Mode Comparison & Risk Analysis of Project Financing

Mode Comparison & Risk Analysis of Project Financing
WANG Wen-quan1
1 School of Traffic & Transportation, Beijing Jiaotong University, Beijing P.R.China 100044
[email protected]
Abstract: The project financing, as a complete new concept and financing method, has abroad been
applied in metaphase and long period construction project in our country, especially in basic
establishment construction project. In this paper, based on the comparison of five typical project
financing model, some risk elusion measure and risk allocation mechanism of project financing are
presented, and offers a reference for our enterprises to study and research project financing in time, to
set up good foundation of internationalizing of marketing finance.
Key words: Project financing, Risk elusion, Risk allocation
1 Introduction
The same as other countries, Chinese foundation establishment construction is also faced the puzzle
from the factors such as sitting heavy on finance capital source being hard up investment main body
singleness lower investment efficiency and so on, it is surely speeder the development of infrastructure
construction in china that how to widen the origin channel of capital urge the main body of investment
multiply enhance investment efficiency. Project financing, which generated from the 1970’s, is
applicable to large-scale infrastructure construction, it emerged quickly from the international capital
market, therefore, making a studying on its application in china has very important practical
significance.
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2 Major project financing mode
Project financing mode is a financing mode that ascertain which financing form can make the
economy intensity of project satisfy the requirement of investors, it is a mode about combination and
conformation of factors of project financing. Generally, project financing include financing mode based
on “product payment” financing mode based on “establishment employment protocol” financing mode
based on “lever tenancy” financing mode of “Build-Operate-Transfer”.[1-3]
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2.1 Financing mode based on “Product Payment”
“Product payment” is one of forepart form of project financing, it doesn’t adopt the manner of
alienation or guaranty to finance, but completely take the property of the product and the distribution
income of the product as gage, the bank provide a loan purchase some shares of product from project,
the income from the product shares would be the repayment source of project financing.
The main character of this project financing mode include: (1) the only source of repayment of this
project is the future sale income from the product of the project; (2) the financing term is shorter than
the economy life of the same project; (3) the bank provides a loan only for the expenses of construction
and capital, but not for operating costs of the project; in addition, the investor of project is required to
present the surety about the least turnout and the lowest quality of product, and so on.
The financing mode based on product payment is lesser restricted by routine debt proportion or
tenancy proportion, the major limit is only from the resource reserves and economy life of the project.
However, its applied scope is very limited, it is only the same with the project that resource reserves has
been proved up and the product flux can be worked out by rule and line.
2.2 Financing Mode Based on “Establishment Employment Protocol”
“Establishment employment protocol” is a agreement that have the property of “payment whether
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pick up the goods or not” managed between the offer and the user of certain industry establishment or
service establishment.
The main character of this project financing mode include: (1) if the project financing can success,
it is the key whether the promises of “payment whether pick up the goods or not” can be obtained; (2) it
is flexible to select the structure of investment; (3) the investor of project can use the credit of the user
of establishment to arrange financing, so can disperse risk and save original devotion.
Financing mode based on “payment whether pick up the goods or not” is mainly applied to capital
compression lower income but relatively steady basic establishment project and project with service,
for example, petroleum natural gas piping establishment for generating electricity belt line for certain
special product and port railway establishment, and so on.
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2.3 Financing Mode Based on “Lever Tenancy”
Financing mode based on “Lever tenancy” is a kind of tenancy based on asset, under the
requirement and arrangement of project investor, the lender purchase the assets of project by financing,
then lease out the assets to lessee. Usually, the lender in lever tenancy only need pay 20%-40% fund for
purchasing equipment in order to hold the property of the equipment in economy, the other fund is pay
by bank or insurer offering cannot demand loan, taking the equipment of lender as guaranty, and the
right of tenancy bargain and getting rent as surety.
Project financing mode based on “lever tenancy” is a little complex, its characters are mainly
embodied in two aspects: (1) the initiator of project can make use of decreasing tax policy to reduce cost;
(2) the property of tenancy assets is belong to the partner who provides a loan, the risk is lower. Expect
the advantage of tax, there are other reasons to make the initiator and loaner use financing mode based
on “lever tenancy”, for example, when presenting fund to asset annex, tenancy mode have greatly
superiority because the property of assets is belong to loaner in the countries without vouching law.
