The importance of project finance in promoting infrastructure development in the developing world is well known. Without the billions of dollars of support generated for infrastructure projects using project finance, hundreds of millions of poor people in the developing world would not have access to basic needs such as electricity, clean water, and sewage treatment.
Typical project financing involves the issuance of a non-recourse loan, wherein the sponsor has no obligation to make payments on the project loan if revenues generated by the project are insufficient to cover the principal and interest payments. Lenders seek to minimize the risks associated with making non-recourse loans by requiring indirect credit supports in the form of guarantees, warranties, and other covenants from the sponsor, its affiliates, or other third parties involved with the project.
Political risk insurance (PRI), which protects a sponsor or lender against non-commercial risks – such as expropriation, currency inconvertibility/non-transfer, political violence, or breach of
contract – is often utilised to remove country risk from the equation. Project sponsors and lenders thereby assume the commercial risks associated with a given project.
The project finance challenge
Project financiers have had to balance their desire to participate in sound, profitable business ventures with the needs and capabilities of the people and governments of developing countries, as well as the interests of non-governmental organisations (NGOs).
This has been a slippery slope for many in the project finance business. Project sponsors, financiers and insurers alike have had to find a balance between the many competing forces that impact the construction and operation of infrastructure projects in the developing world. Their need and desire to adhere to strict credit, accounting, design, construction and operational standards has often conflicted with equally important objectives such as strict environmental compliance, greater socio-economic benefits for workers, and the rights of indigenous peoples.