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CONCEPT OF RISK: DEFINITION

AFRICAN EXPORT-IMPORT BANK STRUCTURED FINANCE SEMINAR Introduction to Limited Recourse Project Financing PRESENTED BY: SIYANGA MALUMO Africana Finance & Investments (AFI) CAIRO 1 DECEMBER 2010. CONCEPT OF RISK: DEFINITION.

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CONCEPT OF RISK: DEFINITION

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  1. AFRICAN EXPORT-IMPORT BANK STRUCTURED FINANCE SEMINARIntroduction to Limited Recourse Project FinancingPRESENTED BY: SIYANGA MALUMOAfricana Finance & Investments (AFI)CAIRO 1 DECEMBER 2010

  2. CONCEPT OF RISK: DEFINITION “Probability of a loss or other negative occurrence, caused by external or internal factors, and which could be mitigated by anticipatory action.”

  3. PROJECT FINANCE The International Project Finance Association (IPFA) :“The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project.”

  4. Specific Risks • Payment system risk • Refinancing risk • Reinvestment risk • Settlement risk • Sovereign risk • Underwriting risk • Capital risk • Completion risk • Default risk • Delivery risk • Exchange rate risk • Interest rate risk • Liquidity risk • Operations risk

  5. STRUCTURED FINANCE • Concept premised on the following: • Every transaction or project involves risk • Every risk requires mitigation • Risks must be allocated to parties best suited to bear them. • Risk mitigation creates comfort to both lenders and equity investors. • No risk can be 100 % mitigated a priori.

  6. TYPES OF RISKS Key Risks • Political • Economic • Commercial • Technical • Socio-Environmental

  7. ADVISORS • Financial • Technical • Legal • Marketing • Environmental • Social • Insurance • Others

  8. ROLE OF ADVISORS • Expertise • Experience • Network • Credibility • Work Load Reduction • Blame Game / Punch Bags • Time Management • Project Management • Process Management

  9. THE PROJECT CYCLE

  10. STRUCTURING & PACKAGING

  11. PROJECT STRUCTURING & PACKAGING •  Key Elements of Project Structuring • The Challenges of Project Structuring & Packaging • Project Development by the Public Sector • Project Development by the Private Sector • Public-Private Partnerships

  12. KEY ELEMENTS OF STRUCTURING

  13. STRUCTURING & PACKAGING • PPP Structure

  14. GRZ Off - taker Insurance (GOVTT (REG) Payments PPA Concession Concession Cover Premium Fees Agreement Debt EE Service Zesco & Dividends SPV AFRICANA TATA Lenders (ITT) (SPV) Loan Equity Agreement Water utilization fee Water rights EPC O&M O&M Fee Contract Contract O&M Operator EPC Contractor ITT Dam EPC O&M Contractor Contractor AFRICANA PROJECT STRUCTURE PPA CONCESSION / IPPA GENERATION LICENSE (ZULU (ZESCO) LENDERS WATER RIGHTS (Water Board)

  15. AFRICANA Financing Structure Payment of insurance premium MUKUNI CO ZULU CO PPA 2 INDOSURE LOAN Insurance PPA 1 LOAN Assignment of receivables/ Escrow Acct AlternativePPA EPC (Assigned to SPV) BANK 1 INDOHYDRO LOAN AFRICANA SPV BANK 2 Intercreditor Agreement AFI

  16. STRUCTURING & PACKAGING • Structuring Challenges: • Type & Strength (financial, technical, managerial, organisational, etc.) of Developers/Investors Targeted • Type of projects (infrastructure, commercial, agriculture, PPP, etc.) • Econo-Political Environment • Legal & Regulatory Environment • Social Environment • Potential Funding Sources (targeted) • Potential Market

  17. STRUCTURING & PACKAGING • Structuring Strategy: • Financial Modelling (Sources & Uses of funds, Price/Tariffs, Production Volume, Return, Sensitivity Analysis, Cost of Funds, Debt Service Coverage Ratio, IRR, Payback Period) • Develop Project Structure • Select Potential Funding Sources • Packaging Strategy: • Security Package (Marketing , Supplier, EPC, Service & Concession Agreements, Insurance, Escrow Account, Asset Pledge – Land & Equipment, Pledge of Present and/or Future Receivables)