In project financing, when project corporation need specifically assets only at a special phase of
project construction or exploitation, short time operating tenancy can be used too. So, penman think that
lever tenancy is mainly applied to purchase a certain large given equipment.
2.4 Financing Mode of “Build-Operate-Transfer”
The basic idea of “Build-Operate-Transfer” is: a sort of concessionary agreement is presented by
local government or belonged institute to the construction and operation as the base of the project
financing, local company or foreign company act as the investor and operator of project to arrange
financing bearing risk exploiting construction project, and getting commercial profit in a certain period
by operating project, finally, the project would be transferred to corresponding government according to
protocol.
The typical form of “Build-Operate-Transfer” is: government and international project corporation
sign contract, and finance & establish a material project by project company; in a section period after
convention of two sides, the project company pay the debt of the project and get disinvestments by
operating the project; when the agreement is over, the project would be transferred to local government
without repay.
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3 Comparison & analysis of project financing mode
According to the described before, there are manifold financing mode with their own character in
project financing process, a comparison analysis is made about project financing mode below. The
comparison about financing mode of project financing is as follows:
Financing
mode
Product
payment
Financing
cost
Quite high
Tab.1 Comparison of main mode of project financing
Investment Property & Source
of Credit surety
risk
operation
fund
Quite high
Syncretism
Capital stock Distribution of
and the fund product
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Applied scope
Project
resource
of
Establishment
Employment
protocol
Lever tenancy
Moderate
Moderate
Syncretism
Moderate
Moderate
Separation
Build-Operate
-Transfer
High
Quite high
Change as
different
period
of purchasing
product
Capital stock
and liability
Mostly
liability
Mainly
foreign
capital
is
is
Payment
whether pick up
the goods or not
Diversification
Government
conduct
Project of basic
establishment
and service
Large-scale
equipment
Part of basic
establishment
4 Risk Management of Project Financing
The same as any other traditional financing mode, there is risk in project financing too, furthermore,
because that project financing needs more time more partner, the risk it brings is sometimes multiplex
risk, upper technology of risk scale & control is needed. So, the risk control & management of project
financing become its an important part, and a complete set of relatively perfect mechanism of risk
elusion come into being, this is one of basic character of project financing.
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4.1 Risk Elusion and Control of Project Financing
Risk management is a process that prevent loss or to reduce the possibility of loss and play down
loss & influence with teleology by plan organization harmony control and other management
function, at the same time, create conditions to impel the appearance and spread of favorable result for
most profit. The risk of project financing is not unusual, its character domino effect and management is
the same as other economy functions, the content and procedure of risk management in project financing
is: risk identify risk measure establishing reply measure constituting plan of risk management and
actualizing.[4-5]
The risk control of project financing is a process that reduce disperse detract risk by all kinds of
economy technology means. The control of risk is the finally purpose of risk identification & risk
estimation, different elusion measure and control method should be adopted for different project risk. As
for the bank providing a loan, should affirm the financing structure based on the different phase of the
project when considering project financing structure. Usually, complete recourse should be taken at the
phase with high risk of project construction period, furthermore, with project entrepreneur provide
surety in law, the risk can be compensated by heightening interest rate too. Complete recourse can be
changed into no recourse or limited recourse at dealing in phase based on the reduction of risk, upper
interest rate can be move to lower level too.
A series of methods and skills are work up in practice by mostly the bank providing a loan that take
part in project financing international, its core is banding together all partner related with project by all
kinds of bargain and contract, bearing risk together. The table below presents the basic risk and its
elusion method of project financing.
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Tab.2 The basic risk of project financing & its elusion measure
Sort of risk
Elusion measure
Risk of complete: consist in project of supposed phase Complete surety;
and test operating phase, mainly represented as delayed Defending letter of carrying out;
construction of project cost overspend miss design Stockholder sustaining;
Engineering contract of “handing over key”.
criterion of project and complete stand-down of project
Risk of operating: The risk consists in the operating Providing contract of energy sources/raw and processed
phase of project such as technology energy sources and materials long period; Surety of carrying out;
material supply management diathesis of work force. Insurance of project; Stockholder sustaining.
Risk of market/sales: The risk of final product consist in Agreement of distribution long period;
the price undulation and distribution aspects.
Powerful distribution meshwork.
Risk of finance: The risk of interest rate exchange rate Measure of reserving value about interest rate exchange
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undulating greatly.
