Research Trends and Conclusions: Project Finance 2010
Jessica Harvey -
Confronted with widespread economic uncertainty and frozen credit markets, project finance has been resilient, with continued activity and exciting areas of growth for 2010. Here we examine key issues that face the legal community as it evolves to meet the changing demands of the market.
A Look Back at 2009
The role that commercial banks play in project finance has traditionally been a central one. With an ability to assess and assume complex construction and performance risks, they provide an invaluable source of financing to the industry. As such, the effects of the global financial crisis have taken a heavy toll on project finance activity. Investors looking for project-specific funding have met increasing reluctance from banks to provide the financing needed for infrastructure development. With long-term financing scarce and expensive, global activity fell sharply in 2009. But the picture is not entirely bleak. Despite this limited liquidity, low default rates for project finance loans over the last two years demonstrate the industry’s hardiness. As John Inglis at Ashurst LLP explains, “project finance transactions have remained relatively immune to the need for restructuring, owing to the robust manner in which they are structured, with full consideration of downside scenarios that affect project economics.” Also, some countries have managed to buck the trend: India in particular. With an estimated $30 billion in deal transactions during 2009, the Indian market has resisted the effects of the general economic downturn.
Alternative Sources of Energy and Financing
Many developers have turned to the capital markets either to complement loan funding or to refinance expensive loans with more attractive bonds. This activity has been varied across the international markets but one theme prevails: as in the M&A arena, government-backed investment accounts for a high proportion of project finance activity. This is true in the US where the Obama administration’s drive toward clean technology, via the Department of Energy’s tax credits and stimulus programme (The American Recovery and Reinvestment Act 2009), has ignited the renewable energy market, making this an area that is very much “in vogue”. Harold Moore at Skadden Arps Slate Meagher & Flom LLP says this has led to changes in legal practice as lawyers guide clients through the regulatory provisions tied in to the stimulus money, and whilst, as Moore says, the projects have thus far been somewhat “glacial”, many of the lawyers that our researchers spoke to anticipated continued growth, particularly in relation to wind and solar energy. With government money making green technologies more commercially viable, a wave of new clients are entering the sector. Many technology-related projects that would have traditionally sought venture capital investment are now looking to project financing techniques and in particular, taking advantage of the billions of dollars allocated under the US stimulus programme. As one prominent source describes, location is an increasingly important factor for firms trying to attract this work. Lawyers in Washington, DC, who in the past have benefited from the close proximity to the federal government and experience of government work, are now facing competition from New York firms keen to tout their banking expertise and understanding of the stimulus funding requirements.
As government energy policies require substantial increases in the generation of electricity from renewable sources, energy infrastructure too is experiencing tremendous growth. One example is the Renewable Energy Transmission Initiative in California, which is bringing further work for lawyers in the region. As many firms look to secure technology clients engaged in renewable energy and transmission services, there has been a corresponding increase in lateral hires and poaching of project finance experts from technology firms in California. Another trend emerges: many of the lawyers we spoke to identified a growing sub-specialisation in different forms of renewable energy, with firms aiming their sights at the growing wind and solar sectors to appeal to future clients with highly technical and specialised expertise.
This behaviour is likely to be mirrored across the Atlantic as the renewable trend continues in Europe. The investment required to meet the European Union’s 2020 target to make renewable energy 20 per cent of total energy consumption is staggering. Estimated up to a massive €22 trillion over the next decade according to figures released by PricewaterhouseCoopers, the opportunities are ever expanding as renewable energy increases its influence in the sector.
Loan Structure, Infrastructure and the Middle East
A hive of project finance activity in recent years, the Middle East provides a salient example of the effects the global financial crisis has had on the industry. Here, similar levels of government lending have stepped in to make up for the private financing shortfall. Lawyers in the region underlined an increased interest in alternative funding sources, including Islamic finance and mezzanine transfers, and a potential return of project bonds. Financing for projects is becoming more complex to put together. The days where it was possible to have one commercial bank take on the risk and solely fund a project are now over. Instead lawyers are having to coordinate financing from several banks, resulting in a need to carefully structure deals and work with a range of sponsors and their legal advisers. Allen & Overy LLP’s Nicholas Crossin summarises the difficulties that pervade the market: “project financings are taking longer to put together and terms and pricing harder than those available a couple of years ago; things are pretty tough, but well-structured projects led by strong sponsors are still being successfully financed”. As a result of this increased complexity, and set against the continuing economic uncertainty in the financial markets, clients are looking for reassurance, turning to more senior lawyers with a depth of commercial savvy.
The fallout from Dubai is having a wider effect on the region. Competition is high for what is, for the time being at least, a limited pool of project finance work. Firms that moved to the region aiming to focus on development projects are now shrinking and reshaping. More and more firms are focusing on oil-rich Abu Dhabi, increasing their local presence there in anticipation that it will become the leading business centre for the UAE.
The nature of projects work in the region has also changed. Experts describe a need for infrastructure in the Gulf region as a whole driving huge demand for financing, with the governments similarly looking to other sources to fill the gap. Allen & Overy
LLP’s Christian Saunders explains: “18 months ago, the petrochemical market was a staple of project finance. With limited new feedstock allocations available, genuinely new deals in this sector have been scarce. Power and infrastructure have come to the fore as a result”. Firms in the GCC have seen this activity play out with the building of ports, universities and waste water projects. But this alone is not enough to ensure a busy time sheet. As Saunders elaborates, “local relationships are key; demonstrating that you are a stakeholder in that particular part of the region is fundamental”. This places firms that have a strong, more long-standing presence in the Middle East at an advantage. With clients wanting their law firms to show a long-term commitment to the area, those that are able to use their presence in the UAE to establish offices in several places in the Gulf region will find that they are best positioned to attract key Qatari and Saudi clients. This strong presence is not the sole province of the corporate powerhouses. Smaller international law firms also leave a footprint, capitalising on the relative profitability of this expansive model and their focused industry expertise. The challenge for project finance lawyers will be concentrating on putting together the right package and platform from which to stand out in the crowded market. Many have already started to do so.
Commercially Conscious
Owing to the nature of projects work, the best project finance lawyers have always fully understood their clients’ businesses. Indeed, as one prominent source says, “Practising project finance is not really like practising ‘law’ – it is about understanding broader business needs and commercial pressures, evaluating long-term economic risks and projections.” What is interesting, however, is that law firms are using this commercial lens to examine their own practices. With an increasing need to structure and coordinate transactions, some firms are assessing and reshaping the packaging of their project finance expertise. There is an increasing trend toward offering a model more in line with project management services, especially for the “high-end work that remains the remit of high-end firms”. For in-house counsel, managing relationships with external legal advisers and taking on certain parts of the work themselves will become ever more important. Here, long-standing client relationships will be a key weapon in the law firm armoury.
One constant source of pressure for the legal profession comes from clients’ demands for different payment structures. This is nothing new in the project finance area. What is growing, however, is the ongoing negotiation over contingency fees and the alternative fee arrangements being requested. Industry experts anticipate that companies will increasingly buy an agreed volume of hours of work for a fixed price. Many of the interviewees cited clients requesting even higher levels of transparency in billing. Requesting upfront discussions and ongoing monitoring of costs, clients are expecting their lawyers to be increasingly budget-minded, keeping track of and reporting spending. Many lawyers anticipate that this pricing pressure will continue as more firms enter the market.
The law firm economic model is also changing. As Marcell Nemeth at Pinsent Masons LLP says (his sentiments were echoed by virtually all of the lawyers we spoke to) “The message from clients is that projects is a risky business, they want firms to take part in some of that risk and prove that they are business-minded.” Firms are adopting an increasingly strategic and commercial examination of projects work internally, assessing risks with high levels of scrutiny before agreeing to take on a job – the days of automatially saying yes are also over. One effect that may be seen is a more flexible remuneration package, for associates in particular. Many of the top-tier interviewees spoke of aligning a larger proportion of associate compensation to performance. With fee earners moving into other practice areas (restructuring being one such example) during the project finance shortfall, many leading firms have looked for ways to enhance profitability in the future. Some are focusing on the firm’s younger generation, amending training profiles to create a more widely deployable skill set. Several of the lawyers described the benefits of a diverse practice that have been clearly demonstrated by the recent tough times.
Here too, the challenge will be in finding the right balance. Expertise remains key to both securing sponsor bids and navigating clients through a difficult economic terrain, but international know-how alone is not enough. A strong knowledge of the local law is essential, as is an ability to call on a range of commercial expertise within neighbouring practice areas. A prime example of this can be seen in the EU with the tremendous growth in public procurement activity.
Facing Forward
Many of the lawyers that our researchers spoke to noted the change in market sentiment in 2010. Indeed, the general feeling is that the year has started very strongly. With the first half complete, banks are slowly starting to underwrite again and while uncertainties brought on by weak economic growth, sovereign and currency risks and new bank regulations (Basel III in particular) cloud the market there appears to be scope for optimism. Activity in Asia, the Americas and India are driving growth and bringing excellent opportunities for the legal market. China in particular, is demonstrating a hunger for investment. Lawyers in Brazil, describing a pent-up demand for infrastructure, noted an increased interest from Chinese players; similarly in Africa, our sources talked of continued Chinese investment. In order to position themselves to take advantage of this emerging demand, international law firms are looking to expand their local presence through lateral hires, local affiliations or new offices. Firms that are able to cross-fertilise a range of industry know-how will best benefit, using their broader reach to secure appointments as the protracted period of economic recovery continues and banks slowly return to the market.