  18. STRUCTURING & PACKAGING • Packaging Strategy: • Variants of Project Development: • Private Sector: • High Risk – High Reward Philosophy • Profit Driven • Success Driven • Efficiency • Productivity • Public Sector: • Public Service / Goods • Political Benefits • National Development • Socio-Economic Progress • Public-Private Partnership

  19. STRUCTURING & PACKAGING • PPP Definition PPP - 1 "Public-private partnerships (PPP)refer to contractual agreements formed between a public agency and private sector entity that allow for greater private sector participation in the delivery of projects.” PPP - 2 " Public-private partnership" (PPP)islegally constituted relationship between the state or its agencies with private sector firm(s) in which the latter substitutes the former in the provision of public goods and services over a specified or indefinite period, for mutual benefit."

  20. VARIANTS OF PPP • Design-Build (DB) • Design-Build-Maintain (DBM) • Design-Build-Operate (DBO) • Design-Build-Operate-Maintain (DBOM) • Build-Own-Operate-Transfer (BOOT) • Build-Own-Operate (BOO) • Design-Build-Finance-Operate or Maintain (DBFO, DBFM, DBFO/M) • Public Social Private Partnerships (PSPP) • Service Contracts • Public Private Development Partnerships (PDP) • Management Contract • Concession • Divesture • Cooperation between Private Foundations (eg. HIV-AIDS, Tuberculosis, Malaria, New and Rare drugs etc) & Public Sector

  21. STRUCTURING & PACKAGING • PPP & Outsourcing Degree of Risk Transfer • Privatisation • State assets sold • State liabilities dispensed • Government has Regulatory function only • PPPs • Private Party: • Finances (whole or most) • Designs • Builds • Operates • Government purchases complete service and/or enables business • Fixed assets belong to Government • Outsourcing • Capitalisation is for the Government Account • Government buys specific services but retains risk • Fixed and movable assets typically belong to Government Source: James Aiello, PPP Unit National Treasury SA

  22. STRUCTURING & PACKAGING • Packaging Strategy: • Security Package: • Marketing , Supplier, EPC, Service & Concession Agreements • Customer Credibility & Credit Worth • Performance Bond • Liquidated Damages • Insurance • Escrow Account • Asset Pledge: Land & Equipment • Pledge of Present and/or Future Receivables • Debt Service Reserve Account • Other Guarantees: Government Support, Shareholders Guarantee, etc.

  23. PROJECT FINANCE • What is Project Finance? • Key Elements of Project Finance • Resource Mobilisation In project Finance

  24. PROJECT FINANCE The International Project Finance Association (IPFA) :“The financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cash flow generated by the project.”

  25. OBJECTIVES OF PROJECT FINANCE • Facilitation of Project Development • Public Debt Reduction • Reduce/Eliminate Impact on Balance Sheet (Limited Recourse/Non-Recourse) • Optimisation of Risk Allocation (Structured Finance) • Management of Project Costs (Fixed Time/ Fixed Price/Lump Sum Contract) • Value for Money • Optimisation of Return on Investment • Attraction of Private Sector in Public Goods & Services Investment

  26. KEY ELEMENTS OF PROJECT FINANCE • The Project • Project Sponsor/Promoter/Developer • Government (Concession/PPP) • Special Purpose Vehicle (SPV) • Equity Provider(s) • Lenders • Offtake (Buyer) Contract(s) • Supply Contract(s) • Engineering, Procurement, Construction( EPC) Contract(s) • Operation & Maintenance (O & M) Contract • Insurance • Cash Flow • Security Package

  27. ANALYTICAL TOOLS 1 • Risk Analysis (Political/Financial/Commercial) • Financial Modelling • Discount Rate • Discounted Cash Flow (DCF) • Free Cash Flow • Internal Rate of Return (IRR)

  28. ANALYTICAL TOOLS 2 • Project Rate of Return • Sensitivity Analysis • Ratio Analysis • Debt Service Coverage Ratio (DSCR): • Loan Life Cover Ratio • Project Life Cover Ratio • Weighted Average Cost of Capital (WAC) • Pay Back Period

  29. THE FUNDING MIX IN PROJECT FINANCE • Equity: • Shareholders’ Contribution • Preference Shares • Debt: • Senior Debt • Subordinated Debt • Hybrids: • Mezzanine • Shareholders’ Loans

