Project Risk Analysis

Risks in Project Financing
PROJECT RISK ANALYSIS2
CONTENTS
Introduction1
Identification of Risk.................................................................................3
Currency related risk................................................................................4
Forward Contracts.................................................................................5
Swaps Contract.....................................................................................5
Futures contract....................................................................................6
Options contract....................................................................................6
Permit, Concession and License Risk.......................................................6
Change of law risk....................................................................................7
Expropriation Risk....................................................................................8
Demand Risks/ Revenue Risk/ Offtake Risk............................................10
Supply Risks...........................................................................................11
Operating Risks......................................................................................13
Delay Risk..............................................................................................14
Technological Risk..................................................................................14
Environmental Risk................................................................................15
Credit Risk/ Counterparty Risk...............................................................17
2 Author: Astha Misra, S. Prathyusha, Shalini Wunnava, LL.M., National Law University,
Jodhpur

Force majeure Risk.................................................................................17
Cross-border Risks..................................................................................18
Mitigating Risks Through Investment Structure.....................................19
Bilateral Investment Treaties..................................................................20
Multilateral Investment Treaties (MITS)..................................................22
ICSID......................................................................................................23
Conclusion..............................................................................................25
INTRODUCTION
Project financing may be defined as the raising of funds on a limitedrecourse or nonrecourse basis to finance an economically separable
capital investment project in which the providers of the funds look
primarily to the cash flow from the project as the source of funds to
service their loans and provide the return of and a return on their equity
invested in the project.3 Project financings typically include the following
basic features
1. An agreement by financially responsible parties to complete the
project and, toward that end, to make available to the project all
funds necessary to achieve completion.
2. An agreement by financially responsible parties (typically taking the
form of a contract for the purchase of project output) that, when
project completion occurs and operations commence, the project
will have available sufficient cash to enable it to meet all its
operating expenses and debt service requirements, even if the
project fails to perform on account of force majeure or for any other
reason.
3. Assurances by financially responsible parties that, in the event a
disruption in operation occurs and funds are required to restore the
project to operating condition, the necessary funds will be made
available through insurance recoveries, advances against future
deliveries, or some other means.
A project financing requires careful financial engineering to allocate the
risks and rewards among the involved parties in a manner that is mutually
acceptable. The business of project financing is founded upon the
identification, assessment, allocation, negotiation, and management of
the risks associated with a particular project. Indeed, as project finance
lenders look to the revenues generated by the operation of the financed
3 JOHN D. FINNERTY, Project Financing: Asset-Based Financial Engineering, 1 (John Wiley
& Sons, 2007).
1 | Page

project for the source of funds from which that financing will be repaid, the
whole basis for project financing revolves around an understanding of the
future project revenues and the impact of various risks upon them. Risk is
a crucial factor in project finance since it is responsible for unexpected
changes in the ability of the project to repay costs, debt service, and
dividends to shareholders. Risks must be identified in order to ascertain
the impact they have on a projects cash flows; risks must be allocated,
instead, to create an efficient incentivizing tool for the parties involved.
Cash flows can be affected by risk, and if the risk has not been anticipated
and properly hedged it can generate a cash shortfall. If cash is not
sufficient to pay creditors, the project is technically in default. If a project
participant takes on a risk that may affect performance adversely in terms
of revenues or financing, this player will work to prevent the risk from
occurring. From this perspective, project finance can be seen as a system
for distributing risk among the parties involved in a venture. In other
words, effectively identifying and allocating risks lead to minimizing the
volatility of cash inflows and outflows generated by the project. This is
advantageous to all participants in the venture, who earn returns on their
investments from the flows of the project company.
Most of the time allocated to designing the deal before it is financed is, in
fact, dedicated to analysing (or mapping) all the possible risks the project
could suffer from during its life. Above all, focus is on identifying all the
solutions that can be used to limit the impact of each risk or to eliminate
it. Risk allocation is also essential for another reason. This process is a
vital prerequisite to the success of the initiative. In fact, the security
package (contracts and guarantees, in the strict sense) is set up in order
to obtain financing, and it is built to the exclusive benefit of original
lenders. Therefore, it is impossible to imagine that additional guarantees
could be given to new investors if this were to prove necessary once the
project was under way. The process of risk management is crucial in
project finance, for the success of any venture and is based on four closely
related steps 1) risk identification, 2) risk analysis, 3) risk transfer and
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allocation of risks to the actors best suited to ensure coverage against
these risks, and 4) residual risk management.
IDENTIFICATION
OF
RISK
Risks inherent to a project finance venture are specific to the initiative in

question; therefore, there can be no exhaustive, generalized description of
such risks. This is why it is preferable to work with broader risk categories,
which are common to various initiatives. The criterion used to identify risk
is chronological, an intuitive choice, seeing as this parameter is generic
enough to be usable across different sectors of application. An essential
aspect of the project finance lawyers role in helping the parties reach a
bankability assessment involves reviewing the project, and in particular
its underlying documentation, in order to identify its potential and
fundamental risks and to determine if, and how appropriately, those risks
have been allocated among the parties.
A project goes through at least two phases in its economic life
1. The construction, or pre-completion, phase
2. The operational, or post-completion, phase
These phases have very distinct risk profiles and impact the future
outcome of the initiative question in different ways. In keeping with our
chosen criterion, the risks to allocate and to cover are
1. Pre-completion phase risks
2. Post-completion phase risks
3. Risks common to both phases
The various types of risk are
1.
2.
3.
4.
5.
6.
7.
8.
Permit, Concession and License Risks

