What is Project Finance?
Project finance is the process through which long term industrial and infrastructure projects are financed and which are primarily repaid through the estimated cash flows from the project rather than trustworthiness of the sponsors.
What are Key Features of Project Finance or Project Loans?
Key features of project finance or project loan are as under:
- Non-Recourse-It means that the creditors have limited claim to the value of assets secured.
- Expensive-these projects require huge floatation costs as compared to other.
- Separate Legal entity-a separate legal entity is formed for execution of these projects.
- Long term- these projects mostly lasts for more number of years
- Capital Intensive-these projects requires huge amount of debt and equity
Risk Allocations-risks like currency risk, supply risk, funding risks, market risks, political risk etc are involved in these projects.
Key participants are involved in the project:
- Government: participate indirectly in the form of approval and control of the company that sponsors it.
- Project Owners or Sponsors-owners having major equity stake in the project.
- Sponsors may be industrial sponsors-includes industrialists who have connections with the project and their core business as well, Public sponsors-includes central or state government or municipalities, Sponsors or Contractors-these are mainly individuals who organize, build or initiate the projects
- Contractors: are mainly liable for the technical specifications involved in the contract.
- Operator: maintains the quality level involved in the project.
- Customers: who wish to buy the outputs of the project
- Commercial Banks: finances the fund involved in the project. In case of bigger projects requiring huge funding, normally project financing is done by forming consortium or syndicates of many banks.
Stages involved in Project Finance
Stages involved in Project Finance: Generally, three stages are incorporated in the Project Finance Process:
- Pre Financing: Firstly this stage involves lenders to identify the project plan, analyzing the same with the underlying objectives of the companies giving Financial Services. Secondly risks involved should be recognized and right steps should be carried out for minimizing the same. Thirdly, lenders should check out the feasibility of the concerned project in terms of finance and technical aspects. For same, the lender banks asked for detailed project report along with CMA data. The project report and CMA data are reviewed and analyzed comprehensively by the lender to determine project feasibility and financial viability of the project.
- Financing Stage: This stage includes arranging fund from financial services whose goals subsist in the project. Lenders and Borrowers negotiate the amount of loan following the documentation and verification of policies related to the project. After completing documentation, the loan amount is sanctioned.
- Post Financing: In this stage, project is monitored at regular basis so as to maintain the quality of the project. Project ends in this stage, following the repayment of loan from the estimated cash flows.
Types of Projects Financing
Types of Projects Financing:
Generally, the projects are financed through:
- Working Capital lending and domestic term
- ECB- External Commercial Borrowing
- Foreign Direct Investment in SPV (Special Purpose Vehicle), developing the project
These projects can also be financed through debt instruments such as availing credit from Export Import Bank of India, debentures. Infrastructures Companies are also financing through issuing Rupee denominated bonds.
Following documents are required to be accounted for project financing:
- Loan Agreements
- Security documents which includes the following
- Hypothecation deed creating a charge on current assets, movable assets
- Mortgage documents creating a charge on land (which may includes memorandum of director’s declaration, indenture of mortgage etc)
- Agreement on share pledge, non disposal undertaking
- Sponsors undertaking or guarantees
- Direct Agreements
- Project report for bank loan and CMA data
- In case where multiple lenders are involved: agreements on inter-creditor settlement
- In case of case-by-case basis-Security trustee and Facility Management agreement
- Agreement on escrow account (trust and retention account)
Project Financing in India
Project Financing in India is used for Brownfield and Greenfield projects in Manufacturing (Cement), Education, healthcare, telecommunication, Public Infrastructure (road, metro rail, ports), Construction, Energy (Power generation _solar, thermal, wind, hydro, power transmission etc)
General Regulatory Framework:
Depending upon the nature of the project finance undertaken, following legislations may apply:
- The Reserve Bank of India Act 1934 and guidelines, notifications issued in connection with the same.
- The Banking Regulation Act 1949.
However in following cases, loan availed is governed by their respective legislation:
In case of external commercial borrowings (ECB), Foreign Exchange Management Act 1999 prevails read with the:
- Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations 2000.
- Foreign Exchange Management (Borrowing or Lending in Rupees) Regulations 2000.
In case of Project funding where equity or quasi-equity instruments are used by non-residents:
- Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations 2000 of the RBI.
- The foreign direct investment (FDI) policy issued from time to time by the Department of Industrial Policy and Promotion (DIPP).
Apart from the general regulatory framework, following material laws should also be taken into consideration:
- Companies Act 2013-regulates matters related to procedural compliances, registration of charge on company’s assets, conversion of debt into equity and in relation to availing of loans and creation of security by companies.
- Indian Contract Act 1872-governs contracts which include security documents .and loan agreements.
- Transfer of Property Act 1882-regulates procedure and creation for enforceability of security over immovable property.
- Securitizations and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI)- regulate enforceability of security for recovering However these benefits do not prevail to foreign creditor except to that of Asian Development Bank and related International Finance Corporation.
- Insolvency and Bankruptcy Code 2016- It covers partnerships, companies, individuals in relation to bankruptcy and insolvency legislations
- Code of Civil Procedure 1908 (CPC)-governs procedure for resolving disputes and civil court proceedings to be used by the creditors for enforcement of security and recovery proceedings.
Following Regulatory Authorities governs different types of projects. These authorities include:
- Airports Authority of India.
- NHAI-National Highways Authority of India.
- Highways and Transport for road projects.
- Maritime Boards, Port Tariff Authority, port trust of the respective states accompanied with any authority concerned.
- Regulatory commissions set up for electricity projects
Apart from above, India has also entered into international treaties that influence cross-border project financing transactions like Free trade, Comprehensive Economic Partnership and Co-operation Agreements, Preferential Trade Agreements etc