  30. SOURCES OF FUNDS • Equity: • Shareholders (Individuals / Institutional Investors) • Preference Share Investors • Venture Capital Funds • Debt: • Development Financing Institutions (DFIs): Bilaterals / Multilaterals • Commercial / Investment Banks (Domestic / International) • Underwriting (Hard vs Soft underwriting)

  31. USES OF FUNDS Project Preparation Advisory Services (Financial, Legal, Technical) Permits / Licenses (Environmental, Water Usage, Operational, Way leave, etc.) EPC Contractor Working Capital Cash Sweep Contingencies

  32. RISK MANAGEMENT

  33. CONCEPT OF RISK: DEFINITION “Probability of a loss or other negative occurrence, caused by external or internal factors, and which could be mitigated by anticipatory action.”

  34. RISK MANAGEMENT: KEY RISKS Financial (Including Cost over runs, Underwriting, etc) Commercial (Including Pricing, Quantity, Marketing) Partner Selection Economic (Macro – Economic Aggregates, Infrastructure, etc) Technical Legal Environmental Social Political Climatic

  35. RISK MITIGATION - 1 Identify Pertinent Risks Develop a Risk Inventory Develop a Risk Matrix Undertake Due Diligence Develop Risk Mitigation Strategy (Covering All Pertinent Risks) Allocate Risks to Various Parties

  36. RISK MITIGATION - 2 • Develop & Agree a Security Package • Key Project Agreements • Key Commercial Agreements • Payments Mechanism • Recourse to Sponsors: • Limited • Management Fees Forfeiture • Dividends (Current and Past) Forfeiture • Cost over runs • More Equity Injection

  37. RISK MITIGATION - 3 • Management of Contractors: • Fixed Time / Fixed Price • Performance Bonds • Take or Pay / Put or Pay • Cost, Insurance, Freight (CIF vs FOB)

  38. PPP RISK ALLOCATION

  39. KEY LEGAL ELEMENTS : • Project Contracts • Shareholders’ Agreement • Joint Development Agreement • Concession/Implementation Agreement • Environmental and Social Impact Certification • Loans Agreement • Common (Lenders) Agreement • Force Majeure Issues • Termination Clause(s) • Conditions Precedent (CPs)

  40. LIMITEDRECOURSE TO SPONSORS: • CIRCUMSTANCES: • Cost over runs • Mismanagement • MEASURES: • More Equity Injection • Management Fees Forfeiture • Dividends (Current and Past) Forfeiture

  41. PROJECT BANKABILITY

  42. PROJECT BANKABILITY • Key Elements: • Legal Framework • Regulatory Framework • Compensation Clauses: • Unilateral Decisions: Government • Unilateral Decisions: Private Sector • Performance Failure by Either Party • Government Support • Transfer of Assets (end of concession) • Dispute Settlement • Re-bidding Option

  43. PROJECT BANKABILITY • Contentious Issues: • Tariffs • Price Adjustments • Termination Clauses • Compensation • Step-In Rights • Direct Agreement (with Government) • Government Support

  44. PROJECT BANKABILITY • Security Package: • Key Drivers: • Concession Agreement • Off-take Agreement (from Project) • Supply arrangements (to Project) • Government Support Agreement • Escrow Account • Tariff adjustment Mechanism • Insurance Arrangements (Policy) • Performance Bonds • Step-In Rights

  45. PROJECT ADMINISTRATION

  46. ADMINISTRATIVE ASPECTS • Site Identification • Staff Settlement/Welfare • Licences/Permits • Project Monitoring Mechanism

  47. LESSONS FROM AFRICA

  48. LESSONS FROM AFRICA • Uganda: Bujagali • Uganda: UEB Privatisation • Tanzania: Tegeta • Tanzania: Ubungo • Mozambique: Cabora Bassa • Nigeria: Lagos Barge Power Station • Nigeria: Ibom Power Project • Botswana: Mamabula • DR Congo: Inga I & II • Ghana: Takoradi • Zambia: Itezhi-Tezhi • Zambia: Kariba North Bank Extension

  49. SUCCESS FACTORS • The Political Climate; • The Economy & Economic policies; • Legal & Regulatory Environment; • Socio-Environmental Aspects.

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