This document discusses project risk management and the role of advisors in project finance. It covers identifying and allocating project risks, common risk management processes, and the functions of legal, independent engineering, and insurance advisors. Proper risk management is important for ensuring consistent cash flows to reduce the likelihood of default, while advisors play a crucial role in risk mitigation through due diligence, project structuring, and monitoring.

1. Project FinanceSession 2 – Project Risk Management

2. AgendaRevision – Session 1Project Risk ManagementRisk Management ProcessesIdentifying Project RisksRisk Allocation with ContractsRole of AdvisorsLegalIndependent EngineerInsurance2009Project Finance - Session 22

3. Revision – Session 1Characteristics of Project FinanceDebtor is a Project Company (SPV)Legally Independent from SponsorsInvesting in a Capital AssetLenders have limited recourse to Sponsors AssetsRisk (more) Equitably Allocated Finance Granted on the basis of future cash flows2009Project Finance - Session 23

4. Revision – Session 1Current Trends in Project FinanceOverall Project Finance market down 61% (3rd Qtr)Shift in Market DynamicsDeveloping CountriesBanks Types of ProjectsThe Future of Global Infrastructure$ Billions to Maintain current living standardsPower, Roads2009Project Finance - Session 24

5. Session 2 – Risk Management

6. Project Risk ManagementFrom 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.2009Project Finance - Session 26

7. Risk Management StandardsGlobally Recognised Standards include:AS4360: Risk ManagementCOSO ERM Framework IRM: Risk Management StandardOGC: Management of Risk PMI: Risk Management StandardAll documents have a similar methodology for the identification, analysis & treatment of Risks2009Project Finance - Session 27

8. Risk Management Processes2009Project Finance - Session 28

9. Identifying Project RisksPre-completion PhaseActivity PlanningTechnology ConstructionPost-Completion PhaseSupply RiskOperational Risk Market Risk 2009Project Finance - Session 29Risk Breakdown Structure (RBS)Common RisksInterest Rate Risk Exchange Risk Inflation RiskEnvironmental RiskRegulatory Risk Legal RiskCredit / Counterparty Risk

10. Indentifying Project Risks2009Project Finance - Session 210

11. Risk Measurement & Analysis2009Project Finance - Session 211Forecast: Journey time to work18016010014080120Cumulative (%)100Frequency%608040604020200047 minutes254060Time (min)

12. Risk Allocation with ContractsThe 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 postponedAdditional covenants are included in the loan agreements2009Project Finance - Session 212

13. 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 ContractIs usually fixed price, the contractor taking the risk of any fluctuations in the cost of labour or materialsFIDIC / NEC / Bespoke 2009Project Finance - Session 213

14. Turnkey / EPC ContractFeatures:(Fixed) PriceCompletion Date Handover, Testing & Commissioning (FAC) Plant Performance (Minimum Standards)Liquidate / Make Good Guarantees & WarrantiesDamages (Liquidated) Force Majeure 2009Project Finance - Session 214

15. Supply RiskPut-or-Pay AgreementsSupplier Sells @ Pre-agreed Prices If supply is lacking, the Risk lies with the Supplier i.e.Compensates the Project Company 2009Project Finance - Session 215Input SupplierProject CompanyIndexed PaymentsThe Input supplier bears the price risk on finding an alternative supplier – either directly or indirectlySupply of raw materials from Alternative SourceAlternative Supplier

16. Operational RisksO&M AgreementsFixed Price Contract: The Operator assumes risks relating to the fluctuations in operating costsPass-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. 2009Project Finance - Session 216

17. Market RiskOfftake Agreements: Long-term contracts where the Offtaker agrees to purchase nominated volumes/quantities of a good or services from the Project CompanyTake-or-Pay: the offtaker is obligated to pay even if it does not actually take the good or service i.e. PPAShadow 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. 2009Project Finance - Session 217

18. The Role of Advisors2009Project Finance - Session 218

19. 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 DealsLegal AdvisorsIndependent Engineers Insurance Advisors2009Project Finance - Session 219

20. Legal AdvisorsUsually the first “Advisors” to be appointed by both Sponsors & LendersAddress specifics of International Legal Systems i.e. Civil Vs CommonActivities involved in, include:Incorporation of the Project Company (SL)Due Diligence (AL)Legal Opinions (AL)Project Contracts (SL)2009Project Finance - Session 220

21. Independent EngineerOversees & monitors the Project on behalf of the lending banksThere may be a number of “Independent Engineers” dependent upon the technical nature of the project. Activities involved in, include:Due Diligence ReportingCertification / Issuing of Progress Reports Oversight of Testing & CommissioningMonitoring of Operations2009Project Finance - Session 221

22. 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. 2009Project Finance - Session 222

23. Insurance AdvisorsThe scope of work for an insurance advisor includes:Preliminary Insurance Report Identifying analysis of contractual documentation & recommendations for risk coverageFinal 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 2009Project Finance - Session 223

24. Typical PF Insurance ProductsThe most common forms of coverage used are: Construction / Contractors – All-Risks Transport PolicyMaterial & Damage – All RisksForce Majeure Key Man Insurance 2009Project Finance - Session 224

25. SummaryProject 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 DiligenceStructure / Viability of the Project Monitoring 2009Project Finance - Session 225