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Project Finance   Session 02
 

Project Finance Session 02

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Slides from Session 2 of the Project Finance Class that I\'m currently teaching at ESADE.

Slides from Session 2 of the Project Finance Class that I\'m currently teaching at ESADE.

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    Project Finance   Session 02 Project Finance Session 02 Presentation Transcript

    • Project Finance
      Session 2 – Project Risk Management
    • Agenda
      Revision – Session 1
      Project Risk Management
      Risk Management Processes
      Identifying Project Risks
      Risk Allocation with Contracts
      Role of Advisors
      Legal
      Independent Engineer
      Insurance
      2009
      Project Finance - Session 2
      2
    • Revision – Session 1
      Characteristics of Project Finance
      Debtor is a Project Company (SPV)
      Legally Independent from Sponsors
      Investing in a Capital Asset
      Lenders have limited recourse to Sponsors Assets
      Risk (more) Equitably Allocated
      Finance Granted on the basis of future cash flows
      2009
      Project Finance - Session 2
      3
    • Revision – Session 1
      Current Trends in Project Finance
      Overall Project Finance market down 61% (3rd Qtr)
      Shift in Market Dynamics
      Developing Countries
      Banks
      Types of Projects
      The Future of Global Infrastructure
      $ Billions to Maintain current living standards
      Power, Roads
      2009
      Project Finance - Session 2
      4
    • Session 2 – Risk Management
    • Project Risk Management
      From a Project Finance perspective …
      Proper Risk Management helps to ensure consistent cash flows throughout the life of the Project, thereby reducing likelihood of default on debt servicing requirements.
      From a Project Management perspective …
      Risk Management helps to ensure that the probability & impact of Positive events are increased (negative events are decreased), thereby optimizing profitability of the venture.
      2009
      Project Finance - Session 2
      6
    • Risk Management Standards
      Globally Recognised Standards include:
      AS4360: Risk Management
      COSO ERM Framework
      IRM: Risk Management Standard
      OGC: Management of Risk
      PMI: Risk Management Standard
      All documents have a similar methodology for the identification, analysis & treatment of Risks
      2009
      Project Finance - Session 2
      7
    • Risk Management Processes
      2009
      Project Finance - Session 2
      8
    • Identifying Project Risks
      Pre-completion Phase
      Activity Planning
      Technology
      Construction
      Post-Completion Phase
      Supply Risk
      Operational Risk
      Market Risk
      2009
      Project Finance - Session 2
      9
      • Risk Breakdown Structure (RBS)
      Common Risks
      Interest Rate Risk
      Exchange Risk
      Inflation Risk
      Environmental Risk
      Regulatory Risk
      Legal Risk
      Credit / Counterparty Risk
    • Indentifying Project Risks
      2009
      Project Finance - Session 2
      10
    • Risk Measurement & Analysis
      2009
      Project Finance - Session 2
      11
      Forecast: Journey time to work
      180
      160
      100
      140
      80
      120
      Cumulative (%)
      100
      Frequency%
      60
      80
      40
      60
      40
      20
      20
      0
      0
      47 minutes
      25
      40
      60
      Time (min)
    • Risk Allocation with Contracts
      The Project Company normally allocates risk through the config. of prelim. contracts before soliciting funds.
      However, Bank Analysis may reveal further risks, in which case:
      Financing is postponed
      Additional covenants are included in the loan agreements
      2009
      Project Finance - Session 2
      12
    • Construction Risk
      The price paid to the contractor is usually the largest capital expenditure incurred by the project company.
      The contract is also the most likely source of significant cost overruns.
      Turnkey / EPC Contract
      Is usually fixed price, the contractor taking the risk of any fluctuations in the cost of labour or materials
      FIDIC / NEC / Bespoke
      2009
      Project Finance - Session 2
      13
    • Turnkey / EPC Contract
      Features:
      (Fixed) Price
      Completion Date
      Handover, Testing & Commissioning (FAC)
      Plant Performance (Minimum Standards)
      Liquidate / Make Good
      Guarantees & Warranties
