Focus on financial services: project finance and derivatives from a lawyer’s perspective

Project Finance is about structuring the financing of a specific project or asset on a limited recourse basis. It could be the construction of a power station or a toll road, the acquisition of a cooper mine or an aircraft, or the development of a commercial property project. In this context, the main objective sought by the sponsors would be to avoid affecting its own credit standing or balance sheet. On the opposite, the lender or financier will try to ensure the financing to be fully repaid with the revenues produced by the project or asset itself. Sponsors would have to select the appropriate ownership structure for a project – for example, trusts, consortium, partnerships, or joint ventures – but typically the financing would be made to a special purpose vehicle (SPV) owned by the project sponsors. An SPV is used to insulate the shareholders from the insolvency of the project and to seclude the lenders from the insolvency of the sponsors. To that extend, risk analysis, in order to identify and manage the potential risks, is critical to the lender and the borrower. One way to mitigate potential financial risks associated with the project or asset is using derivatives as a way to stabilise the economics of the project or asset by transferring risk.

A derivative is a financial agreement that gets its value from an asset or market variable. Parties to a derivative transaction agree to pay or exchange money or goods at a future time, based on the value of the underlying. A derivative can be used to gain exposure to, or create an offset against, the underlying asset without buying or selling that asset. As a contractual agreement, derivatives are based on the essential feature that a right-holder is entitled to receive something on the exercise of its right under a contract which itself has a distinct value. Together with acknowledging that there are some common topics between project finance and derivatives, the first as a financing technique and the latter as a valuable tool to mitigate financial risks, no one should ignore that derivatives have their own risks; some of them are strictly financial, but others may be transactional or legal.

As a banking and financial lawyer, I am very motivated to understand and cross the boundaries between law and finance. In the end, in the business of borrowing and lending money, our job is to facilitate the process in an ever-changing legal, social and environmental environment.