Chapter 1 Introduction to the Theory and Practice of Project Finance 1
Introduction 1
1.1 What Is Project Finance? 2
1.2 Why Do Sponsors Use Project Finance? 2
1.3 Who Are the Sponsors of a Project Finance Deal? 4
1.3.1 Industrial Sponsors in Project Finance Initiatives
Linked to a Core Business 4
1.3.2 Public Sponsors with Social Welfare Goals 5
1.3.3 Contractor/Sponsors Who Develop, Build, or Run the Plant 6
1.3.4 The ‘‘Purely’’ Financial Investor 7
1.4 Overview of the Features of Project Finance 7
1.4.1 The Contractor and the Turnkey Construction
Contract (TKCC) 8
1.4.2 Operations and Maintenance Contractor and the
O&M Agreement 9
1.4.3 Purchasers and Sales Agreements 9
1.4.4 Suppliers and Raw Material Supply Agreements (RMSAs) 9
1.4.5 Project Finance as a Risk Management Technique 10
1.5 The Theory of Project Finance 10
1.5.1 Separate Incorporation and Avoidance of
Contamination Risk 11
1.5.2 ConXicts of Interest Between Sponsors and Lenders
and Wealth Expropriation 15
Chapter 2 The Market for Project Finance: Applications and Sectors 19
Introduction 19
2.1 Historical Evolution of Project Finance and Market Segments 19
2.2 The Global Project Finance Market 22
2.2.1 A Closer Look at the European Market 26
2.2.2 PPP Development 27
Chapter 3 Project Characteristics, Risk Analysis, and Risk Management 31
Introduction 31
3.1 Identifying Project Risks 32
3.1.1 Precompletion Phase Risks 33
3.1.2 Postcompletion Phase Risks 35
3.1.3 Risks Found in Both the Pre- and Postcompletion Phases 35
3.2 Risk Allocation with Contracts Stipulated by the SPV 45
3.2.1 Allocation of Construction Risk: The Turnkey (or Engineering,
Procurement, and Construction—EPC) Agreement 45
3.2.2 Allocation of Supply Risk: Put-or-Pay Agreements 48
3.2.3 Allocation of Operational Risk: Operations and
Maintenance (O&M) Agreements 49
3.2.4 Allocation of Market Risk 49
3.3 Summary of the Risk Management Process 61
Chapter 4 The Role of Advisors in a Project Finance Deal 63
Introduction 63
4.1 The Role of Legal Advisors in Project Finance Deals 64
4.1.1 Legal Advisor, Legal Advisors, and Law Firms:
The International Part and Local Legal Counsel 65
4.1.2 Project Financing Development Stages and
Impacts on the Role of Legal Advisors 66
4.2 The Role of the Independent Engineer in Project Finance Deals 75
4.2.1 Initial Due Diligence Reporting 76
4.2.2 Monitoring Realization of the Project
(Engineering and Construction) 78
4.2.3 Assistance at the Time of Plant Acceptance 83
4.2.4 Monitoring Operations Management 87
4.3 Role of Insurance Advisors and Insurance Companies in
Project Finance Deals 88
4.3.1 Rationale for Using Insurance in Project Finance Deals 89
4.3.2 When Should Insurance Products Be Used? 90
4.3.3 Areas Where the Insurance Advisor Is Involved 91
4.3.4 Types of Conventional and Financial Insurance Products
Available for Project Finance Deals 93
4.3.5 Integrated Insurance Solutions—Structure and Content 97
4.3.6 Classification of Insurance Underwriters 98
Chapter 5 Valuing the Project and Project Cash Flow Analysis 101
Introduction 101
5.1 Analysis of Operating Cash Flows and Their Behavior in
Different Project Life-Cycle Phases 102
5.1.1 Inputs for Calculating Cash Flows 105
5.2 Defining the Optimal Capital Structure for the Deal 116
5.2.1 Equity 118
5.2.2 Senior Debt 119
5.2.3 VAT Facility 121
5.2.4 Stand-by Facility 123
5.2.5 Identifying Sustainable Debt/Equity Mixes for
Sponsors and Lenders 124
5.3 Cover Ratios 132
5.3.1 What Cover Ratios Can Tell Us and What They Can’t 134
5.3.2 Cover Ratios as an Application of the
Certainty Equivalents Method 139
5.4 Sensitivity Analysis and Scenario Analysis 140
5.4.1 Which Variables Should Be Tested in Sensitivity Analysis? 141
Chapter 6 Financing the Deal 147
Introduction 147
6.1 Advisory and Arranging Activities for Project Finance Funding 147
6.1.1 Advisory Services 149
6.1.2 Arranging Services 152
6.1.3 Integration of Advisory and Arranging Services 153
6.2 Other Roles in Syndicated Loans 157
6.3 Fee Structure 157
6.3.1 Fees for Advisory Services 158
6.3.2 Fees for Arranging Services 159
6.3.3 Fees to Participants and the Agent Bank 159
6.3.4 Example of Fee Calculation 160
6.4 International Financial Institutions and Multilateral Banks 162
6.4.1 Multilateral Organizations 164
6.4.2 Regional Development Banks 171
