Less risky project finance transactions expected

18 February 2014

Performance bonds or limited company guarantees could lower risk for lenders

The GCC could see different types of project financing with risk-reducing elements develop in the region, says Michael Baker, a London-based senior director at financial information provider S&P Capital IQ.

Project financing typically stands on its own rights without a guarantee from companies involved. In emerging markets such as Russia, however, hybrids have been developed to help raise lenders’ confidence in infrastructure projects, which tend to require long-term investments.

“There have been situations where a sponsor has provided limited guarantee, or the credit strength of a project could be enhanced through the issuance of performance bonds, for instance. Those methods could also be used in the GCC,” says Baker.

The bond and sukuk markets are set to play a bigger role in project funding. The Saudi government recently releases a draft consultation on ratings agencies, which could lead to more ratings being undertaken by international agencies. That raises the possibility for bond issuance around infrastructure projects.

That would come at a time when international banks face higher lending costs following changes in global regulation. Cash-rich local banks have less to worry about, however, as they are unlikely to cover all project funding needs.

“Saudi banks probably have some capacity to lend into the project finance field. I think their challenge is that’s not a particularly developed asset class in the country and they’ll have to develop the in-house capabilities to correctly assess the risk,” says Baker.

Other players could also come into the market, such as institutional investors looking to do long-tenor investments.

Limits on regional banks’ ability to lend to government-related entities could lead to more project finance transactions instead of loans to companies, according to him.

In November 2013, the UAE central bank issued rules capping banks’ exposure to state-related entities, while Saudi banks’ lending limits are currently set at 25 per cent of capital per company. Some contractors in the kingdom either have reached or are close to reaching that ceiling.

“If project finance transactions are conducted through a special purpose vehicle, they may not necessarily be considered government-related lending,” says Baker.

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