Using Project Finance to Fund Infrastructure Investments

USING PROJECT FINANCE TO FUND INFRASTRUCTURE INVESTMENTS Throughout most of the history of the industrialized world, much of the funding for large-scale public works such as the building of roads and canals has come from private sources of capital. It was only toward the end of the 19th century that public financing of large “infrastructure” projects began to dominate private finance, and this trend continued throughout most of the 20th century. Since the early 1980s, however, private-sector financing of large infrastructure investments has experienced a dramatic revival. And, in recent years, such private funding has increasingly taken the form of project finance. The principal features of such project financings have been the following:
A project is established as a separate company, which operates under a concession obtained from the host government.
A major proportion of the equity of the project company is provided by the project manager or sponsor, thereby tying the provision of finance to the management of the project.
The project company enters into comprehensive contractual arrangements with suppliers and customers.
The project company operates with a high ratio of debt to equity, with lenders having only limited recourse to the government or to the equity-holders in the event of default. The above characteristics clearly distinguish project finance from traditional lending. In conventional financing arrangements, projects are generally not incorporated as separate companies; the contractual arrangements are not as comprehensive, nor are the debt-equity ratios as high, as those observed in the case of project finance; and the vast majority of loans offer lenders recourse to the assets of borrowers in case of default.
Our purpose in this paper is to explore some possible rationales for the distinctive characteristics of project finance, from the viewpoint of both the project sponsor and the host government. We do so in the specific context of