Risk of country: The risk of project lost the change of
project credit structure cannot change foreign exchange
that induced by the change of political condition in the
project country.
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rate.
Getting the guarantee from government;
Project with government direct interposition;
Surety of political risk.
4.2 Risk Allocation Mechanism of Project Financing
In the traditional corporation financing mode, the risk of project is certainly taken on by investment
company and related sponsor, investment company burden entire responsibility of project debt, and the
loan that bank provide to the project get surety guarantee only from project borrower and loan warrantor.
If the project is defeated, investment company would be charged with whole loss of the project alone
and be responsible for repaying loan until bankruptcy, the risk that bank faced is mainly the credit of
borrower and the assurance ability of warrantor. But in project financing, the main body that take on the
risk of project is different from traditional corporation financing, the risk is not focus on one partner.[6-7]
From the measure of risk elusion that described former we can see, the essential of the risk elusion and
control of project financing is that the risk is distributed to all of the partner of the project, avoiding
focus on any one of project investor, this is the embodiment of risk elusion.
Observe all kinds of commitment and offer basic establishment guarantee
Insurance
agent
Engineering company
Construction company
Insurance contract
Design contract
Equipment contract
Self-identity
Government of
project
Enterprise body A
Enterprise body B
Enterprise body C
Financing contract
Project
company
Basic
establishment
Investment
manufacturer
Surety contract
Bank of
providing a
loan
Contract of creditor’s
rights transfer
Distribution
contract
Joint venture
contract
Repayment
by sales
Distribution
client
Repayment
of capital
Sales payment
Affiance
contract
surety
assignee
Surety of engineering
Fig.1 Risk allocation structure of project financing
For the partners of project, the risk category and degree that they would bear is different, risk
elusion is not averagely deal the risk to the partners, but adopt the basic principle of “distribute the
whole of some kind risk to the partner that adapt to them best of all”. For example, homeland
government wouldn’t take on commercial risk, but would bear political risk, foreign investor is on the
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other way round, they can take in hand commercial risk, but not political risk. The risk management of
project financing is distributing project risk in partners with reason by all kinds of contract and credit
surety agreement. The fig 1 reflected the risk elusion structure in all partners of project financing.
In a word, for the sake of lightening the risk of project financing, the investor needs ascertain the
key risk of project during their operating, evaluating the acceptable risk of each project and allotting risk
to related undertaker, namely risk allocation, combining project risk with financing structure, allotting
project risk to partner, completing the tremendous profit distribution with lofty negotiation ability
brightness and specialty level.
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5 Conclusion
After several ten years’ development, the project financing has got its own completed system of
theory and practice, Now, the project financing is one of the branches of international finance. As a
means of financing for the construction of large scale infrastructure projects, the project financing is
highly effective and is getting consummate. In this paper, aimed at five typical mode of project
financing, detailed research is made about its peculiarity and applied area, elusion measure and
allocation structure of different risk in project financing is offered.
Reference
[1] Ian H. Giddy, “Asset Securitization In Asia: An Overview”, Hill & Knowlton, 1998, 11(5): 112~120
[2] Bernadette Minton, Tim Opler and Sonya Stanton, “Asset Securitization among Industrial Firms”,
Ohin State University, November, 1997, 17(9): 73~86
[3] K. T. Yeoa, Robert Tiong, Positive Management of Difference for Risk Reduction in BOT Projects.
International Journal of Projects Management, 2000, 18(3): 185~190
[4] Jeff Ruster, Mitigating Commercial Risk in Project Finance, The Public Policy for the Private Series,
World Bank, February 1996: 335~340
[5] Benoit P. Project Finance at the World Bank: An Overview of Policies and Instruments, World Bank,
1997: 258~269
[6] Soldad. Genevieve, Increased Risk Appetite for Project Finance, Asia Money, Dec, 1996: 201~209
[7] Peter K. Nevitt, Frank Fabozzi: “Project Financing”, Euromoney Publication PLA, 1995: 57~88
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Author in brief
WANG Wen-quan, Male, was born in Apr 1973 graduated from North-Eastern University Sep
2003, earned doctor degree of administration, the direction of research including finance engineering
investment banking project financing; And now is engaged in the study of post-doctor in School of
Traffic & Transportation, Beijing Jiaotong University.
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