Hello everyone. This is the first session that we spend together in this course
and it is really the introductory session
where we try to understand a little bit more in detail,
what's the meaning of financing and investing in infrastructure in modern time.
In particular, we will focus our analysis on Project Finance.
Professor, what is Project Finance and
what does distinguish Project Finance from traditional corporate finance?
Project Finance is the financial technique that the private sector has
envisaged in order to finance on a privately basis complex infrastructure.
In a sense, I would say the term is indicative because
project finance is the financing of one specific project namely an infrastructure.
If you want, there is a clear correspondence between one project
and one entity that is created with the sole purpose to design,
to build, and to manage that specific infrastructure.
And that company goes under the name of Special Purpose Vehicle.
You can understand that there is a basic difference between
project finance and the traditional corporate finance.
In traditional corporate finance,
one company can carry out more than one project simultaneously and
basically an existing company looks for money to banks or to capital markets,
in order to fund a portfolio of initiatives.
While instead in project finance,
you are looking for money in order to finance one specific initiative.
So there is a clear correspondence between one single project and the entity
that will be entitled to carry out this initiative from the beginning to the end.
Where is project finance applied?
Could you give us some data regarding sector and market evolution?
A nice question. I would say,
project finance has a lot of applications.
So if you look at the universe of infrastructure,
infrastructure involves many sectors from oil and gas to power generation,
from transportation projects to telecom,
from water and sewerage to social infrastructure,
where social infrastructure involves building and management of prisons,
schools, hospitals, social housing, et cetera.
So you can understand that the spectrum of
possible sectors interested in the field is very large.
However let me say that,
if we look at the data available in the market,
particularly in recent times,
there are clearly some sectors that retain the most in term of financing.
And these sectors are typically power generation, oil and gas,
transportation and from time to time with
a higher degree of volatility among the different years, telecommunication networks.
So these are basically the four sectors that retain
the largest proportion of project finance commitments by banks and sponsors.
From a geographical point of view instead,
if you are interested in geographical development of the market,
I would say that out of the total bulk of financing that has
been recently committed to project finance and we are in the region of 220,
250 billion on a yearly basis between 2012 and 2013,
there has been a clear reallocation of funds
from more traditional industrialized countries, the western one.
So let's say, Europe,
Middle East, and Africa,
and United States and Canada to fast growing economies.
If you look at the breakdown of the evolution of the market recently,
most of the funding have been pumped and provided
to Asia Pacific and Middle East where the need of
infrastructure is more sought after and the need to
fill in the gap of infrastructure is particularly relevant.
It is also because those areas have suffered a little bit
less in terms of the result of the financial turmoil.
And when and where the public administration is still have
dry powder on the public balance sheet in
order to sustain the development of private infrastructure.
Why is project finance
the most used financial techniques
by private sectors in supporting infrastructure projects?
Nice, nice question indeed.
There are a number of reasons why project finance has emerged as
the most used technique for providing finance to privately financed projects.
Let me give you some basic indications.
One on the sponsor's side,
the other on the lender's side.
On the sponsor's side,
you can understand that if in normal circumstances,
you develop a new project like an infrastructure which is typically
a very complex project triggering the use of a large amount of funds,
typically long term with a long payback period,
if you are an existing company and you finance this initiative on your own balance sheet,
there is case that if for whatever reason the project gets bankrupt,
this could trigger some contamination on all the other assets
that you are managing and so it could also trigger the bankruptcy of the company itself.
If instead you resort using project finance,
at the end of the day you set up a new special purpose vehicle.
This new special purpose vehicle ousts
the new initiative that you are running and so you as a shareholder,
when you provide a certain amount of money you limit your responsibility and also limit
your losses to the maximum amount of equity
that you have injected into the vehicle itself.
So from this point of view,
avoiding contamination risk is
an important benefit from the sponsors point of view because on one side,
the level of default risk for the sponsor or the sponsors is reduced significantly.
Second, because if contamination risk is reduced you could
also avoid the negative effect of an increased weighted average cost of capital.
So an increased cost of funding on
the existing company's balance sheet and this is
certainly something that shareholders look very favorably.
On the lenders side instead,
the reason is very simple.
If I am a lender,
a bondholder, or a bank,
and I want to finance one specific project because I love
that project and I consider that project as something that deserves my money.
I don't want to mix up this project with
all the other projects that the company has already in place.
Because I simply don't want to share the cash flow that
the SPV will be able to generate with other creditors,
preexisting creditors of the company.
Another reason why creditors typically love project finance because
is something that can help me to concentrate on one specific initiative.
So, my evaluation exercise will be based only on analyzing if
that specific project will be able to
generate sufficient cash to repay principal and interest.
I don't have to take anything else into account
because it is something that will remain outside the special purpose vehicle.
