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AnintroductiontoprojectfinanceinemergingmarketsHenriqueGhersiyJaimeSabalEstudioIESAN°29 ©EsadeColección“Workingpapers”deEsadeMarzo,2006Depósitolegal:B-22537-2005ISSN:1699-5872EstepapersepublicaconautorizaciónexpresadeEsade,emitidael10deoctubrede2006.©IESA,2006HechoeldepósitodeleyDepósitoLegal:lf23920063304186ISBN:980-217-313-4ParaserpublicadocomoEstudioIESAuntextotienequeseraprobadoporelComitédePublicaciones.LasopinionesexpresadassondelautorynodebenatribuirsealIESA,asusdirectivosniaEdicionesIESA.Paracualquierinformaciónsobreesteestudio,favordirigirseaEdicionesIESA,Apartado1640,Caracas,Venezuela1010-A.Teléfono:58-212-555.44.52.Fax:58-212-555-44-45.Direcciónelectrónica:ediesa@iesa.edu.ve. ContentsAbstract......................................................................................................................................4Introduction...............................................................................................................................5Characteristicsofprojectfinance.......................................................................................5Typesofcontracts...........................................................................................................6Projectfinancevs.venturecapital.................................................................................6Projectconstituents................................................................................................................7Comparisonwithtraditionalfinancing...............................................................................7Riskanalysisandallocation.................................................................................................9Symmetricalrisks............................................................................................................9Asymmetricalrisks..........................................................................................................11Financialcostsandriskrating.............................................................................................12Conclusions.............................................................................................................................13References................................................................................................................................14 EstudioIESAAbstractTheuseofnon-recourseprojectfinancinghasgrownsteadilyinemergingmarkets,especiallyinbasicinfrastructure,naturalresourcesandtheenergysector.Becauseofitscostandcomplexity,projectfinanceisaimedatlarge-scaleinvestments.Thekeyisinthepreciseestimationofcashflowsandriskanalysisandallocation,whichenableshighleverage,andinensuringthattheprojectcanbeeasilyseparatedfromthesponsorsinvolved.Projectfinanceismoredifficultinemergingcountries,whichtendtoposeunpredictableriskswithunfavorablybiasedresults.Thisimposestheneedtointroducecontractual,financingandstructuralelementsthatyieldthemaximumpossibleexpatriationofoperatingflows.4 EstudioIESAIntroduction3.ThebulkoftheinvestmentisaimedattangibleassetsUnliketraditionalleveragepolicies,whichhave4.Thetotalityoftheproject’sassetsarepledgedbeengivenextensivecoverageinthefinancetofinancialcreditorsliteratureinthewakeoftheseminalworksof5.HighleverageisusuallyemployedMillerandModigliani(1958,1961),project6.Investmentsareusuallylong-term(e.g.,20financingisuniqueinthatitisnotdesignedforyears)businessesthatarealreadyunderwaybutrather7.Theonlypurposeofthefinancingistocompleteforthefinancingoflarge-scaleprojects.theproject,andassuchithasalimitedlifetimeSpecialfinancingforlarge-scaleprojectshasProjectfinancetendstobeusedinprojectswithincreasedsteadilyoverthelast40years,extend-tangibleassetsandpredictablecashflowsinwhichingchieflytotheareasofoil,petrochemicalsandtheconstructionandoperatingtargetscanbeeas-gas,infrastructure(e.g.,roads),telecommunica-ilyestablishedthroughexplicitcontracts(e.g.,re-tions,electricity,watersupplyandwastetreatment.fineries,mines,roads,etc.).ThereasonforthisisThisisatypeoffinancingthatcanfacilitatethatinsuchcasesitisrelativelyeasytoassesswhetherornottheworkhasbeencarriedoutsuc-theexecutionofprojectsanywhereintheworld,cessfullyandwithinthescopeoftheprogrammebutparticularlyindevelopingcountriesthatfaceasitwasoriginallylaiddown.seriousdifficultiesinsecuringfinancialresources.InthisdocumentwewillintroducethetopicofThekeytoprojectfinanceisintheprecisefore-projectfinancewithparticularemphasisonthecastingofcashflows.Ineffect,thepossibilityofestimatingcashflowswithanacceptablelevelofpracticeofthistechniqueinemergingcountries.uncertaintyallowsfortheallocationofrisksWewillsetforththegeneralcharacteristicsofamongstthevariousinterestedpartiesbasedonprojectfinance,andhowitdiffersfromtraditionaltheirrelativeadvantage.Theensuingcertaintyincorporatefinancing.Wewilldescribeeachofthecashflowsrenderstheexistenceofhighdebtlev-partiesthatusuallyparticipateandalsotheriskselsandenablestheprojectassetstobeseparatedinvolved,andwewillthengoontodiscusscrite-fromthecompaniesandsponsorsinvolvedinit.riaforallocatingbusinessflowsandrisks.WewillTheseparationofthebusinessisstructuredfinishbymentioningtheimportantroleplayedby1throughthecreationofaSpecialPurposeVehiclecreditagenciesinthismodeoffinancing.(SPV,alsocalledtheProjectCompany).Thislegalentityhasalimitedandindependentlife,andistheformalborrowerunderallloandocumentssoCharacteristicsofprojectthat,intheeventofdefault(and/orbankruptcy),financesponsorsarenotdirectlyresponsiblebeforefinan-cialcreditors.Instead,theirlegalclaimsareagainstInvestmentsthatareliabletobefinancedthroughtheSPVassets(i.e.,non-recoursefinancing).thismethodhavethefollowingmaincharacter-Thefactthatallfinancialobligationsareoff-istics:balancesheettothesponsorspresentsthegreat1.Projectsevolvethroughtwoclearlydif-advantageoflimitingtheirexposureincaseoffi-ferentiatedstages:constructionandoperationnancialdistress.Nonetheless,thesponsorsare2.Asthefinancingis“madetomeasure”,itsboundbycertaintypeofcontractualobligationsstructuringtendstobecostly,andthereforeis(underthecommercial,financialandconstructiononlyjustifiableforlarge-scaleprojectsdocuments)thatdefinethetermsofactionthroughoutthelifeoftheproject.Forinstance,itiscommoninemergingmarketsthatsponsorspro-1WeareindebtedtoLuisE.PaulBelloforhelpfulcomments.videprojectcompletionguarantees.5 EstudioIESATypesofcontracts•Thesponsor’scontrolovertheprojectislimitedWementionedearlierthatprojectsmustevolvethroughaclearly-definedcontractualthroughtwoclearlydifferentiatedstages:arrangement.constructionandoperation.However,forthe•Inprinciple,highercosts,giventhatthepurposeofensuringtheneatestpossibleisolation,contractorexpectsareasonablereturnonhistheseparationoftheenterprisefromtherestofinvestment.theactivitiesofitssponsorsandotherinterestedInthegeneralcasewherethesponsordoesnotpartiesmustbeveryclearlyestablished.havecompetitiveadvantagesinmanagingtheProjectfinanceinemergingmarketsiswidelyproject.thefinalcostsofdevelopingitdirectlywillusedbymultinationalcompanieswillingtolimitundoubtedlyexceedthefinaltallyofanycontrac-theirexposuretocountry,commercialandfinanc-tor.Hence,thelastdisadvantagemightnotapplyingrisksinherenttodevelopingeconomies.Insuchinpractice.Thisisespeciallytrueinthosein-casesthemultinationalentity(sponsor)seekstostanceswhenthesponsorisaninefficient(andtransfermostoftheseriskstobanks,ExportCreditevencorrupt)governmentalinstitution,acommonAgencies(ECAs)andmultilateralagencies.Multi-occurrenceinmanydevelopingcountries.nationalsponsorstendtoplayacentralroleintheTherearetwomainvariantsofBOT:BLTfinancing,constructionandoperationoftheir(Build,LeaseandTransfer)andBOO(Build,Ownprojects.andOperate).WhenthesponsoristhehostgovernmentofUnderBLT,oncetheprojectisfinishedandanemergingeconomy,thelongest-establishedandpaidfor,thesponsorleasestheassetsfromthemostwidespreadmethodofprojectfinancingiscontractorforacertainperiodoftimeduringwhichBOT(Build,OperateandTransfer),inwhichthethesponsorretainscontrolandoperatesthefacili-designatedStateagencydevelopsbiddingguide-ties.Whentheleaseexpiresthesponsortakesfi-linestoattractmultinationalconstructorsandop-nalpossessionoftheproject’sassets.eratorswhichwillfinanceandoperatetheproject.UnderBOO,thecontractorownstheassets,Asitsnameindicates,theagreementstartswithmeaningthattheyareneverreturnedtothespon-building,continueswiththeoperationofthefa-sor.Alongerhorizonforexploitingthefacilitiescilitiesforapre-establishedperiod,andconcludesshouldimplyamoremoderateyearlyreturnonin-withthetransferoftheoperationstothesponsor.vestmentforthecontractorandhencelowercostsUnderBOTthecontractorassumesallthetothefinalconsumer.projectrisks,takingchargeoffinancingarrange-Overtheyearsmanyothermethodshavebeenments,management,operationandmaintenancedevelopedthatprovidefordifferentpatternsofforapredeterminedperiodoftime,afterwhichownershipofthefacilitiesandcanincludethetheproject’sassetsarereturnedtothesponsor.originaldesignoftheproject,thefinancialstruc-Fromtheviewpointofthesponsorthereareturingand/orlong-termmanagement.certainadvantagesanddisadvantagesassociatedwithBOT:Projectfinancevs.venturecapitalBesidesnothavingtoparticipateasafinan-Acleardistinctionshouldbemadebetweenthecier,themainadvantageisthatthebulkofthetypeofprojectsthatlendthemselvestotheuseofproject’srisksremainwiththecontractor.projectfinanceandthosethatrequireventureca-Themaindisadvantagesare:pital,inwhichtheentrepreneursareexperimenting•Thecostsandcomplexitiesofsettingupthewithsomethingtotallynovel,thesuccessorfailurecontractualarrangementsfortheproject’sofwhichisnoteasilymeasurable,suchasinvest-financing.mentsinnewtechnologies.6 EstudioIESAThoseprojectsthatarebestsuitedtoprojectWithinthisgroupwemustdifferentiatebetweenfinancecanbeexpectedtodisplayahigherprob-commercialbanksandmultilateralinstitutionsabilityofpositivethoughrelativelymodestresults,(suchastheIFC,CAForIDB).whereasventurecapitalprojectsarecharacterizedInemergingmarkets,multilateralinstitutionsbyresultsthatarepotentiallyattractivebuthaveaarelikelytoplayakeyroleinprojectfinancingformuchlowerprobabilityofsuccess.atleasttworeasons:a)giventhattheyareconsid-ered“preferredlenders”,theirloansareviewedaslessriskyandthusendupbeinglesscostlythanProjectconstituentsregularbankloans,andb)theirparticipationasfinanciersisreadasapositivesignbycommercialFourwell-differentiatedgroupshavecontractualbanks,whicharethereforemorewillingtojoinin.arrangementswiththeSPVinatypicalproject:ExportCreditAgencies.Government-ownedoperatingconcerns,clients;governmentinsti-bankswhoprovideguaranteestoprojectlenders.tutions;andthegroupoffinanciers.ECAscoverbothpoliticaland/orcommercialrisksTheoperatingconcernsconsistof:sponsors,forthatcomponentoftheprojectcoststhatiswhotaketheinitiativetopromotetheproject;sourcedfromtheincumbentcountry(e.g.USprojectplanners,constructorsandsuppliers,whoEximbankwillguaranteethefinancingofequip-participateactivelyintheearlystagesofthementmanufacturedintheUnitedStates).project;andoperators,whomanagetheprojectOnefinancingarrangementthathasbecomeonceitisupandrunning.increasinglypopularinrecentyearsisthatof“A/Thentherearetheclients,whoacquiretheBloans”,throughwhichthemultinationalinstitu-productsand/orservicesarisingasaresultofthetionactsasthe“lenderofrecord”andthenpar-project,andthegovernmentinstitutionsthatholdticipatesportionsoftheoriginalloantopartici-legalandregulatoryresponsibility.pantbanks.QuiteoftenitisstateenterpriseswhotaketheFunds.Thesearespecializedfundsthatpartici-initiativetocarryoutaproject.Thusitisnotun-pateasdistinctivelendersthroughso-called“mez-usualforthesamegovernmentbodytoactasbothzanineloans”.Thereturnontheseloansisvari-sponsorandclient.ableandusuallytiedtotheproject’sfreecashflow.Thelastgroupisthatofthefinanciers,whoMezzaninefinancingissubordinatedtoallothersharetherisksoftheprojectonthebasisofapriortypesofdebtfinancingandisonlyseniortoshare-negotiationbetweenalltheinterestedparties.Theholders.financiersconsistof:EquipmentManufacturers.WhocanfinancetheirShareholders.Inadditiontothesponsors,theyequipmentsalesdirectly(“vendorfinancing”)orcanincluderiskcapitalfirmsandminorityshare-incooperationwithexportcreditagencies.holders.IndevelopedeconomiesmutualfundsInsurers.Whoassumemostoftherisksthatonlymightparticipateandsubordinateddebtmightbeinvolvethepossibilityofloss(knownasinsurableissuedinthecapitalmarkets.However,boththeserisks)andwhicharenotundertakenbyanyofthepracticesareuncommoninemergingmarkets.Inotherparties.emergingcountriesitisusualtofindforeignshare-holderswithcontrollingstakes.Occasionallyspon-sorsmightalsoparticipateassubordinatedcredi-Comparisonwithtraditionaltorsortakesomeconvertibledebt.financingBanks.TheygenerallytakeseniordebtandactasintermediariesfortheflowoffundsassociatedWeunderstandtraditionalfinancingasthatwhichwiththeproject(e.g.,bankaccounts,trusteeships).characterizesordinarycorporationswhosedebtand7 EstudioIESAequityinstrumentstendnottobedirectlylinkedThemaindifferencesbetweentraditionalfi-toanyofthefirm’sspecificoperations.nancingandprojectfinancearesummedupinthefollowingtable:Corporatefinancevs.projectfinanceItemCorporatefinanceProjectfinanceDestinationofthefinancingMultipurposeSinglepurposeDurationofthefinancingVariableLong-termandlimitedbythelifetimeoftheprojectFinancialstructureDebt-holdersnotrelatedDebt-holderstiedbyageneralagreementRiskanalysisHighlydependentonfinancialInaddition,technicalconsiderations,statementsandcashflowcontractualagreementsandthedebtstructureareallveryimportantLiquidityofthefinancialCanbehighiftheyarenegotiatedGenerallylow,asthefinancialinstrumentsoncapitalmarketsagreementisprivate,madetomeasureandimpregnatedwithcontractualrelationshipsFinancialcostsRelativelylowRelativelyhigh,owingtoboththestructuringcostsandthelowliquidityoftheinstrumentsRoomformanagementtoPlentyifthecompanyhasopenLittle,owingtotherigidcontractualmakedecisionscapitalstructureAgencycostsHighifthecompanyhasopenLow,asthecontractualstructurecapitalleaveslittlemarginforindependentactionbythepartnersSomecommentsshouldbemadeinconnec-alleviatesanycapitalrestrictionstowhichthespon-tionwiththiscomparison.sorsmightbesubject.Inprojectfinance,thecostsoffinancialdis-Thefinaldebt-to-equityratiowillhingeonbothtresstendtobelower.Thisisbecausethenegotia-theparticularcharacteristicsoftheprojectandthetionsbetweenthefinanciersresultinthesourcesfinancingarrangements.Themaindeterminantsofandusesoffundsbeingdefinedingreatdetail,leveragewillbe:leavingverylittletomanagementinthewayof•Incomelevelandrisk.Thisisaparticularlydiscretionarypowers.Thismakesitpossibletosignificantfactorwhenincomeistiedtoaachievehigherlevelsofleveragethanthosethatregulatedtariffstructurethatmightbeareusuallyseeninconventionalcorporatefinance.sensitivetopoliticalmanoeuvring.Thehigherlevelofleveragemakesfortwo•Costlevelandstructure.Thecostleveldeter-possibleadvantages:a)itguaranteesthebenefitminesnetincomewhereasthecoststructure,ofamoreattractiveincometaxshield,andb)it8 EstudioIESAmeaningtherelationshipbetweenvariableandLetustakealookateachofthese.fixedcosts,affectsprofitvariability.