The project finance industry is booming. The global market is as strong as it has been for many years. The key economic driver has been a significant market shift in the demand for energy, commodities and industrial materials. A number of ‘mega’ projects are being planned and carried out in the oil, gas and mining sectors.
This trend is particularly noticeable in the Middle East, where multiple processing plants are being developed near the cheapest feedstock sources in the world. The upswing in industrialisation, coupled with major population growth across the region, has also resulted in a need to enhance power and water-producing capabilities. Much of this industrialisation and associated infrastructure is being financed with limited or non-recourse project finance loans.
And yet, certain jurisdictions in the Middle East do not provide the robust legal framework that lenders might customarily expect. Some, such as the United Arab Emirates and Oman, have adopted commercial codes and other laws that have given comfort to investors and lenders by providing an environment that facilitates cross-border investment, providing relatively predictable outcomes from contractual disputes, permitting the enforcement of interest payments and allowing lenders to perfect a traditional security package over a project company’s onshore assets. Other jurisdictions, most notably Saudi Arabia, have yet to promulgate legislation that would provide more legal certainty to investors and lenders.
However, the macro-economic drivers are currently so significant that project sponsors and lenders are addressing these issues, and, where possible, structuring around them so as to close large-scale financings that historically may have been challenging to effect.
Saudi ArabiaIn 2006, Saudi Arabia has become by far the largest project finance market in the Middle East. Examples of major capital projects that have recently signed or closed include the $2.5bn (£1.31bn) Shuaibah Project, the first independent power and water project in the kingdom, the $9.9bn (£5.18bn) Rabigh oil refinery and petrochemical facility and the $2.5bn (£1.31bn) Saudi Integrated Petrochemical Project. In addition, Saudi Basic Industries Corporation and certain private sector companies have executed a number of petrochemical financings, including the Al Waha project, which signed earlier this month and is the first long-term sharia-compliant financing of an entire project in the kingdom.
This huge capital investment is being made in a jurisdiction that many lenders would customarily find challenging. The payment of interest on loans is not enforceable under Saudi law: except with respect to mortgages granted to The Saudi Industrial Development Fund, notaries will not permit the perfection of mortgages over real property; certain provisions in project contracts may not be enforced (the payment of liquidated damages); and the legal and regulatory frameworks in certain sectors (the electricity industry) are still evolving and lack certainty. However, the government has embarked on a steady evolution of the legal framework and has introduced laws to facilitate more foreign investment. It is also studying carefully how to privatise and promote foreign investment in infrastructure.
Legal frameworks aside, projects in the kingdom have proven attractive in the current economic environment. Availability of highly competitive feedstock ensures that downstream oil and gas projects are economically strong, which, when coupled with share pledges, offshore revenues and cash waterfalls, give lenders comfort that their loans will be repaid. In the Shuaibah Independent Water and Power Production project, the ministry of finance guarantee and English law-governed project agreements were regarded as key to the bankability of the project, notwithstanding the uncertainty regarding the enforcement of foreign judgments and the as yet untested enforcement of foreign arbitral awards following Saudi Arabia’s signature of the New York Convention.
QatarThe State of Qatar has witnessed significant economic growth (with GDP reaching as much as 20 per cent per annum). This success has been driven by huge investment by Qatar Petroleum (QP) and its foreign partners in the North Field (one of the largest gas fields in the world), as well as in downstream liquefied natural gas (LNG), petrochemical and other industrial facilities. Like Saudi Arabia, from a collateral perspective, Qatar has yet to promulgate effective legislation permitting the perfection of security interests in onshore assets. Initially, in the first project financings in the late 1990s, lenders required the use of a ‘conditional sale’ structure based on certain provisions of the Qatari commercial code. However, since there are doubts about the effectiveness of this structure, the commercial bank market (and latterly other financing institutions) have lent on the basis of an offshore security package with no share pledges.
QP has been very effective in developing a documentation template, which is used in most of the Qatari projects. Lenders therefore know what to expect and have become familiar with the legal issues and the basis on which these issues are addressed. This has enabled the Qataris to accelerate the pace of their financings. While the level of activity in Qatar has diminished since the highs of 2005, the closure of the Qatargas 3 LNG Project and the forthcoming bond issuance by Qatar Gas Transportation Company have, in 2006, maintained the momentum the market has come to expect.
Islamic financingA number of recent projects have successfully put in place financing based on Islamic principles, or the sharia. These include the Rabigh refinery and the Al Waha petrochemical project, both in Saudi Arabia. In the capital-hungry Middle East, Islamic financing has provided an additional pool of liquidity. These financings are usually made by combining istisn’a/murabaha (purchase or supply contracts) with ijara (forward leases). As Sukuks (Islamic bonds) become more common in the corporate finance market, they too may be integrated into project financings. Some regional project sponsors are beginning to express a preference for structuring their financings on an Islamic basis. Many leading banks now have Islamic desks and are interested in participating in this market.
From a legal perspective, the appetite of such institutions to participate in Islamic financings was enhanced by the decision in the Beximco case, in which an English court held that it would not apply sharia principles to the enforceability of financing agreements. In English law-governed financings, this has provided more contractual certainty, and encouraged some conventional banks to participate in the Islamic financing market. However, as a result of the case, some Islamic banks have become reluctant to have agreements governed by English law. The integration of Islamic tranches can have timing implications – each institution has its own sharia board (which must approve the documentation of each transaction). Since the requirements of religious boards can differ from bank to bank, this can impact significantly on the timetable for financial closing. The development of model-form sharia-compliant documentation would almost certainly assist the evolution of this nascent finance market.
The ongoing boom in project finance activity in the Middle East has stretched the capacity of commercial banks in the region. As a result, in a number of the larger project financings, sponsors have needed to involve other funders (such as export credit agencies and Islamic institutions). This has been the case in Saudi Arabia, where the need to integrate these institutions has led to a re-evaluation of the legal framework and financing structures (which had historically evolved in the commercial bank market). The main impact on sponsors in multi-sourced financings has been a tightening of terms and conditions (rather than debt pricing, which remains competitive). As the wider finance market becomes more familiar with the legal issues of different jurisdictions in the Middle East, so the pace of structuring and documenting these complex financings should increase. Bearing in mind the current macro-economic background, lawyers and other advisers can expect to remain busy for a while yet. nJohn Dewar is a partner at Milbank Tweed Hadley & McCloy