Project Finance

Question: Case study on Project Finance. Answer: Project Finance Project finance refers to the financing of infrastructural construction and industrial projects on a long term basis. The funding of the projects is based on the financial structure of limited recourse. The cash flow obtained fr4om the object is then used to repay the debt that was used to fund the project. The reasons why public-private partnerships (ppp) are common in project finance. Public-private partnerships are common in project finance because of the benefits that come with such partnership. In most cases, the projects are huge and can take several years to be completed. The projects always require financing that runs into billions of dollars. Considering the sizes of the projects and the amount of financial funding that is involved, most of the projects are owned jointly. Public and private partnership, therefore, tends to be common in the financing of such projects. The two partners consult each other in their control of the project. The joint ownership has the following advantages: Joint ownership allows for sharing of risk between the partners. The public and private partners would be able to share risks that may be associated with the project finance. It is always very tricky if a risk arises when the sponsors of project finance have pledged that they would guarantee the completion of a project. The partnership would reduce the cost involved. The two partnerships would jointly raise the total amount of money needed to alleviate the risk. According to (Puentes, 2016, pg. 41), Joint partnership of sponsors also allows sharing of ideas and knowledge. The exchange of ideas generates new skills that may be of great benefit in the financing and development of the project. Financial skills, as well as operational skills, can all be shared between the sponsors. The project may be so massive that it cannot be funded by a single private company or a single public institution. It is, therefore, necessary for the sponsors to join hands together and raise the needed amount of money. The partnership would enable the sponsors to raise the needed amount of money without any problem. A project site may also be immense such that a single sponsor may be unable to marshal the managerial capacity that is required. The partnership would hence enable the sponsors to share the managerial task. They would then be able to manage the project with ease. Greater commitment is likely to attract project lenders to release money with ease. The partnership between a public and a private sponsor is an evidence of significant commitment. (Fhwa, 2012, pg. 15), confirms that development of some projects may demand that the sponsors lease some of their assets. Lesser partners may not have enough assets that can be leased. However, sponsorship partners drawn from the public and the private sectors would obviously have the capacity of owning several assets of huge value. They would hence not face any problem when it comes to the leasing of some of their property. The task of project finance demands specialization of the highest order. There must be an availability of financial experts as well as technical experts. The lending firm would first assess the level of experts in place to judge the expected projects productive capacity. A sponsor would require engineers, financial consultants, accountants, lawyers, auditors and environmentalists among other experts. Such experts can only be withdrawn from the public sector in collaboration with the industry. Public-private partnership in project finance, therefore, makes it quite easy to access such experts and at reasonable costs. Risks Related to Public-Private Partnerships There is the need for identification of risks that may be associated with a project throughout its life to have a successful project. The identified risks must then be evaluated and managed well. A public urgency must address all the obstacles that may hinder the project from being successful. An available opportunity must also be used effectively to improve success. Public-Private Partnership in itself is a way of risk management. There are several risks that are associated with public-private partnerships. (Fhwa, 2012, pg 34), states that, most of the risks can be used to assess that the loan borrower can also be exposed to too. However, project finance is more prone to the risks. The case of project finance arises because the borrower doesnt possess assets that can be used as security. The lender will hence incur high losses if the borrower defaults to repay the loan. Lenders must, therefore, be very conservative when carrying out their calculations. The case will not be the same if the loan is secured because the associated risks would have been minimized. The recoverable resource is an example of the risks. The lender has to find out whether the amount of the resources can adequately cover all the commitments if the prices of the resources fall. However, the lender may seek revenue guarantee from the government authority if the development project is to the public for example infrastructure and generation of electricity. The other risks are as follows: Political will According to (Puentes, 2016, pg. 37), senior government officials must offer their support from the government must provide their support for the project for it to be successful. Such support must come from both the executive wing of the government and the legislative wing too. Lack of government commitment may lead to the withdrawal of the private partners from the implementation of a project. An agreement may be reached between the government and the private partner, but some government officials may simply block the allocation of funds meant to finance a project. The project may eventually be canceled. Such cancellation of projects arising from non-commitment from the government may make private partners shy away from partnering with the government again. Regulatory risks (Nettler, 2016), states that, regulatory risks arise when inappropriate project framework has been put in place. The government and the private partners should come up with clear regulations that are meant to govern the development of the project right from the beginning to the end. The government should not come up with restrictions of any kind once regulations have been agreed and put in place. Any further restrictions may be judged as non-commitment. Site Risk Several risks may arise from the site where the project is to be developed. The suitability of the place may prove to be a major challenge. The presence of archeological remains and unfavorable geological conditions may prevent the implementation of the project. The poor relationship between the government and the residents may also cause problems. The residents may become hostile towards the implementation of the project. Community relationship must, therefore, be taken into consideration before the implementation of any project in a given area. Successful Factors in Public-Private Partnership Selection of politically smart projects (Xhang, 2016), states that, it is important to understand the existing political environment before choosing a project. Despite the fact that the public would retain ownership of the project, the private partners also have control over the project. The partners should, therefore, come up with a project that would be supported by the majority of the political stakeholders. Such support would facilitate successful implementation of the project. The lenders would also be willing to allocate financial resources for the development of the project. Understanding the needs of the Private Sector The public partner should come up with projects that are in the interest of the private sector. The sector would never enter into a partnership to develop a project that they consider a threat to the public. Transparent procurement process Project finance involves an enormous amount of money. It, therefore, involves competitive procurement procedures. (Puentes, 2016, pg 22), confirms that transparency should be upheld during the entire process. Issues of corruption in during the acquisition process may lead to an abandonment of the whole project. The procurement process is a sensitive stage and should be carried out with maximum care to ensure the success of the project. Reference list GAO, 2014. Bank Capital Reforms: Initial effects of Basel on Capital, Credit and International Reforms. United States Government Accountancy Office Apra, 2012.Regulation Impact Statement: Implementing Basel III Capital Reforms in Australia. Basel Committee Fecility Barker, 2015. The Reserve Bank Application of the Basel III Requirement for Banks. Australian Reserve Bank Kevin Davis and Mark Lawrence, 2015. Australian Banking. Monash University Press iCreate, 2016. Basel III. Basel III Committee, 2016. World Finance on Basel III. Patrick Sabol and R. Puentes, 2016. Private Public Capital Good. Brookings Education Jonathan Nettler, 2016. 6 Risks of Public-Private Partnership.