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    Security in Project Finance

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    Ishaya Amaza
    This document provides an overview of security structures in project finance. It defines project finance and discusses how it differs from traditional corporate lending. Key aspects include the independent project company, limited recourse to sponsors, and service of the project loan from future cash flows. Security plays an important risk mitigation role and can include real rights over project company assets as well as contractual arrangements. Common security includes pledges of shares, assignments of receivables, and floating charges over pools of assets. Since reforms, the ability to appoint an administrative receiver with a floating charge is now limited in the UK.

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    © All Rights Reserved
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    Security in Project Finance

    Uploaded by

    Ishaya Amaza
    205 views25 pages
    This document provides an overview of security structures in project finance. It defines project finance and discusses how it differs from traditional corporate lending. Key aspects include the independent project company, limited recourse to sponsors, and service of the project loan from future cash flows. Security plays an important risk mitigation role and can include real rights over project company assets as well as contractual arrangements. Common security includes pledges of shares, assignments of receivables, and floating charges over pools of assets. Since reforms, the ability to appoint an administrative receiver with a floating charge is now limited in the UK.

    Original Description:

    A synopsis on securitisation in project finance transactions

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    This document provides an overview of security structures in project finance. It defines project finance and discusses how it differs from traditional corporate lending. Key aspects include the independent project company, limited recourse to sponsors, and service of the project loan from future cash flows. Security plays an important risk mitigation role and can include real rights over project company assets as well as contractual arrangements. Common security includes pledges of shares, assignments of receivables, and floating charges over pools of assets. Since reforms, the ability to appoint an administrative receiver with a floating charge is now limited in the UK.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    205 views25 pages

    Security in Project Finance

    Uploaded by

    Ishaya Amaza
    This document provides an overview of security structures in project finance. It defines project finance and discusses how it differs from traditional corporate lending. Key aspects include the independent project company, limited recourse to sponsors, and service of the project loan from future cash flows. Security plays an important risk mitigation role and can include real rights over project company assets as well as contractual arrangements. Common security includes pledges of shares, assignments of receivables, and floating charges over pools of assets. Since reforms, the ability to appoint an administrative receiver with a floating charge is now limited in the UK.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 25
    At a glance
    Powered by AI
    Some of the key takeaways from the document are that project finance involves financing infrastructure projects through a legally independent project company using cash flows from the project to service the debt rather than the balance sheet of the sponsors. It also discusses various security structures and risks commonly addressed in project finance.

    Project finance is characterized by financing infrastructure projects through an independent project company using future cash flows from the project rather than the balance sheet of sponsors. It differs from traditional corporate lending in that repayment comes from project cash flows, liability of sponsors is limited, and risks are structured separately.

    Project finance structures aim to address various project risks like technical, economic, political and legal risks as well as bank risks such as syndication and refinancing risk. The risks are outlined on pages 5-6 of the document.

    SECURED

    LENDING IN COMMERCIAL TRANSACTIONS


    TRENDS AND PERSPECTIVES

    Security in Project Finance

    JanHendrik Rver

    Overview
    What is project finance?
    Project finance after the financial crisis
    Functions of security in project finance
    What is security in project finance?
    Security structures in project finance
    How secure is security in project finance?

    What is project finance? A general definition


    Project financing is characterised by five criteria and thus clearly
    differentiated from traditional corporate lending:

    Purpose of financing
    Financing of a clearly defined
    (green or brown field) project

    Borrower
    Legally and economically
    independent project company

    Service of project loan


    (repayment and interest)
    from future cash flows
    of project company

    Liability of sponsors

    No or only limited recourse to sponsors


    security interests of project company
    (limited) security interests of sponsors

    Risk structuring

    What is project finance? The Parties

    Sponsor 1

    Sponsor 2

    Loan 1

    Project company
    Loan 2

    Bank 1
    Intercreditor
    agreement

    Bank 2

    What is project finance? The Risks

    Bank risk:
    Refinancing
    risk
    Bank risk:
    Syndication
    risk
    Project risk:
    Legal risks

    Project Risk:
    Credit risks
    Project risk:
    Technical risks
    Risks faced by a
    project company
    and its lenders

    Project risk:
    Force majeure
    risks

    Project risk:
    Economic risks

    Project risk:
    Political risks

    For project risks see also summary of risks in Basel II Principles, appendix 4 table 1 (supervisory slotting criteria
    for specialised lending) issued by Basel Committee on Banking Regulation (in this respect not superseded by Basel
    III); see also Article 87 5 of Directive 2006/48/EC

    What is project finance? The types of projects


    Power / energy
    (incl. renewable
    energy)
    35%

    Mining
    4.5%

    Transportation /
    infrastructure &
    public private
    partnerships

    Other sectors

    25%

    Industry

    Leisure & Property


    Telecommunications
    Petrochemicals
    Water & Sewerage

    Oil & gas


    12.5%
    Percentages represent 2010 share of sector in total volume of project finance transactions
    Source: Thomson Reuters Project Finance International

    Waste & Recycling


    Agriculture & Forestry

    23%
    6

    Project finance after the financial crisis (i)


