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Risk Mitigation in Project and Structured Finance

A proper review of a proposed transaction for potential risk elements that require de-risking is frequently an involved but valuable process.

27 April 2021

While the genesis of a successful project finance is always a great idea, a great idea is not by itself enough. This is because project and structured finance both rely on developing risk mitigation strategies to “de-risk” a transaction. What de-risking requires is in concept very straightforward. It involves examining every aspect of a project and structured finance transaction to determine the areas that present risk, both actual and perceived, to an investment. Then structural enhancements are developed as part of the financing in order to minimize the implementation and operational risks of the financing. The structural enhancements frequently involve a “belt and suspenders” approach to the various risks presented by a transaction until a financing structure is arrived at that the capital markets and even the ratings agencies view as favorable from a risk to capital perspective. Adopting this approach is critical to capital markets success and can achieve extraordinary results in terms of the availability and cost of capital.

A variety of approaches are frequently employed to effectively mitigate risk in financings. The approaches run the gamut from EPC and O&M contracts with performance guaranties from institutional providers of the services to insurance products that insure repayment of the debt if, for example, an operating metric is not met. A proper review of a proposed transaction for potential risk elements that require de-risking is frequently an involved but valuable process. It requires a detailed analysis of identifying risk elements as well as the appropriate steps to follow to successfully eliminate the risk. Creativity is important as well. But the benefits of doing so become abundantly clear when one considers how fundamentally risk affects the availability and pricing of capital. Projects that are viewed as high risk frequently are difficult to impossible to access capital for. However, a successfully de-risked project attracts an array of capital from high quality capital sources on favorable terms, because capital, especially debt providers, place a premium on low-risk investments that are viewed as safe by the appropriate investor market.

And a risk mitigation approach to financing can also have a very favorable effect on the ability to obtain interim financing. Bridge financing is frequently a necessity in a large project or structured financing transaction. The first item that a bridge lender explores is the viability of take-out financing. A transaction that has been successfully de-risked upfront can frequently be paired with high level confidence letters from placement agents sourcing the financing. This, coupled with an appreciation by the bridge financing source that a well-developed business plan is in place for the construction and operation of the project, provides the bridge financing source with great confidence that the bridge investment in the project is well placed and will likely yield a positive outcome. At Pritchard Griffin, we apply a risk management approach to all of our project and structured financing engagements. We combine this with an integrated approach that marries relationships and solutions to the risk management exercise. Our current mandates often incorporate successive rounds of capital designed to build toward the ultimate project or structured financing that is focused on achieving the best capital result possible. As always, the initial starting point is to review and address the risk elements of a transaction in the most constructive manner.

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