Project finance

Project finance (프로젝트 파이낸스/項目金融) is the long term financing of infrastructure, or social overhead capital like highways, bridges, harbors, power plants, etc. What is different from conventional corporate lending, project finance (abbreviated P/F) depends solely on the projected cash flows of the project rather than the balance sheets of the project sponsors. So the lenders cannot claim the loan if the real cash flows are not sufficient to repay the principal of and interest on the loan.

That's why So project finance is called as "non- or limited recourse financing" (비소구·제한적소구 금융/非遡求·制限的遡求金融). For this purpose, a special purpose company shall be established to implement the project and borrow the loans.

The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders have security interests on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Key words
project finance, cash flow, privately financed infrastructure, legislative guide, SPC, non-recourse financing

History of P/F
In Korea, project finance was successfully arranged to build the expressway from Seoul to the Incheon Airport for the first time in 1995.

On the international scene, United Nations Commission on Trade Law (UNCITRAL) tried to formulate a model law, but reached to set up legislative guide regarding privately financed infrastructure projects. Into the 2000s after the Millenium, international banks are requested to pay attention to the Equator Principles for the cause of sustainble development.

Statutory ground in Korea
Since 1990s, the Korean government with budget constraints has expanded its social overhead capital (SOC, 사회간접자본/社會間接資本) facilities such as express highways, railways, harbors, school buildings, environment facilities, etc., which used to be built with government budget, by inducing private capital. Upon completion of such facilities, the project company transfers its ownership but is awarded the privilege to operate and manage the facilities for a period of 20 - 30 years so as to collect the initial investments and a certain profit. In many cases, the project company is established as a special purpose company (SPC) for non- or limited recourse financing (비소구금융/非遡求金融).

While the government, central or local, is in charge of planning, assessment, approval and financial suppot of the project, the private sector is responsible for the design, financing, construction and maintenance of the facilities.

Privately financed infrastructure projects were put into high gear by legislation:
 * In late 1994, the Act to Promote Private Capital toward SOC Facilities (사회간접자본시설에 대한 민간자본유치촉진법) was established as Act No. 4773 and came into force in November 1994.
 * In 1998, the Act on Private Investment in SOC Facilities (사회간접자본시설에 대한 민간투자법) was renamed since the private sector was reluctant to invest in infrastructure in the aftermath of the IMF Crisis, and, for the first time, introduced the MRG provision in December 1998. Also unsolicited infrastructure projects by the private sector were also encouraged since April 1999. In this connection, PICKO (Private Infrastructure Investment Center of Korea, 민간투자지원센터) was established under the Korea Research Institute for Human Settlements (KRIHS, 국토연구원) in March 1999.
 * In 2005, the Act was again amended into the Private Investment Act on Social Infrastructure Facilities (사회기반시설에 대한 민간투자법). Subject to the amendment to the Act in January 2005, PICKO was merged into PIMAC (Public & Private Infrastructure Investment Management Center, 공공투자관리센터) as a subsidiary of the Korea Development Institute (KDI, 한국개발연구원).

Mechanism of P/F
Without exception, project finance calls for a special purpose company (SPC, 특수목적회사/特殊目的會社). In this case, the special purpose means non- or limited recourse financing. In other words, the SPC itself borrows funds necessary to finance the project and implement the project. Also the lenders have only to recover the loan from the cash flows generating from such project. That's why equity investors and lenders alike pay attention to the expected cash flows as well as the project risks. Accordingly, the debt service coverage ratio (DSCR) subject to the financial feasibility study is required to exceed a certain ratio, e.g., 120%.

Parties to P/F
Usually, a project financing structure involves a number of equity investors, known as sponsors, as well as a syndicate of banks that provide loans for the operation of project.
 * Project company
 * Sponsors
 * Equity investors
 * Commercial banks
 * Export credit agencies (ECA)
 * International financial institutions
 * Suppliers
 * Host country

Contractual framework
There are a number of contracts to be executed in an ordinary project finance as follows:
 * - (Syndicated) loan agreement
 * - Financial advisor retaining agreement
 * - Concession/franchise agreement
 * - Host government licenses/assurances
 * - Shareholders'/joint venture agreement
 * - Project company documents
 * - Construction contracts
 * - Technology/operating licenses
 * - Supply/utility contracts
 * - Project products sales/offtake/throughput contracts
 * - Project management/consultancy contracts
 * - Land title documents
 * - Security agreements
 * - Project insurances
 * - Third Party's bonds and guarantees
 * - Shareholders' investment guarantee
 * - Minimum revenue guarantee (MRG, 최소운영수익보장/最少運營收益保障)
 * - Inter-creditor agreement, etc.

Financing cases
Euro Tunnel was constructed by two SPCs established at Britain and France, respectively. The company was formed on August 1986 with the objective of financing, building and operating the Channel Tunnel. The tunnel cost around £9.5bn to build, about double its original estimate of £4.7bn. The tunnel, which was financed partly from investment by shareholders and partly from £8bn of debt, was officially opened on 6 May 1994. In its first year of operation the Company turned out to be financially fragile. After as series of restructuring or bankruptcy protection efforts, Eurotunnel was able to announce a small net profit - €1 million for 2007 - for the first time in its existence.

At the beginning of 2011, a large-scale P/F scandal broke out in Korea. A thrift located in Busan was reported to suffer huge deficit from a number of project financing programs at home and abroad. Top management of the thrift allowed to form hundreds of SPCs for the financing of doubtful projects including a memorial service center at countryside. Some of the SPCs were proved as fake. Busan Savings Bank financed the construction of a new town - residential complex at Phnom Penh, Cambodia, but failed to recover the loan as a whole because the global financial crisis devastated the project.

Regarding how to apply P/F scheme to the rehabilitation of the roads and railways in North Korea during or after the reunification of the Korean Peninsula, see the Infrastructure in North Korea.