Currency-related risks
Expropriation Risks
Change of Law Risks
Political Risks
Country Risks
Law and Legal Systems Risks
Construction Risks
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9. Demand Risks/ Revenue Risk
10.
Supply Risks
11.
Operation Risks
12.
Cross-border Risks
13.
Environmental Risk
14.
Credit Risk or Counterparty Risk
15.
Force majeure Risk
16.
Delay Risk
17.
Technological Risk
The importance of risk to project finance has been stated several times.
There are no complete definitions of risk, but it is often considered in
relation to uncertainty and incomplete information. An uncertain or
unknown future event can have a potential negative impact on some
characteristic of value/the business and that is what is most often
understood by risk. In relation to project finance it is as mentioned very
important to identify, assess and allocate the risks. As the lenders place a
large degree of reliance on the performance of the project, they will
naturally be concerned with the feasibility of the project and its two
possible events affecting it negatively. The aforesaid risks that have been
enlisted dealt with separately in the following chapters.
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RISK
Strategic
risk
Economic risk,
Industry risk,
Strategic
transactional
risk,
Social risk,
technological
risk,
Political risk,
Organisational
risk
Reporting
risk
Operational risk
Environmental
risks, Financial
Risks
Business
Continuity Risks,
Innovation risk,
Commercial Risk,
Project risk,
Human resource
risk,
Health and Safety
risk,
Property Risk,
Reputation Risk
CURRENCY
Information
Risk,
Reporting
Risk
Complaince
risk
Legal and
regulatory Risk,
Control Risk,
Professional Risk
RELATED RISK
This sort of risk develops when some financial flows from the project are
stated in a different currency than that of the SPV. It mostly occurs in
international projects where cost and revenues are work out in different
currencies. Even in the domestic project a similar situation may arise,
when counterparty wants to bill the SPV in foreign currency. The best
possible ways to cover tis kind risk is currency matching, means advisors
of an SPV try to state as many flows as possible in the home currency,
avoiding any use of foreign currency. If this is not possible (usually
because counterparties have strong bargaining power), the following
coverage instruments provided by financial intermediaries must be used4:
1. Forward agreements for buying or selling
2. Futures on exchange rates
4 GATTI STEFANO, Project Finance in theory and practice Designing, Structuring, and
Financing Privateand Public Project 37 (Academic Press, 2008).
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3. Options on exchange rates
4. Currency swaps
One of the ways to manage the currency risk is Derivatives contracts.
Covering financial risk in a project finance venture does not differ greatly
from policies on corporate treasury management, though there is a major
difference which is that the project life of such ventures is always longer
than the time horizon for which these instruments are traded. In
particular, this is the case regarding coverage instruments listed on stock
exchanges and for some over-the-counter derivatives (such as futures on
exchange rates). For this reason, structured finance transactions most
often involve specific negotiated forms of coverage earmarked specifically
for the project or use rollover strategies on standard contracts as they
reach maturity5.
Forward Contracts
This kind of contract involves an exchange with a delayed settlement in
which the traders set down contract conditions (specifically the date of
settlement and the price) upon signature of the contract, and the
exchange is actually settled at a future, pre-agreed date. A forward
contract might pertain to a currency exchange rate (on maturity, the
traders sell each other one form of currency for another on the basis of an
exchange rate set when the contract is drawn up), a financial asset, or an
interest rate. In the cases where the price is fixed when the contract is
made and remains unchanged until settlement, any potential fluctuations
in the quotation on exchange rates, interest rates, or the financial asset in
question do not affect the two parties, so both are covered. But where the
listed prices rise above the negotiated price level of the forward contract,
the buyer is at an advantage; the reverse will occur if the listing falls
below the agreed-on price level. (Naturally, for the seller the opposite is
5 Supra note 2, p. 37.
6 | Page

true.)6 Forward contracts are used for the most part as coverage against
exchange rate risks.
Swaps Contract
The contracts which are made between two counterparties that stipulate
reciprocal disbursement of payment streams at pre-established future
dates for a set period of time are known as Swaps. A swap is a
combination of several forward transactions. In any case, the payment
streams relate to interest calculated on given principal. When interest
rates are stated in two different currencies, we refer to currency swaps,
and the two streams can be either fixed rate or variable rate. When
interest rates pertain to the same currency, obviously one of the flows is
calculated at a fixed rate and the other at a variable rate. Contracts
known as interest rate swaps, in their simplest form, are a periodic
exchange of fixed-rate streams against variable-rate streams (usually
indexed to LIBOR or Euribor) for a given time horizon. Swaps are usually
used to modify the conditions of a pre-existing loan. These are over-thecounter contracts which are handled by intermediaries on the basis of the
specific needs of a trader, which make them contractual structures that
are well suited to covering currency risk and interest rate risk in project
finance deals.
Futures contract
Future contract is a forward agreement in which all contractual provisions
are standardized (the underlying asset, date of maturity and date of
delivery of the instrument in question, minimum contract lot). The future
markets offers contracts written on the most widely exchanged currencies
on an international level.
Options contract
The contracts which are either listed on the stock markets or negotiated
over the counter, that allow (but do not oblige) the buyer to purchase (call
option) or sell ( put option) a commodity or a financial asset at a fixed
6 Supra note 2, p. 38
7 | Page

price (strike price) at a future date in exchange for payment of a premium.
Unlike all the contracts discussed previously, it let the buyer choose
whether or not to settle the contract. And because of this the buyer pays
premium to the seller as a cost of this choice. In project finance deals,
options are used both for covering currency rate risk and protecting an
SPVs cash flows from interest rate risk.
This kind of currency risk can be managed by (1) borrowing an appropriate
portion of project debt funds in U.S. dollars, (2) hedging using currency
forwards or futures, or (3) arranging one or more currency swaps.
PERMIT, CONCESSION
AND
LICENSE RISK
There are many facets to regulatory risk mainly consist of permit,

concession and license risk, the most common are the following:
1. The permits which are needed to start the project are usually delayed
or cancelled by the regulatory authorities.
2. The basic concessions and permission for the project are unexpectedly
renegotiated.
3. The core concession for the project is revoked.
These kinds of delays or risks are usually caused by inefficiency in the
public administration or the complexity of bureaucratic procedures. If in
case these delays are the resultant of specific political intent to block the
initiative, the situation would become more similar to political risk.
CHANGE
OF LAW RISK
Political risk takes in various forms and change of law is one kind of that
risk. Any change in the political situation can also bring the change in law
and administration which may not share the same view as the previous
one. The modification in law can result in hinder project operations. This
kind of risks are more common to find in the countries which do not have
a very well defined legal structure, mostly have political unstable
government, and law can be easily be change according to the will of the
8 | Page