•Debtlevelandcoverage,ofbothprincipalandConstructionrisksinterest.HereweareconcernedwiththeriskoftheThecombinationoftheabovefactorswillde-projectnotbeingabletogetunderwayasorigi-terminethefinalperiod-by-periodfreecashflows.nallyplanned,orentailingunexpecteddelaysorThefundingwillbemoresecureandlesscostlycosts.Thekeyelementsforthistypeofriskarethehigherandlessunpredictabletheseflowsturnthecategoryofthecontractor,thequality,pricesouttobe.andvolumesofthesuppliesduringtheconstruc-tionphase,andthecharacteristicsofthetechnolo-Inaddition,riskallocationiscarefullyevalu-giesadopted.ated,structuredandnegotiatedonthebasisoftheadvantagesthateachpartyhasforassumingtheseItshouldbenotedthatatechnologythatisrisks.Consequentlytherisksareallocatedefficientlytriedandtestedmaybemorereliable,butcouldatthelowestpossiblecost.rapidlybecomeoutdated,withgraveconsequencesforthefuturecompetitivenessoftheproject.OnTheothersideofthecoinisthat,owingtoitstheotherhand,ahighlynoveltechnologymayin-complexity,thefinancialstructuringtendstobevolveseriousrisks.Thereforeitisimportanttoverycostly.Forthisreason,projectfinancerequireschooseatechnologythatnotonlysuitsthechar-theexistenceofacertainscaleandonlymakesacteristicsoftheprojectbutalsostrikesabalancesenseforlarge-scaleinvestments.betweentheoverlynovelandtheoverlyfamiliar.Furthermore,giventhatprojectfinanceisadGiventheirknow-howandtheabilitytocon-hoc,itssecurities,bothdebtandequity,usuallytrolthesetypesofrisks,theyarebestassumedbyhaveaverylowliquidity.Thisisacharacteristicthecontractorsandsuppliers,eachaccordingtofeatureofthistypeofbusinessandshouldbere-theirareaofresponsibility.However,emergingflectedintheexpectedyieldoftherespectivein-marketcontractorsoftenlacktherequiredfinan-struments.Ofcoursethereisalwaysthepossibil-cialstrength.Therefore,theirresponsibility(“liq-ityofcomingtoprivateagreementsguaranteeinguidationdamages”)tendstobelimitedtoacer-therepurchaseofthesecuritiesundercertaincon-tainpercentageoftheproject’svalue(e.g.,20%).ditions,dependingonthewishesofeachprovideroffunds.Anotherpossibilityistosetupan“Engineer-ing,ProcurementandConstruction”(EPC)agree-mentbywhichthecontractorisliabletofinishhisRiskanalysisandallocationworkwithinapredefinedtimeperiodandforastipulatedamountofmoney(lumpsum).How-Perhapsthemostimportantkeytosuccessinanyever,hedoesnotguaranteethedebt.projectfinanceschemeliesinriskanalysisandInemergingmarkets,asizeableportionoftheallocation.Wefindtwotypesofrisks:symmetricalriskthatisnottakenbythecontractorsisusuallyandasymmetricalrisks.retainedbythesponsorsthrougha“completionguarantee”issuedinfavorofwhoevercommis-Symmetricalriskssionedtheproject.However,onlyrarelycontrac-Theserisksmayyieldnotonlylessfavorablebuttorsareliablefordamagesoncetheprojectentersalsomorefavorableresultsthanoriginallytheoperationalphase.expected.Symmetricalriskscomprisethoseinherentintheconstructionphase,risksofaBusinessrisksbusinessnature,andthoseassociatedwithThissortofriskarisesoutofunexpectedfluc-macroeconomicvariables.tuationsindemand,sellingpricesand/orvariable9 EstudioIESAcosts,andmayyieldresultsthatdifferfromthoseconstructionandtheoperationstages.Theimpactthatwereexpected,withthepossibilityoffar-oftheforeignexchangeriskwilldependonthereachingeffectsondebtservicingcapacity,andonimbalancebetweenrevenueandexpenditureintheshareholderearnings.strongreferencecurrency(e.g.,US$).Asthesearerisksthatareinherentinthebusi-Itisalsoimportanttotakeintoaccounttheness,theyshouldinprinciplebebornebytheshare-correlationsbetweencashflowsinlocalcurrencyholders.However,debt-holdersusuallyretainpartandtheexchangerate.Whenthecompany’scashofthisriskinexchangeforlargercollateral.flowsinlocalcurrencyarecorrelatedwiththeex-Itisalsocommontotransferpartofthisriskchangerate,therealforeignexchangeriskislessthroughoff-takeagreementswithclientsorsup-thanitwouldappear,asinthiscasetheoperatingpliers.Theseagreementsareusedtofixvolumesflowsinlocalcurrencybehavewhollyorpartlyasand/orpricesofinputsorendproductsbefore-cashflowsinforeigncurrency.handwithmajorsuppliersorclientswhousuallyForeignexchangeriskscanbemitigatedbyhaveabettercreditratingthanthatoftheproject.seekingabalancebetweenthesensitivitiesofrev-Thestandardpracticeinemergingmarketsistoenueandexpendituretoexchangerates,withthetieoff-takeagreementstooff-shoreaccountsinaresultthattheirimpactonequityisassmallasdevelopedcountryorataxhaven.possible.Onewayofdealingwiththeseimbal-Oneingeniousthoughscarcelyusedsolutionancesistonegotiateagreementswiththesourcestocombattheriskofpricefluctuationistoissueordestinationsofthefundsthatinonewayorbondswhoseyieldiscloselycorrelatedwiththeanothercanshiftpartoftheforeignexchangerisk.priceoftheproduct.Forexample,theinterestcou-Anumberoffinancialinstrumentsarealsoavail-poncanbelinkedtothepriceofaparticularcom-able,eitheroverthecounteroronfinancialex-modity.changesthatenabletheseriskstobetransferredOnespecialcaseisthatofreserverisk.Thisisatotallyorpartially,atacost.veryspecifickindofbusinessriskthatapplieswhenTheso-calledexchangeratelagtendstobepar-theprojectisaimedatexploitingsomenaturalre-ticularlyimportantinemergingcountries.Itoccurssource(e.g.,oil,mining)andreferstotheuncer-whenthereisastrongdivergencebetweenthede-taintythatmayexistregardingtheextentofthevaluationandinflationrates.Whenthelocalcur-reservestobeexploited.Thisisariskthatisdiffi-rencyisdevaluedmoreslowlythanthedifferenceculttotransferandhastobenegotiatedbetweenbetweeninflationabroadandathome,amonetarythesponsorsandthebusinessshareholders.overvaluationresultsandgivesrisetoanapparentadvantageforindebtednessinforeigncurrency.TheMacroeconomicrisksoppositehappenswhenthelocalcurrencyisreval-Theseriskshavetodowithgeneralmacroeco-uedmoreslowlyandthereisanundervaluation.nomicvariables,particularlyrelevantinemergingTheexchangeratelagisunsustainableinthecountries,asmanyofthemareknownfortheun-longterm,assoonerorlaterparitywilltendtodisciplinedmanagementoftheirtaxationandmon-seekabalancewithpurchasingpower.Thisgener-etarypolicies.allytakesplacebymeansofmaxi-devaluations(orMacroeconomicrisksfallintothreecategories:maxi-revaluations)thatheightentherisk,especiallyforeignexchangerisks;inflationrisks;andinterestintheeventofimbalancesbetweenassetsandli-raterisks.abilitiesindifferentcurrencies.Itshouldbemen-a)Foreignexchangerisktionedthatexchangeratelags,suchasdelaysinFluctuationsintheexchangeratecanaffectthethedevaluationofthelocalcurrency,aremuchnetcashflowoftheprojectthroughoutboththemorecommonthanexchangerateadvances.10 EstudioIESAThisriskalsotakesonimportancewhenfluc-Thevolatilityofthecreditgapcangenerategreattuationsintheexchangerateaffectthebalanceuncertaintyregardingthecostoffunds.sheetitems(assetsandliabilities)unequally.Thus,Standard&Poor’shavetwoindicesforthekeepingcheckontheforeignexchangeriskrequirescreditgap:onereflectingindustrialcompanieswithtimelyadjustmentofboththeitemsofrevenuehighsolvency(investmentgrade)andtheotherforandexpenditureandthoseofassetsandliabilitiesindustrialcompanieswithappreciablerisk(specu-indifferentcurrencies.lativegrade).Theinstrumentsderivedfromtheseb)InflationriskindicesofferaninterestingwayofcoveringtheInmuchthesamewayaswiththeexchangevolatilityofthecreditgap.rate,inflationcanaffectthebalancesheetitemsIngeneraltermsthecontrolofmacroeconomictotheextentofjeopardizingtheequitybase.Inrisksshouldbetheresponsibilityofthefinanciersordertoprotectit,constantvigilanceandadjust-asawhole,butparticularlytheshareholders.mentisneededinthecompositionofassetsandliabilities.AsymmetricalrisksEqually,thenetoperatingflowsareaffectedUnlikesymmetricalrisks,asymmetricalriskscandifferentlydependingontheintensitywithwhichonlyyieldunfavourableresults.inflationhitsthedifferentitemsofrevenueandAmongasymmetricalrisks,wecanmentionexpenditure.Inflationaryimbalancesbetweennetenvironmentalrisks,breachofcontract(e.g.,con-operatingflowsandfinancialcommitmentscanbetractorsandfinanciers),accidentsorinsurableriskscompensatedfinancially,forexamplebyissuing(e.g.,fire),forcemajeure(e.g.,wars,majorearth-debtatavariableinterestrate.quakesorfloods),andespeciallypoliticalrisks,Ingeneral,thebestwaytomitigateexchangewhichtakeongreatimportanceinemergingcoun-andinflationriskisbymaximizingtheproportiontries.ofcashflowsinstrongcurrenciestobechanneledWewilltakeacloserlookattwoofthesetypesthroughoff-shoremechanisms.ofrisks:politicalrisksandtheriskofbreachofInthecaseofprojectswithregulatedprices,contractbyfinanciers.exchangeandinflationriskarebestamelioratedbyindexingtariffs.However,thisstrategyisquitePoliticalriskssensitivetopoliticalrisk,atopictobedealtwithTheseentailsomeunexpectedgovernmentin-furtheron.terventioncausingdefaultofobligationsorsig-c)Interestraterisknificantlyaffectingthereturnsexpectedbythesuppliersoffunds.Failuretocomplywithcontrac-Fluctuationsininterestratescanalsohaveantualagreements,expropriations,changesinlawsundesirableeffectoncashflowsandtheequityorregulations,pricecontrolandexchangerestric-position.Thistypeofriskcanbemanagedthroughtionsaregoodexamplesofpoliticalrisk.durationortransfertechniquesbymeansofswapsorotherinstrumentsavailableeitheroverthePoliticalriskneedsnotnecessarilybeassumedcounteroronthefinancialexchanges.initsentiretybytheshareholders,andcanbeman-Intoday’sinternationalfinancialmarkets,thereagedinvariousways.Onefairlycommonpracticeareinstrumentsformanagingtheinterestrateriskthatisparticularlyimportantinemergingmarketsassociatedwiththecreditgap.Thecreditgapmea-istoincorporateinfluentiallocalpartners(includ-surestheborrower’screditriskandisequaltotheingthegovernmentinstitutionsthemselves)whodifferencebetweentheinterestrateonabondandmaybeabletopalliateoratleastgivesomewarn-therateofatreasurybillwiththesamematurity.ingofanycounterproductivemeasures.11 EstudioIESAAnotherfrequentpracticeistosubmitcertainisaminimumofcertaintythatthecreditorswillcontractsassociatedwiththeprojecttothejuris-havesufficientfundstorepaytheircredits,thisdictionofcourtsindevelopedcountries(e.g.,modeoffinancingbecomeslessrecommendableUSA).Thisservestoreducetheriskassociatedasasymmetricalrisksbecomemoremanifest.Thiswiththelegalandinstitutionalinstabilitythatisconstitutesaproblemforemergingcountries,whichcharacteristicofmanyemergingcountries.ispreciselywheretheseriskstendtobemostinThereisalsoanotherhighlyrelevanttypeoftheforefront.politicalriskthatisassociatedwiththeissueofexchangerates:transferrisk.ThisriskreferstotheimpossibilityofconvertinglocalflowsintohardFinancialcostsandriskratingcurrency,orofremittingcashflowsabroad,asaresultoftheintroductionofexchangecontrolsorRiskratersplayanimportantpartinthecostofothermeasurestakenbythelocalauthorities.financingprojects.NotonlydoesamoderateTransferriskandotherpoliticalriskscanbeleverageratiohaveapositiveeffectonthecredittransferredtoprivateinsurersandgovernmentratingbutfurthermore,ifaprojectinanemergingsponsoredinsuranceinstitutions(e.g.,theOver-countryhasundergonewell-managedriskanalysisseasPrivateInvestmentCorporationorOPIC,inandallocation,theprojectmayevenachieveamoretheUSA).favorablecreditratingthanthatofthecountryinwhichitistotakeplace.TheparticipationofexportcreditagenciesandmultilateralbanksasfinanciersisanimplicitThekeyelementsforthistohappenareasfol-mechanismtoamelioratecountryrisk,sinceanylows:lackofcompliancewiththeseinstitutionsaffects•Theoperationsshouldpreferablybeunder-notonlytheprojectbutthecreditworthinessoftakeninasectorofcriticalimportanceforthethecountryasawhole,withpotentiallycostlypo-localgovernment,giventhatundersuchliticalandeconomicconsequencesattheinterna-circumstancesgovernmentsarelesslikelytotionallevel.takedecisionsthatareharmfultotheventure.