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What is project finance?

What is project finance?

Project finance is the financing of, often long-term, industrial projects and increasingly those which provide public services or infrastructure. They are often based upon complex financial and contractual structures commonly involving many legal entities.

The cash flows from the project are usually the sole means of repayment of the borrowed funds. The risk of the transaction is generally measured by the creditworthiness of the project itself rather than that of its owners (sponsors).

Project finance debt is often termed as “non-recourse.” The debt is typically secured by the project assets and the core project contracts.

Practically, there are two main types of project financing:

  • Greenfield – a fresh start
  • Brownfield – expansion of an existing project

History of project finance

Project finance has been used by the Romans and Greeks as solutions to raise funds to export goods to other parts of the known world. It was also used for the development of the Panama Canal, but project finance really gathered momentum in the 1980′s and 90′s, when the ability to analyse complex cash flows increased in line with desktop computing power and availability.

During the 1990′s and 2000′s, governments grasped the opportunity to have the private sector assist in the development of assets and services under the PFI/PPP umbrella. In essence, there is little difference between project finance and PFI/PPP but the two approaches vary greatly when debt pricing, debt tenor, documentary and often transaction size and frequency are compared.

Project finance is a core service of developmental banks and they often facilitate companies developing projects in transitional and emerging markets where traditional bank finance would be practically impossible.

The risks

Project financing is all about identifying risks, allocating them appropriately and ensuring that the responsible parties are adequately incentivised to manage their risks efficiently. With often billions of dollars on the line, multiple parties involved, including sponsors, contractors, suppliers, host governments and global financiers, it is no surprise that from the inception of an idea to financial close, a project finance deal can take years to negotiate. Just some of the risks usually considered are:

  • Construction time, costs & specification
  • Operational cost, reliability
  • Supply reliability, quality, cost
  • Off-take volume, price
  • Political environment, war, local hostility, currency inconvertibility
  • Labour quality, availability
  • Socio-environmental responsibilities
  • Legal, documentary and tax risk
  • Modelling and analytical risk
  • Macroeconomic risks

Who is involved in a project financing?

A typical greenfield project financing involves many different parties, including:

  • Sponsors to ‘champion’ the construction of the asset
  • Construction parties to build the asset
  • Certifiers – to confirm it is built to specification
  • Lead arrangers/underwriters – to provide primary debt funding
  • Syndicated lenders – to reduce the exposure of the lead banks
  • Insurers – to cover many of the insurable risks
  • Consultants – to provide expert opinions and services as needed
  • Lawyers – to ensure the required contracts/agreements are in place
  • Off-take parties – to secure the sale of the end product or service

The role of consultants in project finance is extensive and varies from project to project, but common to most transactions are experts in the following fields:

  • The particular market of the product
  • Financial modelling (and model auditors)
  • Environmental
  • Engineering
  • Process design and costing
  • Insurance
  • Economists
  • Industrial relations
  • Government liaison experts and lobbyists

What are the benefits of using project finance?

There are many benefits to funding a project with a project finance package, these are namely:

  • Comparatively low finance cost
  • Does not impact the balance sheet of the sponsor (“off balance sheet”)
  • Widely available around the world
  • Debt capital markets are ‘deep’ ~ 20 trillion US dollars in 2006
  • Most risks have well understood structural solutions available
  • Well organised and reputable providers

What are the drawbacks of using project finance?

Project finance is a great solution to many funding requirements; however it does have several drawbacks, including:

  • Generally only used for special projects rather than corporate finance
  • Long transaction time
  • High fixed transaction costs owing to number of parties
  • Highly restrictive covenants and security constraints
  • Robust financial analysis needs to be performed and validated
  • Frequent monitoring of financial performance
  • A payment default usually passes ownership/control to the lender(s)

Who provides it?

Project finance debt is provided in many forms by hundreds of companies around the world. It is traditionally sourced from:

  • Investment banks
  • Commercial banks
  • Infrastructure funds
  • Government export credit agencies
  • Development banks
  • Multilateral agencies
  • Hedge funds

Common used abbreviations in project finance

  • DSCR – debt service cover ratio (debt service coverage ratio)
  • LLCR – loan life cover ratio (loan life coverage ratio)
  • PLCR – project life coverage ratio
  • RLCR – reserve life coverage ratio
  • DSRA – debt service reserve account
  • LIBOR – London inter-bank offer rate
  • PRI – political risk insurance
  • PFI – private finance initiative
  • SPV – special purpose vehicle
  • PPP – public private partnership
  • ECA – export credit agency

Development organisations

  1. The World Bank
  2. MIGA
  3. EFIC
  4. KFW
  5. International Finance Corp
  6. Asian Development Bank
  7. European Bank for Reconstruction and Development
  8. The United Nations
  9. United Nations Development Projects
  10. Development Bank of Southern Africa
  11. The Equator Principles
  12. African Development Bank
  13. International Monetary Fund
  14. Overseas Private Investment Corporation

Publications & periodicals

  1. The Journal of Structured Finance
  2. Global Finance Magazine
  3. Project Finance Review (including Deal-Logic)
  4. Project Finance Magazine
  5. Thomson Deals (project finance)
  6. Power Finance & Risk

Industry links

  1. OPEC

Project finance links

  1. International Project Finance Association
  2. Standard & Poors
  3. Moodys
  4. Fitch Ratings
  5. Harvard Business School (Project Finance Portal)

Project finance advisors

  1. DNA Project Finance

Central banks

  1. The Federal Reserve
  2. The Bank of England
  3. The Reserve Bank of Australia
  4. BIS (Bank of International Settlements) Database


  1. Decisioneering (Monte Carlo Simulation Tool)
  2. Palisade (Monte Carlo Simulation Tool)

Online information

  1. The CIA World Fact Book
  2. Econometric Time Series

Rickard Wärnelid
by Rickard Wärnelid

Rickard's passion for financial modelling is built on specialist roles in the highly quantitative fields of derivatives and project finance, a career path complemented by an academic grounding in engineering physics. Born in Sweden and with global consulting and leadership experience, Rickard is an internationally recognised authority, speaker and thought-leader on the organisational benefits of best practice financial modelling.

Contact Rickard Wärnelid

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