announced the largest budget in its history, with infrastructure spending increasing by 7% on the year before. 

“This approach gives all stakeholders in the local construction industry, whether developers, contractors, banks, or other finance outfits, confidence in the market.”

Demonstrating this confidence, Arada recently unveiled Aljada, a master-planned development that boasts a gross real estate value of $6.5bn (AED24bn). It is the developer’s follow-up venture to its $408m (AED1.5bn) Nasma Residences project, also under construction in Sharjah.

While identifying potential funding sources may be the biggest challenge for regional players in the construction industry, it is far from being the only hurdle that they have to overcome, says Paula Boast.

Boast, head of construction, engineering, and projects in the Middle East at the London-based law firm, Charles Russell Speechlys (CRS), notes that banks, financiers, and lenders have grown more cautious as a result of the global recession, resulting in “increased requirements for diligence, heightened credit data and checking procedures, more negotiation, and a focus on cautious structuring around projects”.

She says: “Most of that stems from a ‘lessons learned’ approach, which cannot be faulted. But it is essentially now the new normal when it comes to project finance.”

Boast adds that companies need to comply with the increasingly stringent requirements being set by financial institutions; otherwise, they will have difficulty getting funding for their projects “on preferred terms”.

“Many [companies] are now compelled, as part of their overall procurement plans, to reach out to a significantly higher number of potential financiers than they did previously,” she explains.  

To improve their chances of securing financing, Boast recommends that companies see to it that they have sufficient information with them when approaching banks and other financial establishments.

“Financiers expect to see project and risk planning and analysis, [as well as] feasibility studies,” says Boast. “They want corporate ownership and credit information. They want the backdrop to stalled or postponed projects. They want documentation that satisfies their own internal and legal requirements for due diligence, anti-money laundering, and regulatory compliance purposes – all as an absolute minimum. They want to know exactly who or what they are doing business with.”

Boast also warns against poor project structuring, revealing that it’s the most common issue CRS encounters when dealing with disputes.

“Projects that were, for example, stalled or on hold, suddenly coming back on line with funding secured quickly or unexpectedly, with little thought to project incomes or projections, or trajectory further down the line.

“[It’s a practice] more geared towards getting [funding] than re-procuring or re-master planning projects for current market requirements.”

Talking about what companies can do to increase their chances of getting their projects financed, Umer Ahmad, vice president for investment development at SNC-Lavalin Capital, suggests hiring advisors.

He discloses that there have been many cases where projects being submitted for financing deals “are not appropriately structured for non-recourse project financing”, elaborating: “Typical issues in that regard include no appropriate off-take or off-taker, [as well as] seeking to push as many risks as possible over to the developer or project company, [when] the optimum solution would be to involve placing [the] risks with the parties best [suited] to manage such risks, thereby creating a ‘best value for money’ situation.”

This type of situation, he explains, can lead to projects that can be effectively – and privately – financed. 

“In many cases, if procurers were to hire appropriate financial, legal, and technical advisors at the outset, these issues could be addressed. This requires a bit of a medium-term perspective, taking into account that money spent on the right advisors ought to give rise to better value by getting projects successfully financed or executed.”

Ahmad continues: “Furthermore, some engineering and construction companies do not have access to their own equity finance capability, nor the ability to structure a financing deal and the ability to facilitate or mobilise other investors and debt capital, be it banks or export credit agencies.” 

He makes it a point, however, to underscore that yes, there has been a considerable tightening in liquidity, echoing Mathew and Boast’s observations about the state of project finance in the region.

“On the face of it, project finance debt appears to be readily accessible, but banks are, in fact, increasingly reluctant to lend for longer periods and are looking for much shorter repayment schedules, making financing that much more difficult,” he says.

“Another key issue, [but] far less obvious, is that banks are increasingly only making balance sheets available for their relationship clients,” he adds, concluding: “SNC-Lavalin is very fortunate as we are well-placed in these respects, with our Capital division providing a strong platform for financing activities.” 


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