Local lenders bolster project finance deals

Governments across the region are looking to the private sector to partner in the development of infrastructure projects.

The demand for road and rail infrastructure in the region is placing pressure on governments to find alternative sources of funding. Recent shifts in
The demand for road and rail infrastructure in the region is placing pressure on governments to find alternative sources of funding. Recent shifts in

As the Middle East continues to grow in every conceivable way, there is a steady but subtle shift towards project finance infrastructure projects, together with the more traditional petrochemical, power and water developments. Last year, the Middle East raised US $70 billion in project finance, almost double that of the previous year, according to Arabian Banking and Finance magazine. This is a clear indicator that change is afoot within the region, with a greater emphasis on local lending.

"With the power, water and petrochemicals sectors all remaining strong and a lot of countries in the region looking to further develop their infrastructure, which in turn will lead to a greater demand for utilities, metals and plastics, the Middle East is currently one of the most buoyant markets for project finance in its various guises and it is to the clients' advantage - in terms of lower costs, increased responsiveness and convenience factor - that there are now professionals capable of providing advice on such transactions rather than having such work being done in the UK or the US," says Martin Preston, senior associate, Norton Rose.

According to Preston, such demand has led to a change in lending patterns in the region, with an increasing local emphasis. "Lenders tend to be a mixture; up until a few years ago you'd find that most of the lending came out of London, with a small local tranche, whereas now on some of the deals we are seeing a much more local element," he says.

 

Preston adds that some clients prefer a joint team made up of some lawyers based in London and others based in the Middle East. The advantage of such an arrangement being the client has the full benefit of project finance expertise in London - where specific industry knowledge may be more developed, such as rail transport, for example - while having access to lawyers on the ground with knowledge in the relevant jurisdiction.

But has this approach been popular? "It seems to be successful to date; we've had a couple of large petrochemical projects that have closed with locally based lenders," says Preston. Furthermore, it is his belief that the anticipated growth in infrastructure projects will open up the infrastructure market to contractors other than the large EPC contractors, who on the whole are the only ones who can carry out such sizeable projects. "Although it may not appeal to all because of the risks, the banks expect construction contractors to take in project finance deals, some may decide to take an equity stake in the project company to benefit from any upside generated by the project," he says.

While still early days, Preston expects the PFI model, favoured by the UK government since the 1990s for building schools, roads, hospitals and prisons, to be employed to an increasing extent within Dubai and the wider region. "We are seeing a few infrastructure funds with a lot of capital to invest, so going forward in terms of construction there will be those funds investing, with BOT [build-operate-transfer] and PFI/PPP projects on the infrastructure side.

"We do expect more infrastructure projects following the UK PFI model to be developed throughout the region. This model has been used to procure projects as diverse as schools, leisure centres and airports, and as countries in the region look to attract tourism and provide new infrastructure to do so, we expect this to be a growth area over the next few years," says Preston.

The emphasis on BOT, seen more as a regional standard rather than specific to Dubai, is due to it being a good mechanism to acquire the necessary funds. For example, Jordan, which doesn't have an abundance of oil reserves and is therefore not as rich as some other Gulf states, may not have the finances in place to get the infrastructure, so it awards the concession to a developer who is able to get a loan to build and then recover its money from direct payments from the government - over 25 years - or by charging the public.

Preston is not concerned that a lack of exposure to such financial practice will hinder the growth of project finance in oil-rich states, due to the fact that many of the contractors in the region are divisions of, or have links to, the big contractors in the UK and Australia. And these firms can draw on their previous experience of such project finance transactions.

Further evidence of the financial growth in the region can be seen through Dubai International Financial Centre's new workshop series for financial professionals. These quarterly workshops, combined with seminars and conferences are aimed at providing a platform for senior economists, financial analysts and market specialists to discuss economic and financial developments, challenges and themes related to the region's economies.

Each workshop will present economic and financial data from forecasts supplied by participants and will discuss market developments as well as the effects of economic, monetary, regulatory and financial policies on the regional economies.

Chief economist at DIFC, Dr Nasser Al Saidi, explains that there is a "crucial need for exchange and analysis of economic and financial information", which can broaden public awareness of the relative opportunities and issues within the region.

Also growing across the region is the concept of Islamic finance, which requires investors to spend and generate returns in a manner that falls within the parameters of Islamic legal and regulatory thinking. According to Preston, typical project finance opportunities, particularly in the context of infrastructure opportunities, provide a ‘good fit' because the positive broader social implications of most of these developments sit well with Islamic notions of investment.

In terms of the manner in which investors spend, there are a number of Sharia compliant products that are used to providing investors with the opportunity to do so without having to resort to conventional lending structures and the earning of interest based returns (which are prohibited). These products have been used successfully in the multi-sourced context - for instance the Bapco financing for the upgrading of the oil refinery at Sitra in Bahrain and QatarGas.

Consequently, Preston says that Sharia compliant project funding is only going to increase in the future. "The fact that the Islamic market has witnessed double-digit growth - coupled with the continuing development of more sophisticated products with the requisite flexibility when it comes to factors such as tenors, making them more competitive with conventional means of financing - has meant that their use in projects in the Middle East has increased dramatically. It is not unusual these days to see at the very least an Islamic tranche being considered for most projects that are developed," he says.

 

“With the power, water and petrochemicals sectors all remaining strong and a lot of countries in the region looking to further develop their infrastructure ...

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