government and political leaders in power. The primary focus of this risk is
on projects lenders, whose lawyers analyse and manage the risk. Their
jobs is to ascertain in advance that any change in the commercial laws of
the host country can bring any kind of problems during the construction or
post completion phases.
It should be noted that contract enforceability does not depend
exclusively on the degree of economic development in a country but also
involves a series of other factors, such as a countrys judicial tradition and
the institutional conditions and context characteristics and changes which
come in them with the passage of time period.
There are two ways through which these risks can be covered
1. To draw up an agreement with the government of the host country
stating that the government will create a favourable environment for
the sponsors and SPV in the case of change in law.
2. To provide an insurance market. Insurance policies are available
offering total or partial coverage against these risks. These policies are
offered by multilateral development banks and export credit agencies
as well as by private insurance companies.
The magnitude this problem has reached has led various research
organizations to compile indices that actually measure the degree of
corruption and reliability of political and administrative institutions of a
given country.
With change in law often led the project-sponsor to devote considerable
time and effort to obtaining the appropriate legislative and regulatory
approvals to allow a project to proceed. The existence of such hurdles can
have a significant impact on the sponsors decision on where to build the
project. Making the appropriate arrangements with the host country
government can reduce substantially, or even eliminate, this problem.
EXPROPRIATION RISK
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International investors and lenders face the risk of expropriation of their
project investments. Projects in foreign jurisdictions and in particular those
in politically unstable or developing countries must be structured to
ensure that there is both contractual and treaty protection to safeguard
such investments.
Historically, the lack of appropriate mechanisms open to foreign investors
and lenders to protect projects and the associated risks caused a
restriction in the flow of international investment into certain countries. In
order to overcome this difficulty, to remedy the concerns of investors and
lenders and to improve the flow of investment funds, there have been an
increasing number of contractual protections that have become market
standard for international projects and treaty protections for investors and
lenders such as bilateral and multilateral investment treaties between
states.
In recent years there has been a marked increase in the number of
investors and lenders that have sought compensation from states
perceived by investors and lenders to have expropriated their projects.
This has been in part due to the internationalisation of projects and the
ability of investors and lenders to seek recourse for such expropriation
through investment treaties.
In a nutshell, expropriation is the taking of a project by the state, whether
for public purposes or otherwise. As case law on expropriation has
developed, so the understanding of what is and what is not expropriation
has become clearer. At a basic level, expropriation can be divided into
direct and indirect expropriation.
Direct expropriation is where the state exercises its sovereignty over a
project either on an individual basis or as part of a wider scale
nationalisation programme. Generally direct expropriation is a clear action
by the state that transfers title of the project from the investors to the
state and as such provides clear grounds for the deprived investors to
seek compensation from the state; for example following Venezuelas
10 | P a g e

expropriation of oil projects in the Orinoco Belt in 2007. In other words the
investors and lenders have a specific action and point in time from which
they can measure the states liability.
Indirect expropriation is less specific. As GC Christie surmised:
1. a state may expropriate property, where it interferes with it, even
though the state expressly disclaims any such intention, and
2. even though a state may not purport to interfere with rights to
property, it may, by its actions render those rights so useless that it will
be deemed to have expropriated them.
Commentators
have
described
indirect
expropriation
variously
as
disguised, creeping and consequential expropriation, for example the

refusal to renew or the withdrawal of a licence (Tecmed v Mexico)7,
undermining contractual arrangements (CME v Czech Republic)8
and
termination of contracts for irrelevant reasons (Azinan v Mexico)9. For an

investor and its lenders the main issue is that there is no clear single
action by the state and as such the moment from which compensation
should accrue may lack definition. The investor may therefore find itself in
a position where it is unclear whether it should continue to operate the
non-profitable project or abandon it and try to claim that expropriation has
taken place due to the states indirect interference. It is worth noting that
not all changes to legislation or regulation by a state which are to the
detriment
of
project
can
be
classified
as
expropriation.
Non-
discriminatory measures that are lawfully taken by a state, including the

introduction of quotas, changes to taxation, environmental protection,
labour laws and other measures may not be deemed to be expropriation
despite the loss suffered by the investor and lenders and as such little or
no compensation would be available to the investor and lenders in such
7 ICSID Case No ARB (AF)/00/2
8 UNCITRAL, Partial Award 13 September 2001.
9 ICSID Case No ARB (AF)/97/2 (Robert Azinian and Others v United Mexican States).
11 | P a g e

circumstances. Such non-discriminatory measures however must be in
line with international law and must not have the effect of eviscerating
the rights of the investor (Eureko v Poland)10.
In short, the risk is that following a direct or indirect expropriation the
investor is not compensated. Investors and lenders would argue that any
expropriation by the state should result in sufficient compensation from
the state to ensure that the investor is in no worse a position than if the
expropriation by the state had not taken place. However, from case law
the general trend is for the expropriating state either to seek to justify its
expropriation
of
the
asset
or
project
and
thereby
not
pay
any
compensation, or claim that no expropriation has taken place and

therefore no compensation is due, such as in Metalclad v Mexico11.
POLITICAL RISK
The form of risk most commonly considered in financial arrangements
relates to political risks. Essentially, these are risks that arise from political
and governmental circumstances and behaviour in the jurisdiction at
issue. These include less severe circumstances such as change in
government (which may occur at fixed intervals in many contexts but may
be less predictable in other contexts), legal changes ( for example ,as a
result of new legislation or treaties) and the classic consideration of
nationalisation(i.e., government seizure or expropriation of assets). At the
outset, the most effective management technique is simply to locate
projects within stable political environments. Though it is not always
suitable or desirable, as additional levels of risk should bring with them
possibility of higher rates of return. Political risk is not completely
ameliorated by a close relationship with the government of the time, as
governments and political arrangements and political arrangements
should carry on with the commitments of previous governments and
10 RG 2006/1542/A Brussels CA
11 ICSID Case No ARB (AF) /97/1.
12 | P a g e

regimes,
this
may
not
be
politically
acceptable
in
the
actual
circumstances. While direct involvement and commitment of the host