    Banking world in turmoil since insolvency of Lehman Brothers (2008)
    Changes in the general framework
    Accounting changes (IFRS 10*)
    If sponsor holds majority of shares in project company he must
    show debt financing of project company on its group balance
    sheet (no off-balance sheet financing by sponsors)
    Banking regulation
    Higher equity requirements for specialised lendings**
    Five types of specialized lending of which project finance is one
    Banks typically use Internal Ratings-based (IRB) Approach to
    credit risk and allocate risk weightings of up to 250%
    Supervisory slotting criteria for specialised lending

    * Applicable since 1 January 2013; incorporated by Regulation (EU) No. 313/2013 of 4 April 2013
    ** See Basel Committee on Banking Regulation, Basel III: A global regulatory framework for more resilient banks and
    banking systems, revision June 2011

    Project finance after the financial crisis (ii)


    Change in environment for PPP/PFI projects
    Coming to an end of privatisation wave
    Change in perception of creditworthiness of public entities (in
    particular PIIGS countries [Portugal, Italy, Ireland, Greece and Spain])
    Change in risk realisations: long-term assumptions in cash flow models
    were falsified by reality
    Renewable energy: wind forecasts
    Transportation: traffic forecasts
    Oil and gas: gas price development
    General: tax assumptions

    Project finance after the financial crisis (iii)

    Changes in project finance structures


    Generally further increase in risk awareness and risk mitigation leading
    to more complex financing structures
    Increase of sponsor support (transformation of limited recourse
    financing)
    Lower debt/equity ratios (i.e. higher equity element)
    More comfortable financial covenants
    Shorter loan tenors / incentives for early repayment or refinancing
    such as margin increases over time
    Leading to a renaissance of quasi mini-/medium-perm
    financings
    9

    Project finance after the financial crisis (iv)


    Risk mitigation instruments

    International financial institutions (A/B loan structure)


    European Investment Bank (EIB) initiative: Loan Guarantee
    Instrument for Trans-European Transport Network Projects,
    LGTT (networks in the transportation, power and
    telecommunication sector), launched in 2008
    Generally reduced availability of bank financing
    Increased interest in project bonds as replacement of bank
    financing
    EIB: Europe 2020 Project Bond Initiative, launched in 2012
    First project: Natural gas storage Castor in 2013

    10

    Project finance after the financial crisis (v)


    Bank world for project finance has contracted from its peak in 2008

    Source: Thomson Reuters, Project Finance Review, Full Year 2012

    11

    Functions of security in project finance


    Security is a shield, not a sword (Philip R. Wood*)
    Limited market value of project companys fixed assets
    Negative or defensive function of security (exclusion of third party
    creditors); security provides power to enforce and/or priority in
    enforcement; enables restructuring
    Not: assignment of insurance contracts
    Not: security assignments of other receivables
    Management function of floating charge
    Positive function: enforcement of security
    Priority function of security in insolvency

    * Project Finance. Subordinated Debt and State Loans, 1995, p. 30

    12

    What is security in project finance? (i)


    By way of security a creditor ensures for himself a privileged status,
    either
    by establishing real rights over one, some or all of the debtors
    assets (real security) or
    by having recourse to a third party who has undertaken
    responsibility to the lender for payment if the debtor defaults
    (personal security)*

    * Sir Roy Goode and Ewan McKendrick, Commercial Law, 4th ed. (London 2010)

    13

    What is security in project finance? (ii)


    Part of the definition of project finance is risk structuring with a view
    to risk mitigation
    Security in a functional sense in a project finance context is
    broader than personal and proprietary security
    Comprises any contractual tool that secures debt service
    Includes financial covenants
    Includes further other coventants
    Debt service reserve account
    Control of cash flow
    Broad view on security confirmed by Basel II supervisory
    slotting criteria for specialised lending (see category security)

    14

    Security structures in project finance (i)


    Security in a narrow sense (two layer model)
    On the level of sponsors
    On the level of project company
    Includes security on the level of the general construction
    contractor (EPC); (performance)guarantee of the general
    construction contractor
    Provided to the project company
    Hence, additional security assignment of any (future) right
    under the guarantee to lender
    Furthermore, socalled direct agreements / stepin rights
    (para. 6 of Schedule 2A Insolvency Act 1986) with main contractual
    partners (operators, suppliers or offtakers)

    15

    Security structures in project finance (ii)

    Level of sponsors

    Asset

    Type of security

    Sponsors shares in project company

    Pledge of shares

    Sponsors assets

    Completion guarantee

    Project companys rights to payment


    of account deposits
    Real estate
    Level of
    project company
    (continued on next
    slide)

    Equipment and machinery

    Pledge for the benefit of bank


    Security interest in real estate

    Fixed charge (UK) /


    Security transfer of ownerhip (GER)

    Rights under insurance contracts

    Security assignment of receivables

    Rights under general construction contracts

    Security assignment of receivables

    Rights under supply contracts

    Security assignment of receivables

    Rights under offtake contracts

    Security assignment of receivables

    16

    Security structures in project finance (iii)


