Risk in global infrastructure project financing

Abstract

Project financing has been the main financing structure of public-private ventures in infrastructure projects. Investors face several risks when going into these projects. These risks are even higher when the project is located in a foreign country. This thesis examines the risk exposure of investors and more specifically of lenders when financing foreign infrastructure projects. Basically these risks can be divided into three main categories: financial risks; political risks; and project's performance risks. The first category includes risks that have to do with the financial aspect of the investment such as interest rate risk, currency transfer and inconvertibility risks, and mainly currency devaluation risk. Political risks are country specific risks that could result from political, legal or regulatory actions that are unfavorable for the project's interest. The third category of risks includes the project's specific risks. These could vary from construction delays or cost overrun, to quality of performance of the project, to market risk... The first step in risk management is to identify and quantify the exposure to each of these risks. This is relatively easy when dealing with financial risks, however much more difficult in the two other categories. Hedging financial risks is done by the appropriate use of financial derivatives coupled with internal hedging strategies. Political risk hedging is mainly achieved by either introducing "strong sleeping partners" or by buying insurance policies. Finally performance risks could be easily prevented by adopting appropriate contractual agreements. Based on the results of a survey conducted with the major US commercial banks, lenders account for most of these risks. And when involved in international infrastructure financing they do hedge part of their risk exposure using the same hedging techniques discussed previously.