government are genera;;y essential, at the same time , depending upon
actual circumstances, this may not be sufficient to manage and mitigate
political risk concerns.
Political risk component contains three risk factors. The first is investment
risks, which relates to currency convertibility and transfer a component,
which has to do with government restricting the outflow of money from
the country and converting the cash flows into other currencies. This is
often necessary as the loan taken on the project is denominated in other
currencies than the one of the host country. Developing markets often
have poor financial markets that are not capable of providing the funds
needed for the project, in which case the loan is denominated in foreign
currency. Investment risk also includes the risk of expropriation of the
investment by the government and war or internal and external conflicts,
which makes the project unable to function properly or entirely. The
second component of political risk component is change of law which
include factors like: price controls, withdrawal of permits, licences or
concessions, deregulation of the market introducing new competitors,
increases in tax, tariffs, import duties or controls. All of which could create
some of the input or revenue risks discussed previously. It also includes
new rules and requirements on environmental issues, safety, health and
employment. All of these can interfere with the operation of the project
and the primary political risk is in government interference by changing
the current setting in which the project operates. Under this is also
creeping expropriation, which is found in the last political risk, component:
Quasi-political risk. This also includes sub-sovereign risk, the risk that
lower levels of officials interfering with the projects viability, and breach of
contract which incorporates the risk of the host government not honouring
their obligations or the legal system not being objective. This risk of the
legal system not providing objective ruling is also mentioned earlier as the
many contracts in a project finance deal depends on the legal system of
the host country.
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Issues which commonly arise in relation to such cover include
1. The
scope
of
political
risk,
including
regulatory
risk
and
administrative risk;
2. Whether or not political risk includes events in more than one
country or different states of the host country;
3. The relationship between political risk and other normal project risk
( for example completion risk);
4. The extent to which a shareholder( particularly a local shareholder)
can influence events which compromise political risk; and
The consequences of a political risk event occurring and how it affect, for
example, shareholder obligation to achieve completion, liability of
shareholders under indemnities provided to export credit agencies or the
basic agencies or the basic liability of the borrower.
COUNTRY RISK
The risk that a foreign government will significantly alter its policies or
other regulators so that it negatively impacts the business climate in that
country or the returns on a particular industry, company or project. Macro
country risk deals with policy changes that harm, say, exporters or foreign
owned businesses in general ,while micro country risk implies that a
government will deliberately target a particular company or way of
making a living. For example, the political climate of a country in which
defences contractors operate may turn against one particular company
because of its perceived excesses or against contractors in general. This
may cause the government revoke contracts for one or more defence
contractors. Country risk varies from one country to next. Some countries
have high enough risk to discourage much foreign investment. Country
risks are basically assessed on the basis of a track record, and the
maintenance of such a track record cannot be taken for granted.
International Country Risk Guide bases its analysis on corruption risk,
expropriation risk for private property and risk of contract repudiation. For
each country, this guide complies statistics on the level of exposure with
said risk. It is easy to see that in these cases, contracts are likely to be
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evaded if the institutional system does not adequately safeguard the
rights of lenders. Narrowly defined, country risk is refers to cross currency
and foreign exchange availability risks. More broadly defined, it can also
include the political risk of doing business in a given country. Country risk
is essentially a weighted average of the political or financial factors that
are perceived to constitute country risk. Once a country risk is measured it
can be incorporated into a capital budgeting analysis by adjustment of the
discount rate. The adjustment is somewhat arbitrary, however and may
lead to improper decision making.
LAW AND LEGAL SYSTEM RISKS

Additional risks are associates with foreign investment, leading regulatory
and other laws, or the lack of them and different legal systems and
cultures. The local laws of the jurisdiction where the project is located
should be carefully examined by the project participants, particularly the
project sponsor and lenders, early in the structuring and documentation
process. The legal system of most emerging countries continue to be less
developed and in industrialized countries. This results in a degree of
uncertainty as to the legal environment the project must construct and
operated in. It also provides uncertainty to the project lenders, if
compelled to enforce their rights. Significantly considerations include
access of foreign entities to judicial system, enforceability of foreign
judgements, whether arbitration is permitted for dispute resolution, and
enforceability of arbitration awards. An acute problem facing project
financing investments is the state of the judicial systems of many Latin
American countries. International project finance in these countries can
proceed only so far without the host countrys institutional and legal
support to help manage various risks. All too often, the element of legal
risk as a result of the poor quality of judicial systems and other dispute
resolution alternatives overcomes the projected profit margin and
discourages potential foreign lenders and investors In these nations, legal
risk can translate into many different obstacles for project financing
should there be an impediment or conflict. Unfortunately, many Latin
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countries have slow, bureaucratic, inefficient and corrupt judicial systems
when compared to similar institutions in the U.S. and Europe. To
compound matters, the disputes that originate from international projects
can be technically complex, and many of these countries courts do not
have the requisite resources and technical comprehension to incorporate
the findings of expert third-party participation. Differing legal cultures
almost always require expensive international litigation procedures, each
carrying cross-cultural challenges that require the support of lawyers,
translators, experts and an ever-growing list of professionals. Along the
way, there is another form of risk to be mindful of: legislative risk.
Legislation may be enacted that changes the power relations among the
parties and creates even more tension. As a consequence to these legal
risks, when a dispute occurs, resorting to host countries judicial systems
often means fewer profits; in some cases it may mean hindering the
projects progress to the point of compromising its success. In sum, due to
poorly managed or anticipated legal risks, a conflict may slow down a
project, increase its costs and reduce the return on the investment, if not
put it on hold or even end it.
CONSTRUCTION RISK
In assessing risk, it is also often helpful to look at the various stages of the
project separately since each may have a different risk profile and
financing requirements. Most projects consist of three main phases:
development, construction and start-up and operation. In development
phase, risk is usually very high, and only equity capital from the main
sponsors is generally used. During construction and start up, risk is high
and large volumes of finance are required, typically in a mixture of equity,
senior debt, subordinated debt and guarantees. In the operational phase,
risk is generally lower (because the outlook is less uncertain), and it may
be possible to refinance senior bank debt in the capital markets with
cheaper, less restrictive bonds.
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In the development phase, the prospective sponsor assesses the projects
scope, seeks any necessary regulatory and concession approvals from the
government or municipal authorities, and attempts to attract financing.
Risks sometimes arise because of unclear and arbitrary government
processes, which cause long delay and may even lead sponsors. In the
construction phase, the major risk is that construction will not be
completed on time or will not meet the specifications set for the project.
An incomplete project is unlikely to be able to generate cash flows to
support the repayment of obligation to investors and creditors. Long
delays in construction may raise the cost of a project significantly and
erode its financial viability. A project may fail to reach completion for any
of a number of reasons, ranging from technical design flaws to difficulties
with sponsor management, financial problems, or changes in government
regulation. Project companies hedge construction risk primarily by using
fixed price, certain date construction contracts, with built-in provisions for
liquidated damages if the contractor fails to perform, and bonuses for
better than expected performance. The project company will probably also
take out business start up and other kinds of standard insurance , include
a construction contingency in the total cost of the project, and build in
some excess capacity to allow for technical failures that may prevent the
project from reaching the required capacity. Because lenders cannot
control the construction process, they seldom assume completion risk,
which is usually the responsibility of the project company, its sponsors,
contractors, equipment suppliers, and insurers. Typically, creditors and
investors are interested in both the physically and financially aspects of
project completion.
Design engineering and construction risk are risks that are inherent during
project design and construction phases. As construction moves forward,
new risks arise and others subside. Design development and construction
risks are primary risks to the project sponsors and the construction loan
lenders, although each project participant is concerned with whether the
project will be construction on time for the price upon which project
financial projections are based. The classic construction risk is the
17 | P a g e

necessity of a change in the work that is not contemplated in the
construction price, such as a change necessitated by technical design
refinements.
DEMAND RISKS/ REVENUE RISK/ OFFTAKE RISK