    Asset

    Type of security

    Payment rights under shareholder loans


    Shareholder loans instead of capital
    contribution may be efficient form of
    financing, since interest can be
    deducted from tax base

    Level of
    project company

    Security assignment of receivables

    (Proprietary or quasiproprietary) security in pool


    of assets like floating charge of English law or
    nantissement de fonds de commerce of French law

    (beginning on the
    previous slide)
    Negative pledge clause
    (covenant not to create security rights
    for the benefit of third parties)
    No security interest; only obligation

    17

    Security structures in project finance (iv): floating charge


    Floating charges were convenient tool for project financings in the
    past; they allowed appointing an administrative receiver and thus
    managing project company in default
    Role in international financings has always been somewhat
    limited due to the fact that continental legal systems were not
    able to recognise English law floating charge

    18

    Security structures in project finance (v): floating charge


    Since the reform of the English Enterprise Act an administrative
    receiver can be appointed only in exceptional cases
    Pursuant to sec. 250 Enterprise Act 2002 and sec. 72B Insolvency
    Act 1986 only exceptions for socalled qualifying floating
    charges, e.g. for
    (2) publicprivate partnership project,
    (3) utility project,
    (5) a financed project (project financing) with a total debt
    amount of at least 50 million
    Scope of project unclear

    19

    Security structures in project finance (vi): security trustee


    Several
    lenders

    Bank 1

    Syndicated loan

    Subparticipation (e.g. EBRD A/B loan)

    Inter
    creditor
    agreement

    Bank 2

    Loan 1

    Bank 2

    Loan 2

    Subparticipation
    agreement

    Bank 1
    Project company
    Loan

    Project
    company

    20

    Security structures in project finance (vii): security trustee


    Creation
    of security if there are several lenders
    Relevant for syndicated loans
    Security trustee under English law for proprietary security interests
    More complex trust structure under German law
    Nonaccessory (nonancillary) security rights*
    Creation for (German law) trustee
    Accessory (ancillary) security rights**
    Creation for each bank in order to secure loan obligation
    Securityholder must also be creditor of the secured debt
    Creation of security for the benefit of a (German law)
    trustee to secure a parallel secured debt (debt acceptance
    [Schuldanerkenntnis])

    * I.e. non-accessory real estate mortgage for security purposes, security transfer of ownership, security assignment of receivables
    ** Pledge of accounts, pledge of shares, accessory real estate mortgage (the latter is not often used in practice)

    21

    How secure is security in project finance? (i)


    There is no difference in the legal efficiency of security in a narrow
    sense in project finance compared to other types of financing
    However, the economic efficiency is quite different
    At least at the early stages of a project if project works (and
    thererfore security is not needed)
    Therefore, security in a narrow sense in project finance has mainly a
    defensive role
    At least at the early stages of a project if project works (and
    thererfore security is not needed)

    22

    How secure is security in project finance? (ii)


    However, in understanding project finance security structures one
    should not focus on security in a narrow sense only
    There are functional security instruments used in project
    finance structures which supplement personal and proprietary
    security
    Leads to high financial stability of projects (provided that
    assumptions are correct)

    23

    Bibliography (i)
    German secured transactions law
    JanHendrik Rver, Realsicherheiten und Direktvereinbarungen, in: Ulf R. Siebel,
    JanHendrik Rver and Christian Kntel (eds.), Rechtshandbuch
    Projektfinanzierung und PPP, 2nd ed. (Cologne, Munich 2008)
    Hansjrg and JrgAndreas Weber, Kreditsicherungsrecht, 9th ed. (Munich 2012)
    English secured transactions law
    Hugh Beale, Michael G. Bridge, Louise Gullifer and Eva Lomnicka, The Law of
    Security and TitleBased Financing, 2nd ed. (Oxford 2012)
    Michael Bridge, Personal Property Law, 3rd ed. (Oxford 2002)
    Michael Bridge, Louise Gullifer, Gerard McMeel and Sarah Worthington, The Law
    of Personal Property (London 2013)
    Sir Roy Goode and Ewan McKendrick, Commercial Law, 4th ed. (London 2010)
    USamerican secured transactions law
    James J. White and Robert S. Summers, Uniform Commercial Code, 6th ed.
    (St. Paul, Minn. 2010)
    James J. White and Robert S. Summers, Principles of Secured Transactions
    (St. Paul, Minn. 2007)
    24

    Bibliography (ii)
    Eastern European secured transactions laws
    JanHendrik Rver, Secured Lending in Eastern Europe. Comparative Law of
    Secured Transactions and the EBRD Model Law (Oxford 2007)
    Western secured transactions law (in particular European Union secured
    transactions laws)
    EvaMaria Kieninger (ed.), Security Rights in Movable Property in European
    Private Law (Cambridge 2004)
    Harry C. Sigman and EvaMaria Kieninger (eds.), CrossBorder Security over
    Tangibles (Berlin 2007)
    Harry C. Sigman and EvaMaria Kieninger (eds.), CrossBorder Security over
    Receivables (Berlin 2009)
    Horst Eidenmller and EvaMaria Kieninger (eds.), The Future of Secured Credit in
    Europe (Berlin 2008)

    25

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