6.5 Bilateral Agencies: Developmental Agencies and
Export Credit Agencies (ECAs) 178
6.5.1 Developmental Agencies 178
6.5.2 Export Credit Agencies (ECAs) 179
6.6 Other Financial Intermediaries Involved in Project Finance 183
6.7 Funding Options: Equity 186
6.7.1 Timing of the Equity Contribution and Stand-by Equity
and Equity Acceleration 186
6.7.2 Can Shares in an SPV Be Listed on a Stock Exchange? 188
6.8 Funding Options: Mezzanine Financing and Subordinated Debt 188
6.9 Funding Options: Senior Debt 194
6.9.1 The Base Facility 195
6.9.2 Working Capital Facility 195
6.9.3 Stand-by Facility 196
6.9.4 VAT Facility 196
6.9.5 Loan Remuneration 196
6.9.6 Loan Currency 197
6.9.7 Repayment Options 197
6.9.8 Refinancing Loans Already Granted to the SPV 201
6.10 Project Leasing 208
6.10.1 Valuing the Convenience of a Project Leasing 208
6.10.2 The Tax Effect 210
6.11 Project Bonds 211
6.11.1 Investors in Project Bonds 214
6.11.2 Various Categories of Project Bonds 215
6.11.3 Municipal Bonds 219
6.11.4 When Should Project Bonds Be Used? 220
6.11.5 Procedure for Issuing Project Bonds 224
Chapter 7 Legal Aspects of Project Finance 233
Introduction 233
7.1 The Project Company 234
7.1.1 Reasons for Incorporating the Project in a Project Company 235
7.1.2 The Project Company as a Joint Venture:
Another Reason to Develop a Project in an SPV 2367.1.3 The Project Company and Groups of

Companies 237
7.1.4 Corporate Documentation: Articles of Incorporation 237
7.1.5 Outsourcing the Corporate Functions of the Project Company:
How the Company/Project Is Actually Run 238
7.2 The Contract Structure 239
7.2.1 Before the Financing: The Due Diligence Report and the
Term Sheet 239
7.2.2 ClassiWcation of Project Documents 242
7.2.3 The Credit Agreement 243
7.2.4 Security Documents: Security Interests and What They Do 265
7.2.5 Other Finance Documents 274
7.2.6 Project Agreements 278
7.3 Refinancing Project Finance Deals 285
Chapter 8 Credit Risk in Project Finance Transactions and the
New Basel Capital Accord 289
Introduction 289
8.1 The Basel Committee’s Position on Structured Finance Transactions
(Specialized Lending, SL) 290
8.1.1 Classes of Transactions Included in Specialized Lending 291
8.2 Rating Criteria for Specialized Lending and Their Application to
Project Finance 292
8.2.1 Financial Strength 293
8.2.2 Political and Legal Environment 293
8.2.3 Transaction Characteristics 294
8.2.4 Strength of Sponsors 294
8.2.5 Mitigants and Security Package 294
8.2.6 Summary of Grading Criteria 294
8.3 Rating Grade Slotting Criteria of the Basel Committee and
Rating Agency Practices 296
8.4 The Basel Accord: Open Issues 297
8.4.1 EVects of the Basel Proposal on the Syndicated
Project Finance Loan Market 298
8.5 Introduction to the Concepts of Expected Loss, Unexpected Loss,
and Value at Risk 304
8.6 Defining Default for Project Finance Deals 306
8.7 Modeling the Project Cash Flows 308
8.7.1 DeWning a Risk Assessment Model 308
8.7.2 Identifying Project Variables and Key Drivers 309
8.7.3 Input Variables: Estimation and Data Collection 314
8.7.4 Estimating Project Cash Flow and Valuing Results 317
8.8 Estimating Value at Risk through Simulations 317
8.9 Defining Project Value in the Event of Default 319
8.9.1 Deterministic vs. Stochastic LGD Estimates 320
8.9.2 LGD Drivers: The Value of Underlying Assets vs.
Defaulted Project Cash Flows 321
8.9.3 Restructuring vs. Default 321
Case Studies 323
Case Study 1 Cogeneration 323
C1.1 Situation 323
C1.2 Production Process 324
C1.3 Sponsors of the Deal 324
C1.4 Agreements Underpinning the Deal 325
C1.5 Financial Structure 328
C1.6 Conclusion: In Arrigoni’s Office 329
Case Study 2 Italy Water System 331
Introduction 331
C2.1 Business Plan of the Project 331
C2.2 Assumptions 332
C2.3 Capital Expenditure 334
C2.4 Financial Requirement and Sources of Financing 334
C2.5 Operational Period 337
C2.6 Economic and Financial Ratios 339
Appendix to Case Study 2: Structure and Functioning of the
Simulation Model 341
Introduction 341
A.1 Breakdown of the Financial Model 342
Case Study 3 Hong Kong Disneyland Project Loan 359
C3.1 Background on Syndicated Bank Lending 360
C3.2 The Hong Kong Disneyland Project Loan 363
C3.3 Designing a Syndication Strategy 370
C3.4 Executing the Syndication Strategy 375
C3.5 Conclusion 377
Glossary and Abbreviations 379
References 395
Index 401