The revenue that a project can generate will underpin its cashflows. The
key risk to revenue generation is that, over the life of the project, the
demand for its output will diminish or that the price it can achieve for its
output will be reduced, whether by other, less costly suppliers entering
the market or a particular off -taker deciding to reduce its purchases. For
that reason, the off -take contract may be central to the finance ability of
a project. A long-term sales contract with an entity that has an acceptable
credit standing, extending for at least the term of a projects loans, may
offer a level of assurance to lenders in respect of these market risks.
Particularly where there is only one or perhaps a few off-takers, the credit
strength of that party or parties will be a key consideration. If a
government owns or controls an off -taker which itself lacks an acceptable
credit standing, it may be necessary that the government itself guarantee
or otherwise assure the off -takers performance under the contract. Offtake arrangements can range from availability or capacity-based revenue
structures, which afford higher predictability of cashflows (i.e. projects in
respect of which the market risk has been contracted), to arrangements
where revenues are a function of volume and/or the price of the output,
where cashflows will be less predictable (i.e. in respect of which the
project is taking market risk).
Many projects operate in markets in which long-term sales contracts are
not available at economic prices. Petrochemicals, natural resources, oil
and gas, telecoms, and, in some cases, electric power, are often sold on
spot or short-term markets. These markets may be mature and deep,
providing assurance that the projects output can be marketed. Project
companies may seek flexibility to enter into a wide variety of short and
18 | P a g e

medium term sales contracts to allow them to manage market conditions.
Issues which need to be considered in this regard include the applicable
regulatory environment, the reliability of access to the market, and the
transparency of pricing.
SUPPLY RISKS
A projects inputs or supply requires just as much investigation as its offtake. The particular supply risks which will apply to a project will be
determined by the nature of the project itself. For example, a toll road
project will depend upon sufficient traffic; telecoms projects will require
handsets; water projects will depend upon sufficient water supply; oil and
gas and mining projects must have sufficient reserves; a processing plant
must have sufficient raw materials and energy; and a power project must
have sufficient fuel. Each project must have a guaranteed and steady
supply of feedstock, fuel, or other necessary resources at a cost that does
not significantly exceed the provision for those costs in the projects
financial forecasts.
To enable the project to access those materials, it is often necessary that
new pipeline, rail, or road infrastructure be constructed, generally by
parties other than the project company. The risk that the necessary
infrastructure will not be completed in a timely manner must also be
addressed. The choice of materials or fuel gives rise to various concerns in
respect of supply and transportation. For example, if a power facility is
gas-fired, adequate reserves of gas must be available and sufficient
pipeline capacity must exist to satisfy transportation needs during the
entire term of the financing. Many gas-fired power facilities have the
capability to burn oil on a temporary basis, so that if gas becomes
temporarily unavailable due to the occurrence of a force majeure or other
event, the project will be able to continue operating until supply is
restored. However, to the extent that the project relies on a single source
of supply, as may be the case, for example, with plants fuelled by LNG
sourced from abroad, the lenders will focus attention on the political or
19 | P a g e

technical risk of the projects LNG sources. For projects that are extracting
and/or processing oil and gas or other natural resources, the lenders will
focus particular attention on the sufficiency of the relevant reserves. The
inquiry focuses both on the extent of the resource in the ground and also
on whether it is economically recoverable. Volumes of resource are
generally classified in accordance with the degree of uncertainty
associated with their existence. The level of uncertainty is highest before
the prospect is bored or drilled, and is reduced with the increase in data
available as the resource area is mapped and assessed. A reserves audit
report may provide a comprehensive tabulation of volumes at any stage
of exploration or development, assigning appropriate risk classifications to
the existence of those volumes.
The other variable, relevant to oil and gas reserves, is whether they can
economically be recovered. When commodity prices are high, the project
company can afford to extract higher cost resources. When prices are low,
reserves that are physically available may nonetheless prove uneconomic
to exploit. Lenders naturally prefer to finance oil and gas projects with
sufficient proven, economically recoverable reserves. Although probable
or possible reserves may be accorded value, these reserves are given less
weight and lenders may require a significant margin of such reserves over
the life of the project. In most cases, lenders will require a reserve tail,
providing assurance that sufficient levels of resource will remain available
to be exploited beyond the scheduled maturity of the debt. Lenders may
require accelerated repayments (i.e. cash sweeps) if such probable or
possible reserves are not converted to proven status at the rate
anticipated in the exploitation plan or if reserves are no longer
appropriately classified either due to technical or economic criteria.
Lenders may also require accelerated repayments of the debt if the
reserve is exploited by the project company at a faster or higher rate than
was originally forecast in the financial model, so as to avoid debt
remaining outstanding should the relevant reserves become depleted.
OPERATING RISKS
20 | P a g e

Operating risk includes the possibility that
1. the cost of operating and maintaining the project will exceed
budgeted forecasts;
2. the facility will be unable to perform consistently at a level sufficient
to meet the required performance criteria; and/or
3. the projects operation will be interrupted by the acts or omissions
of the operator.
The operator must have the financial and technical expertise to operate
the project in accordance with the cost and production specifications that
form the basis of the projects original feasibility study. The necessary
skills extend not only to routine operations, but also to undertaking or
supervising major overhauls of complex equipment (which may be
separately contracted to the relevant equipment supplier). The operator
may be an independent company or an affiliate of one of the sponsors.
The ability to operate the project efficiently and effectively is usually
evidenced by past experience with the same type of project and
technology, ideally in the same country and region, together with
adequate resources, such as appropriately qualified staff. Although
operators generally resist underwriting the full operating risk of a project,
a well-structured operating agreement will provide sufficient incentives to
ensure compliance with industry standards of performance. So, for
example,
contracts
which
appear
under-priced
may
be
regarded
unfavourably by lenders as this might lead to delay or reduced

expenditure on repairs and maintenance. To the extent that the operator
does assume at least some material portion of the risk of operational cost
overruns, the sponsors and the lenders will be able to place greater
reliance on the certainty of the projects financial projections. In addition
to skilled operators, a good management team is crucial to the success of
a project. The management personnel are required to make basic policy
decisions, arrange financing, provide information to lenders and investors,
and take responsibility for administrating the project company. The
management must also control the ability of the project to maintain
production levels and to comply with legal and regulatory requirements.
21 | P a g e

