The Treasurer’s Guide to Trade Finance

A Reference Guide to Trade Finance Techniques

Project finance

Project finance is usually arranged to finance
large-scale construction and manufacturing
projects, including roads, mineral extraction
plants, power stations and pipelines, as well as
ships and aeroplanes. Because of the nature
of the assets or even business that is being
financed, project finance is not always defined
as a trade finance technique.
The scale of these projects, which typically
involve a large number of different companies,
means a separate entity is usually established
to manage and fund the project.

How it works

The underlying principle is that the separate
entity is legally independent from all the
participants. This entity accepts funds from
banks and other sources. In turn, it funds the
various participants to perform their tasks.
The entity will enter into contracts with those
participants, who will commit to providing a
set service by a predetermined date. If the
contractors do not complete their work by that
date, the entity will have recourse to them.
Once the project has been completed, the
financiers will receive revenue from its ongoing
operation. There is no further recourse to the
contractors.
There are variants of project finance
structures which are particularly suitable to
financing projects in developing countries.
‘Build–operate–transfer’ schemes involve the
same underlying structure, a legally separate
entity established to build the project, but this
is granted the right to operate the completed
project for an agreed period of time, before
control of the project is transferred to the
government or other body for a specified sum
(sometimes zero).
Countertrade is a feature of some projects
in developing countries. Again, the underlying
structure is the same, with a separate legal
entity being responsible for delivery of the
project. In this case, the financiers will be
repaid by taking control of the output of the
project. For example, in the case of a project
to build a mine to extract copper, the financiers
would receive the raw copper, which they
could then sell on the open market. This could
be subject to an output limit, for example the
financiers have control of 25% of the output,

and/or a time limit, for instance up to ten years.

The remainder is controlled by a new entity

which will take ownership of the project after

the time limit has been reached. In the case

of countertrade, the country which is seeking

to finance the project will not need to find the

funds to construct the original project.

Advantages

ƒ Because the project is managed by a

separate legal entity, participants are able to

keep those activities separate and at arm’s

length from the rest of the company.

ƒ Funds do not have to be arranged locally.

Because of the existence of a separate

legal entity, funds can usually be arranged

on international markets, either through

loans or bond issues. These funding

streams are not dependent on the appetite

of individual local markets, which is

especially important for infrastructure-type

projects in relatively small countries.

ƒ The separate legal entity also helps to

manage the country risk associated with any

project, especially when significant funds

are injected into the project from abroad.

Disadvantages

ƒ Despite the arm’s-length structure, it can

be difficult to manage country risk. This

is particularly the case for high-profile

infrastructure projects, where the local

government may be tempted to interfere in

the progress and operation of the project.

ƒ Project finance relies on significant legal

documentation to protect the interests of

all participants. This can take some time to

agree initially. In the event that one party

does not meet its commitments, seeking

resolution can also be difficult and costly in

terms of time and money.

Evaluation

Project finance is best suited where a discrete

project can be identified and where a number

of different companies will be participating in

the construction process.

For companies seeking to participate in a

construction project abroad, it provides the

mechanism to hold the project at arm’s length,

reducing country risk.