Chapter 8 - Project Finance and PPPs

Abstract

The recent growth of public–private partnerships (PPPs) is closely linked to the financing technique known as "project finance," which itself is a relatively recent development. Project finance is a method of raising long-term debt financing for major projects. It is a form of ‘financial engineering’, based on lending against the cash flow generated by the project, and depends on a detailed evaluation of a project's construction, operating and revenue risks, and their allocation between investors, lenders, and other parties through contractual and other arrangements. As such, it is well suited to financing PPP projects. "Project finance" is not the same thing as "financing projects," because projects may be financed in many different ways—it is evident that a project could be financed by public sector debt using public-sector procurement instead of a PPP. The growth in project finance is linked to some of the same factors that have led to the growth in PPPs. Project-finance structures differ between various industry sectors and from deal to deal: there is no such thing as ‘standard’ project finance, since each deal has its own unique characteristics. But there are common principles underlying the project-finance approach. It is provided for a ‘ring-fenced’ project, carried out through an SPV, and is usually raised for a new project rather than an established business. There is a high ratio of debt to equity and lenders usually rely on the future cash flow of the project for payment of their interest and loan repayments (‘debt service’), rather than the value of its assets or analysis of historical financial results. Project financing is used for PPP projects because of its higher leverage, risk spreading, and long-term finance.