Thus, the management team needs to be experienced, reliable and serve
as a bridge among the sponsors, the operator, the government
authorities, and the lenders.
DELAY RISK
There are many factors that could delay the scheduled completion of a
project, including the strength and experience of the contractors, the
length of the projected construction period, the availability of building
material and supplies, the terrain over which the project is being
constructed, the risk of not receiving permits as and when required, the
exposure to labour problems, the connection of required infrastructure,
dispute resolution, and political risks. Many of these risk factors will also
have cost implications for the project.
TECHNOLOGICAL RISK
Technology risk will contribute to the overall matrix of both completion
and operating risks. Problems with the application of the proposed
technology during construction may contribute to delays in completion
and, during operation, may result in lower performance, leading to
diminished operational cashflows. The completion risk for projects that
employ proven technology is considered lower, particularly if proven in
similar terrain, climate, and scale. A good example of relatively high
technology risk can be found in the field of telecoms projects, which by
their technical nature require very expensive sophisticated equipment and
software that is often new to the market. The technology underpinning
such projects is constantly evolving and, because such projects will
involve the connecting of many points to fashion a network, they
generally require a large amount of equipment often from several different
sources which gives rise to compatibility risk.
In the growing off shore wind sector, where contractors have been
reluctant to provide EPCM turnkey wraps, lenders have had to analyse
carefully the new techniques used for piling and constructing the civil
22 | P a g e

works which support the turbine towers and this has necessitated the
structuring of appropriate completion support. For example, in the
petrochemicals and refinery sectors, scale-ups of more than 25 per cent
over and above existing and proven facilities may be the cause of concern
to lenders, unless the technical evidence is very persuasive.
Where technology risks exist, lenders are likely to place reliance on the
opinions of an independent engineer, who will likely be required to
confirm, prior to the lenders committing to finance, that the project can be
completed to the required standards on the basis of a reasonable
completion test.
ENVIRONMENTAL RISK
Environmental risk is present when the environmental effects of a project
might cause a delay in the projects development or necessitate a costly
redesign. Most industrial facilities emit at least some waste and pollutants
into the environment and require permits and other authorizations to
construct and operate those facilities. Environmental concerns have
become more prominent as a result of increased public and lender
awareness, more stringent environmental, health and safety laws, and
permitting requirements and heightened liability for the management,
identification,
and
clean-up
of
hazardous
materials
and
wastes.
Regulations to moderate harmful emissions usually exist on a national

level and sometimes also exist at international and local levels. These
regulations often require studies of the impact of project construction and
operation on the natural and social environment and restrictions on the
projects harmful emissions and impacts.
Multilateral and bilateral treaties and other agreements often regulate the
manufacture, use, and release of certain hazardous chemicals and
substances. In addition, increasing emphasis is being placed on the
broader impacts of a project, including labour and working conditions for
those employed by the project and the preservation of local biodiversity.
These legal requirements give rise to fi ve primary risks to a project: (a)
23 | P a g e

liability for the discharge of contaminants into the environment; (b)
liability for noncompliance with environmental, health and safety laws,
and permits; (c) uncertainty in environmental permitting; (d) changes in
laws and enforcement priorities that tend to make environmental
requirements more stringent over time; and (e) potential exposure to
challenges brought against the project by affected populations or
interested non-governmental organizations (NGOs) on their behalf.
Most countries regulate contamination under a polluter pays regime.
Contamination at a project site could give rise to liability and requirements
that the polluter investigate and remediate the contamination. Noncompliance risk arises when a project fails to comply with the terms of
issued permits or applicable environmental, health and safety laws and
regulations. Non-compliance with these requirements can give rise to
governmental action to rescind or terminate permits or authorizations or
impose monetary fines and penalties or criminal sanctions. Permitting risk
arises from concerns about whether a project will be able to obtain
permits to construct and operate on terms that are not unduly
burdensome or unfair. Permitting risk also arises under regimes that allow
NGOs to challenge or appeal the issuance of permits to a project.
Change in law risk acknowledges that environmental laws tend to become
more stringent over time, often requiring capital upgrades for additional
pollution controls or the acquisition of pollution credits. Of particular
concern is the regulation of greenhouse gases that are thought to give
rise to global climate change, which has given rise to international treaties
and host county laws that regulate emissions of greenhouse gases from
industrial operations. Social and biological risk arises from actions taken
by affected parties, or those acting on their behalf, to object to the
projects potential impacts. This risk can often be significant in developing
counties where indigenous populations may be displaced by a project,
biodiversity may be threatened by project construction and operation or
local labour laws may not meet international guidelines and standards. To
24 | P a g e

the extent environmental objections are voiced through the political
process, they give rise to political risk.
CREDIT RISK/ COUNTERPARTY RISK

This risk relates to the parties who enter into contracts with the SPV
(Special
Purpose
Vehicle)
for
various
intents
and
purposes.
The
creditworthiness of the contractor, the product buyer, the input supplier,

and the plant operator is carefully assessed by lenders through an
exhaustive due diligence process. The financial soundness of the
counterparties (or respective guarantors if the counterparties are actually
SPVs) is essential for financers. The significance of credit risk in project
finance deals lies in the nature of the venture itself 1) off-balance sheet
financing with limited recourse to shareholders/sponsors and 2) a very
high level of financial leverage. These features form the basis of a
different approach for determining minimum capital requirements that
banks must respect with regard to project finance initiatives. This
approach was established by the Basel Committee, the international body
that counts representatives of banking supervisory authorities from
several countries among its member.
FORCE
MAJEURE
RISK
The expression force majeur eclause is normally used to describe a

contractual term by which one or both parties is excused from
performance of the contact in whole or in part or is entitled to suspend
performance or claim an extension of time for performance upon the
happening of a specified event or events beyond its control. The effect of
a force majeure clause will depend on how it is drafted, but for the most
part, force majeure clauses are suspensory, that is, the affected
obligations are not brought to an end, but are simply suspended while the
force majeure event is continuing (unless the parties agree otherwise).
Once the force majeure clause is triggered, the non-performing partys
25 | P a g e

