Co-published project finance guide: Interview A glass half full


If you are a sponsor looking for finance, you’ve no doubt seen better days. Here’s the bank counsel’s perspective on how to navigate today’s market


By Danielle Myles, editor G


avin Skene is an executive director at Morgan Stanley responsible for providing legal coverage to the firm’s global


project, commodity and infrastructure finance desk, which has been principally focussed on US and LatAm projects over the past 12 months. He spoke with IFLR on why project bonds are the way forward, how renewables will spur innovation, structuring in light of scarce bank liquidity, and the world’s most successful public private partnership (PPP) programmes.


IFLR: What factors do you see spurring innovation in project finance over the next two years? As a general matter, the uncertain


economic climate – contributed to by the lingering eurozone crisis, impending debt maturity wall faced by many corporates, and looming US fiscal cliff set for the end of the year – will no doubt cast a shadow on the years ahead. As a result, I think there will be increasing momentum to finance projects in the capital markets, rather than in the traditional bank markets. But looking at innovation in project finance specifically, I think we’ll see three emerging themes. First, there is a huge, global and


immediate need for infrastructure development. There is, of course, a serious lack of money at the government level to pay for this. So there will be – or in the US they are hopeful for – stronger


development of PPP models. I think that will simply be a necessity to meet these infrastructure needs. Secondly, the growth of international


energy consumption markets, combined with relatively low gas prices, means that we are likely to see a stronger emergence of LNG [liquefied natural gas], gas to liquids, and regasification projects – at all levels of the upstream/downstream spectrum. We have been working on a number of projects in this space and expect the trend to continue over the next 12 months given the price and demand for gas. Finally, I also think environmental policy


will shape the next couple of years, certainly with respect to the impact of carbon emission trading schemes. Overall, I think this will foster greater development in the renewable industries. On the innovation front, there may be an opportunity for the development of co- build facilities – being the combination of fossil fuel and renewable energy generation at the same site – leading to a more valuable and sustainable product.


IFLR: You are a proponent of project bonds. Don’t bondholders’ aversion to construction risk and decision-making difficulties present hurdles to the instrument becoming a mainstream source of funding? I think it’s largely a myth that these risks


“It’s largely a myth that these risks are


impediments to the success of project bond financings


” www.iflr.com


are impediments to the success of project bond financings. Over the last five to 10 years there is an established track record of large greenfield projects in different sectors – from PPPs in Canada, to LNG projects in the Middle East – that have successfully used project bonds. Bondholders have become increasingly adept at assessing these risks and measuring the strength of any mitigants in the same way as project bank lenders. That said, it does, however, somewhat


depend on the type of the bond investor and market. For example, Rule 144A institutional investors typically take a more passive approach, and are increasingly happy to defer their decision-making responsibilities to independent third parties (such as an independent engineer), bank lenders in bank/bond financings (on the


theory that whatever is good for the bank lender is also good for them), or upon the receipt of a ratings affirmation. However, by contrast, investors in the 4(a)(2) private placement market (usually insurance companies and pension funds) typically wish to take a more active role in the credit, meaning that the instrument becomes more like bank paper than bond paper – they want a heightened degree of control and reporting. I’ve recently worked on a transaction where the sponsor started with Rule 144A styled papers with broader covenants, but the 4(a)(2) private placement investors – once they get involved – started beating them back towards a set of bank papers. Overall, I think the instrument will only


increase in popularity as a viable source of capital in the financing of projects as years go on.


“Looking at innovation in project


finance, I think we’ll see three emerging themes


”


IFLR: Basel III capital charges have forced many banks to scale back their long-term lending programmes. How can sponsors structure their projects to attract the limited bank liquidity that remains in the market? Basel III is one part of it. The general


economic overlay surrounding the eurozone crisis, contraction in European project bank lenders (which have historically been the backbone of much of the market), and other regulatory capital legislation like Dodd-Frank have also had an impact. Taken together, that means a scarcity of bank finance, and limited ability to deploy what is left for long tenors – resulting in shorter dated tenors and a reduction in available capital. Perhaps one exception are the Japanese lenders. For the right project and the right sponsor (usually Japanese), many of them are willing to lend for the longer tenors that we saw pre-crisis. But on the whole, sponsors have to think


long and hard as to how to structure their projects with limited bank capital available. If you can’t employ the use of bonds, say because of the cost of the negative carry, I think it can be increasingly difficult. Structurally, sponsors will need to ensure


IFLR/December/January 2013 67


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