•NoleadingpoliticalactorshouldhaveincentivesRiskofbreachofcontractbyfinancierstoaffectprojectoperationsnegatively.Theriskconsideredhereisthatoftheproject•Whereapplicable,sovereignimmunityshouldnotreceivingthesumsoffinancingontimeandinbeeliminatedandthereferencelegalsystemtheamountsinitiallyplanned.Themagnitudeofshouldbeonewithsatisfactoryrisk(e.g.,US).thistypeofriskshouldbeestimatedbysettingup•Theproject’slegalstructuringshouldbescenariosreflectingwhatmighthappeninrelationsafeguardedagainstthegreatestpossibletothefinancialcapacityoftheprovidersoffundsnumberofunforeseencircumstances.inthefuture.•PenaltiesandothercostsforbreachofcontractThistypeofriskhasadirectimpactontheshouldbehigh.capitalizationoftheproject.Themoresignificant•Theprojectshouldgenerateamajorflowofitis,thegreatertheadditionalcontributionoffundsexports,andalargepartofthecorrespondingmustbe.cashflowshouldbedepositedinforeignbankSymmetricalriskstendtoreflectaprobabilis-accountsfromwhichmanyofthedebtswithticprofitstructurethatismoreorlessbalancedfinanciersandsuppliersofmaterialsandaroundthemean,whereasasymmetricalriskstendequipmentcanbewrittenoff.Furthermore,ittocausebimodalbehaviorintheresults.Givenisdesirableforalargeportionoftheexportsthatprojectfinanceisonlyattractivewhentherebesubjecttooff-takecontracts.12 EstudioIESAConclusionstheexistenceofacertainscaleandonlymakessenseforlarge-scaleinvestments.TheactivitiesthataremostlikelytobesuccessfullyTherisksmustbestudied,evaluatedandne-financedthroughprojectfinancearecharacterizedgotiatedbearinginmindeachparty’sadvantagesbybeinglarge-scaleinvestmentswithastrongforassumingtheserisks,withtheaimofensuringtangibleassetcomponentandtwoclearlytheirefficientallocationatthelowestpossiblecost.differentiatedstages:constructionandoperation.TwomaincategoriesofriskscanbeidentifiedThecentralpurposeofthefinancingmustbetheinprojectfinance:symmetricalrisks,whichtendexecutionoftheprojectinquestion.toreflectaprobabilisticprofitstructurethatismoreUnlikeventurecapitalprojects,whicharechar-orlessbalancedaroundthemean;andasymmetri-acterizedbyresultsthatarepotentiallyattractivecalrisks,whichtendtocausebimodalbehaviourbuthavealowprobabilityofsuccess,thoseprojectsintheresults.Projectfinancingbecomeslessrec-thatarebestsuitedtoprojectfinancedisplayaommendableasasymmetricalrisksbecomemorehigherprobabilityofpositiveyetmodestresults.manifest.Thisconstitutesaproblemforemergingcountries,whichispreciselywheretheseriskstendThekeytoprojectfinanceisintheprecisees-tobemostintheforefront.timationofcashflowsandriskanalysisandallo-cation.ThisgivesrisefirstlytothepossibilityofThekeyfactorsforthefinancialcostsofprojectfinanceinemergingcountriestobeaslowaspos-highleverageatanacceptablerisklevel,andsec-sibleare:thattheprojectshouldaffectastrategi-ondly,theeasyseparationoftheprojectitselffromcallyimportantsectorforthehostcountry;thatitsthefirmsinvolvedandthesponsors,inordertocashflowsshouldbechanneledandallocatedout-limitanycollateraldamagewhichmightbecausedsidethelocalfinancialsystem;andthatthecon-bythefailureoftheenterprise.tractsshouldbesafeguardedagainstthegreatestTheothersideofthecoinisthat,owingtoitspossiblenumberofunforeseencircumstancesand,complexity,thefinancialstructuringtendstobeinsofarasthisispossible,tiedtoahigh-credibilityverycostly.Forthisreason,projectfinancerequireslegalsystem.13 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