liability for non-performance or delay in performance is removed, usually
for as long as the force majeure event continues.12
This risk concerns with some discrete event that might impair, or prevent
altogether, the operation of the project for a prolonged period of time
after the project has been completed and placed in operation. A typical
force majeure provision will describe the events which constitute force
majeure for the purposes of the particular project agreement in some
detail. Sometimes, force majeure may be described as falling within
separate categories such as acts of nature (sometimes called acts of
God); acts of man (such as war, industrial action, etc.); acts of
government (usually addressed in a project financing under political
risk);13 and impersonal acts. Each type of disruption may be addressed
separately with the consequences, associated solutions and remedies and
cures differing markedly. Such an event might be specific to the project,
such as a catastrophic technical failure, a strike, or a fire, earthquake,
typhoon, cyclone or any other natural calamity. Alternatively, it might be
an externally imposed interruption, such as an earthquake that damages
the projects facilities or an insurrection that hampers the projects
operation.
CROSS-BORDER RISKS
Any project fianc issue is not bereft of a single risk, but a consortium of
risks. In cases of cross-border or transnational projects the risk is of many
folds. It includes Currency-Related Risk, Political Risks, Inflation Risk,
Expropriation Risks, Change of Law Risks, Country Risks, Law and Legal
Systems Risks, Sovereign Risk, Permit, Concession and License Risk, etc.
In a transnational project is subject to governmental jurisdiction and
action exists. This can result in risks to the project that, if realized, affects
12 G. H. TREITEL, Frustration and Force Majeure, 12.021 (2nd ed., Thomson/Sweet &
Maxwell, London, 2004).
13 Id.
26 | P a g e

the success of the project, cash flows and operating costs. There are limits
on the control a project sponsor can have over the political stability
surrounding a project. The degree of political risk the project faces is
sometimes determined by the nature of the project. Projects of particular
importance to a host governments social welfare strategies might be less
susceptible to many political risks described in this chapter. In contrast,
projects significant to the countrys security or basic infrastructure might
be more susceptible to certain political risks, such as expropriation. For
Example the Chad-Cameroon Pipeline project had great economic
significance by political risk relating to the project had great repercussion
to the lending agencies, for the successful completion and functioning of
such a project.
MITIGATING RISKS THROUGH INVESTMENT STRUCTURE

The structure that investors and lenders adopt for a project is an
important way in which investors and lenders can avoid any expropriation
or interference in their project by the state. A state may be willing to
provide lenders and investors with some form of sovereign or government
guarantee to act as an incentive for an investment into their country. Such
a sovereign guarantee may be given at the outset of a transaction, as
seen in many infrastructure projects and will provide the investor and any
lenders with comfort that the investment will be backed by the
government and if an expropriation does take place the guarantee should
ensure that the investor and lenders have direct recourse to the
government for breach of contract. It is standard practice for such a
guarantee
to
include
waiver
of
sovereign
immunity.
Sovereign
guarantees are often provided in concession agreements, these typically

take the form of payment guarantees; that is, if the contracting state
entity does not pay the investors then the government will do so. If an
expropriation by the state takes place the investors and any lenders to the
investment will be able to seek compensation under such a guarantee
from the government.
27 | P a g e

Sovereign guarantees will often go further when investors or lenders need
further incentives to invest into the project. The host state will show its
commitment and support of the project through covenants in the
agreement between the investors, lenders and the state, for example
undertaking to implement specific legislation, the grandfathering of key
legislation if applicable, making available government resources and
importantly committing not to undermine the investment through adverse
regulation
or
similar.
Investors
and
lenders
may
also
seek
an
acknowledgement from the state of the investors equity contribution into

the project and that they are due a return on their investment. In short the
investors and lenders are seeking comfort from the host state that
expropriation, whether direct or indirect, will not take place and there is
the maintenance of minimum investment conditions.
Another way that lenders and investors can get comfortable with the
project is to ensure that the accounts of the project company are kept
offshore. Where there are currency restrictions in the host state, (often the
case in developing countries) there will be a need to provide the project
with special dispensation to allow revenues to be sent offshore. By having
the accounts offshore in a friendly jurisdiction, the lenders and investors
to the project can take comfort that they will be able to enforce their
security over the offshore accounts if necessary.
It is increasingly common for lenders and investors to seek Export Credit
Agency (ECA) support for their project. Typically an ECA will provide the
lenders with a guarantee or insurance policy for 85 per cent of value of
the export contract in the project. The ECA will charge a premium for
providing such a guarantee or insurance policy, the cost of this premium is
often dependent upon the risk, particularly political risk, associated with
the host state. Another option is for the sponsors to seek a commercial
insurance policy to cover any potential expropriation of the project.
BILATERAL INVESTMENT TREATIES
28 | P a g e

In addition to the above, the project lenders and investors can ensure
from the outset that the project falls within the scope of a Bilateral
Investment Treaty (BIT) or a Multilateral Investment Treaty such as the
North American Free Trade Association (NAFTA) or the Energy Charter
Treaty (ECT).
A BIT entered into between two states to protect investments made by a
national of either of the states into the other. It also aims to provide a
level of legal protection to the investor. Many BITs contain broadly similar
protections.
To qualify for protection under a BIT, there must be an investor with an
investment located in the host state. A dispute would qualify for
protection under a BIT if it is between the investor and the host state.
Each BIT contains the definition of an investor and an investment.
International arbitration is usually the neutral forum used to resolve
disputes. However, a number of treaties provide for arbitration under the
International Centre for the Settlement of Investment Disputes (ICSID).
This is addressed in further detail below.
The protections commonly found in BITs are
1.
2.
3.
4.
5.
6.
7.
right to fair and equitable treatment;

right to national treatment;14
right to most favoured-nation-treatment;
right to compensation for civil disturbance etc.;
protection against expropriation and nationalisation;
right to repatriate profits and property;
protection against breach of contractual obligations/umbrella
clauses; and
8. dispute resolution/enforcing rights/arbitration.
In any investment decision, the existence and status of a BIT is an
important factor. The protection afforded by BITs is extra-contractual, and
14 This national treatment standard requires a host state to treat foreign investments no less
favourably than the investments of its own nationals and companies (Asian Agricultural
Products v Sri Lanka (1991) (ICSID Case number ARB/87/3).
29 | P a g e

so will apply to an investment contract even if not expressly referred to.
The host states signature of the BIT is sufficiently binding for it to apply to
the investment contract.
The importance of BITs continues to grow. In fact, the total number of
BITs rose to 2,676 by the end of 2008. Despite the intense BIT
negotiating activity of some countries, over the last four years, there has
been no change in the ranking of the top ten signatory countries of BITs.15
The growing number of BITs signed suggests that states value these
treaties as having a tangible effect. However, some commentators submit
that an issue may arise given the arguable inequality of bargaining power
between developing countries that wish to promote foreign investment,
and developed countries that wish to protect their investors 16. Either way,
these are important protections for an investor who is looking to invest in
a higher risk jurisdiction
MULTILATERAL INVESTMENT TREATIES (MITS)