      Damages (Liquidated)
      Force Majeure
      2009
      Project Finance - Session 2
      14
    • Supply Risk
      Put-or-Pay Agreements
      Supplier Sells @ Pre-agreed Prices
      If supply is lacking, the Risk lies with the Supplier i.e.
      Compensates the Project Company
      2009
      Project Finance - Session 2
      15
      Input Supplier
      Project Company
      Indexed Payments
      The Input supplier bears the price risk on finding an alternative supplier – either directly or indirectly
      Supply of raw materials from Alternative Source
      Alternative Supplier
    • Operational Risks
      O&M Agreements
      Fixed Price Contract: The Operator assumes risks relating to the fluctuations in operating costs
      Pass-Through Contract: The Operator receives a fixed payment and performance bonuses
      *Step-In Right: Lenders may request the right to remove the original operator and substitute with another.
      2009
      Project Finance - Session 2
      16
    • Market Risk
      Offtake Agreements:
      Long-term contracts where the Offtaker agrees to purchase nominated volumes/quantities of a good or services from the Project Company
      Take-or-Pay: the offtaker is obligated to pay even if it does not actually take the good or service i.e. PPA
      Shadow Toll System: payment is made by the Public Admin. on the basis of the volume of traffic & service level. Shadow refers to the fact that the end user does not actually pay the toll.
      2009
      Project Finance - Session 2
      17
    • The Role of Advisors
      2009
      Project Finance - Session 2
      18
    • The Role of Advisors
      “Each project finance deal has a critical minimum-size threshold below which structuring costs become excessive in relation to its forecasted income and cash flows.”
      Although efficiency is questionable, the role of advisors is essential to the closure of Project Finance Deals
      Legal Advisors
      Independent Engineers
      Insurance Advisors
      2009
      Project Finance - Session 2
      19
    • Legal Advisors
      Usually the first “Advisors” to be appointed by both Sponsors & Lenders
      Address specifics of International Legal Systems i.e. Civil Vs Common
      Activities involved in, include:
      Incorporation of the Project Company (SL)
      Due Diligence (AL)
      Legal Opinions (AL)
      Project Contracts (SL)
      2009
      Project Finance - Session 2
      20
    • Independent Engineer
      Oversees & monitors the Project on behalf of the lending banks
      There may be a number of “Independent Engineers” dependent upon the technical nature of the project.
      Activities involved in, include:
      Due Diligence Reporting
      Certification / Issuing of Progress Reports
      Oversight of Testing & Commissioning
      Monitoring of Operations
      2009
      Project Finance - Session 2
      21
    • Insurance (General)
      Insurance is an important risk mitigation tool that must be properly coordinated and linked to the project’s contractual structure.
      Insurance should be used when the Project Company’s cost of risk mitigation using insurance policies is less than the premium for risk expressed in the interbank interest rates requested by banks if no coverage exists.
      2009
      Project Finance - Session 2
      22
    • Insurance Advisors
      The scope of work for an insurance advisor includes:
      Preliminary Insurance Report
      Identifying analysis of contractual documentation & recommendations for risk coverage
      Final Insurance Report (Construction)
      Issued at the time of Financial Close – typically constitutes a condition precedent for disbursement (drawdown).
      Conformity of Insurance Program
      Finance Insurance Report (Operations)
      Issued before start-up of Operations
      2009
      Project Finance - Session 2
      23
    • Typical PF Insurance Products
      The most common forms of coverage used are:
      Construction / Contractors – All-Risks
      Transport Policy
      Material & Damage – All Risks
      Force Majeure
      Key Man Insurance
      2009
      Project Finance - Session 2
      24
    • Summary
      Project Risk Management is an extremely important tool in the identification, analysis and mitigation of Project Risks.
      Advisors (Legal, Engineering & Insurance) play a crucial role in the mitigation of risks through:
      Specialized Expertise
      Due Diligence
      Structure / Viability of the Project
      Monitoring
      2009
      Project Finance - Session 2
      25