MITs are similar to BITs. An example of a MIT is NAFTA. NAFTA covers
many issues such as environment, mobility of persons, agriculture and
importantly investment. Other MITs are less detailed and deal with a more
general investment programme between states such as the ECT.
The objective of the ECT is, amongst other things, to protect and promote
foreign investments in the energy sector in member countries. On the one
hand the treaty is explicit in confirming national sovereignty over energy
resources, ie each member country is free to decide how, and to what
extent, its national and sovereign energy resources will be developed, and
also the extent to which its energy sector will be opened to foreign
investments. On the other hand, there is a requirement that rules on the
15 Recent Developments in International Investment Agreements (2008 June 2009)
UNCTAD/WEB/DIAE/IA/2009/8.
16 The International Law on Foreign Investment M Sornarajah (2007).
30 | P a g e

exploration, development and acquisition of resources are publicly
available, non-discriminatory and transparent17.
Disputes under the ECT can either be settled by:
arbitration between parties to the ECT on the interpretation or
application of the treaty;

dispute settlement mechanisms under art 26 which provides for
various
options
for
investors
to
take
host
governments
to
international arbitration;
a specialised conciliation procedure;
a mechanism for settling trade disputes between member countries
(provided that at least one of them is not a World Trade Organization
member); and
bilateral and multilateral non-binding consultation mechanisms for
disputes arising out of competition or environmental issues18.
The ECT came into force in April 1998, and commentators have described
its success since that date19. It is difficult to assess the impact of the ECT
since only 22 disputes have been brought under it to date. The issue of
the recent dispute between Yukos and the Russian government has seen
Russia move towards withdrawal from the ECT, which was never ratified
by Russia but which has also seen the permanent Court of Arbitration in
the Hague decide that Russia is bound by the treaty. It is pertinent to note
that 15 out of the 22 reported ECT disputes are under the International
Centre for the Settlement of Investment Disputes (ICSID)20.
ICSID
17 www.encharter.org
18 http://www.encharter.org/index.php?id=269&L=1%2F%2F%2F%5C%5C.
19 Clarisse Ribeiro Investment Arbitration and the Energy Charter Treaty (2006).
20 http://www.encharter.org/index.php?id=213&L=1%2F%2F%2F%5C%5C.
31 | P a g e

ICSID is an institution that administers and provides facilities for the
conciliation and arbitration of international commercial disputes between
states and nationals of other member states. It was created pursuant to
the 1965 Washington Convention on Settlement of Investment Disputes
between states and nationals of other states (ICSID Convention). It is
available only in respect of disputes to which a state is a party to the
convention. A list of states which has acceded to the convention can be
found at the ICSID website 21. It is important to note that the primary
purpose of ICSID is to promote foreign investment by providing facilities
for conciliation and arbitration of international investment disputes.
ICSID arbitration can arise in two ways either contractually (where the
investor state contracts contain an express reference to ICSID for their
dispute resolution) or outside the contract (where arbitrations arise from
indirect consent to ICSID arbitration contained in either the host states
national investment legislation or a bilateral or multilateral treaty).
Interestingly, 75 per cent of ICSID arbitrations have been brought under
the latter category.
The advantages of ICSID arbitration include the following
1.
2.
3.
4.
arbitration proceedings are administered by the World Bank;

it is a neutral and self-contained system;
it is transparent; and
it has clear and reasonable legal cost schedules.
However, it is imperative for investors to remember to include a waiver

from sovereign immunity clause in their contracts in order to bring a claim
against a state entity - mere reference to ICSID arbitration will not be
sufficient.
The essential criteria for ICSID arbitration is that
1. parties must have consented to it in writing;
21http://icsid.worldbank.org/ICSID/FrontServlet?
requestType=ICSIDDocRH&actionVal=Contractingstates&ReqFrom=Main.
32 | P a g e

2. the dispute must be between a contracting state and a national of
another contracting state; and
3. the dispute must be a contractual legal dispute arising directly out of
an investment.
Although recourse to ICSID is voluntary, once the parties have given their
consent to it, they cannot unilaterally withdraw their consent.
In relation to the recognition and enforcement of ICSID awards, each
contracting state to the ICSID Convention22
1. will automatically recognise the award as binding;
2. will enforce the pecuniary obligations imposed by the award within its
territories as if it were a final judgment of a court in that state; and
3. may enforce an award though its federal courts, providing that such
courts treat the award as if it were a final judgment.
A failure by a contracting state to enforce an ICSID award is a clear breach
of its international treaty obligations. Similarly, and perhaps more
crucially, a lack of enforcement may have implications for the states
World Bank membership. This provides a valuable incentive for states to
comply, and thereby offers a notable protection for investors. It is
therefore
easy
to
understand
why
the
importance
of
ICSID
has
significantly increased in todays world. This is evident from the fact that
today ICSID has 156 signatories 23 and statistically there are already 167
ICSID cases which have concluded,24 with 127 pending25.
22 Non-pecuniary awards will have to be enforced by other means such as the New York
Convention.
23 It has been ratified by 144 , see http://icsid.worldbank.org/ICSID/FrontServlet?
requestType=ICSIDDocRH&actionVal=Contractingstates&ReqFrom=Main.
requestType=GenCaseDtlsRH&actionVal=ListConcluded.
33 | P a g e

It is never too early for investors and lenders to a project to start to plan
ways to protect a project from expropriation. Investors and lenders need
to adopt an integrated structure that will take account of the protection
available and afforded by international law, treaties and conventions.
Wherever possible, investors and lenders should seek appropriate
assurances from the state where the project will be located. In addition to
this, the investors and lenders should factor into any investment model
the threat of expropriation and structure their project accordingly.
CONCLUSION
A successful project financing initiative is based on a careful analysis of all
the risks the project will bear during its economic life. Such risks can arise
either during the construction phase, when the project is not yet able to
generate cash, or during the operating phase. Risk management has
become a relevant topic in corporate finance theory and in managerial
practice. In recent years, corporate executives have progressively
changed their focus from pure financial risk management to enterprisewide risk management and have paid more attention to the links between
enterprise risk, stock price performance, and corporate valuation.
Intuitively, a lower volatility of cash flows, a reduced level of business risk,
and a reasonable balance between debt and equity are all factors that
enhance corporate value and, if the firm is listed, increase stock market
prices.
Risk sharing is another manner of allocation of risk in project finance. A
joint venture permits the sponsors to share a projects risks. If a projects
capital cost is large in relation to the sponsors capitalization, a decision to
undertake the project alone might jeopardize the sponsors future.
Similarly, a project may be too large for the host country to finance
prudently from its treasury. To reduce its own risk exposure, the sponsor or
host country can enlist one or more joint-venture partners.
requestType=GenCaseDtlsRH&actionVal=ListPending.
34 | P a g e
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Project Risk Analysis

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Risks in Project Financing