Bankable project finance ensures revenue streams and the value of the project can be secured in favour of the lenders. Such a regime will ensure that licences, permits and other regulatory permission as well as contractual rights of developers are capable of assignment in favour of the lenders. This is because the lenders will be expected to have not just the financing but technical acumen to take over and see through the project if there is default from the developer.
As lenders will be repaid their financing costs only after the project commences commercial operation and starts generating a revenue stream, the temporal gap between the upfront financing and repayment period exposes lenders to a mismatch risk. Therefore, the borrower accepts the trade-off of more control from lenders and agrees to provide greater transparency to the lenders. This is achieved by both financial covenant and other corporate governance undertakings required to be adhered to by the borrower in the facility and other financial documents.
Nepal’s project financing regime is replete with discussions on the issue of construction risks, delay in land acquisition and other developer’s risks. However, there is also a need to equally appreciate the bankability crisis which is crucial to the viable financing of infrastructure projects. Usually, it is the lenders who will have higher exposure than the equity investors in project costs. However, the laws and policies in Nepal are far from suitable for a bankable project finance regime. While there are laws that promote further infrastructure financing, there is inconsistency across policy preferences of various instrumentalities that defeat the bankability of efficient project financing.
In Nepal, the industry can only acquire a prescribed portion of land as per Land Act 2021. If further land is required, in excess of the land ceiling limits, then the industry must seek land ceiling exemption approval. The Parliament enacted the Industrial Enterprise Act 2020 which restricts the creation of security over land acquired more than the ceiling. The lease agreement entered by project developers for government land in Nepal tends to have an anti-assignment covenant of leasehold rights even though they are not restricted under Nepali law. As the assets in the concerned project are spread across sites with different components, it is unreasonable for lenders to take control over piecemeal assets which will fail to maximise the going concern value of the project in project financing.
This is also against the sound credit practice mandated by Nepal Rastra Bank (NRB) to provide adequate security coverage and provisioning of contingent liabilities. While NRB requires lenders to make provisions if there is no adequate security coverage, the inconsistent policy of allowing only partial security by IEA makes it difficult for lenders to exercise sufficient risk mitigation. The inadequate security will also mean that the risk premium of the project increases and ultimately any increase in the cost of borrowing is passed on to the project developers.
Ambiguity in Compensation Lenders
As per Electricity Act 1992, if there is a default from developers the generation licence is terminated and the project will come under the basket of the Government of Nepal. However, this law fails to account for the financing costs already incurred by the lenders. As the financing is incurred prior to the generation of revenue, there is a huge risk to lenders that the financing costs will not be repaid. Usually, when the project is in default with or without the fault of the developers, there should be payment of transfer price before it can be handed over to concession granting authority. The transfer price generally consists of the financing costs principal, interest, and other financing costs incurred by lenders. As per best practices, the transfer price component will also include rate of return which a bank will be entitled to expect had such funds been lent at a market rate to a third party borrower. This is to ensure that the concession granting authority is not unduly enriched while the financiers are not able to recover their financing costs. While this has been achieved in some precedent projects by way of project development agreement entered with the government, this should be clarified expressly and available to all lenders.
Inconsistent Policy Preferences
The bankability of the financing regime cannot be functional without consistency in policy preferences between various governmental authorities. There are certain policies that are mutually inconsistent with each other. For example, the priority sector lending directive issued by NRB requires banks to advance 10% of the loan to energy sector by mid-July 2024. If the loan is not advanced within the period, then banks are subject to penalty at the interest rate levied for such insufficient allocation.
However, it fails to grasp the practical difficulties banks are facing right now. Without adequate comfort of the assignability of PPA payments, a guarantee of take-or-pay clauses, priority in insurance proceeds, assignability of licences, banks are not comfortable sanctioning loans. Although the project might obtain commercial operation there is no guarantee of completion of the transmission line for evacuation of energy. Therefore, without having such comfort, advancing loans will be against the risk management norms of banks. As such on the one hand, there is an imminent mandate from NRB to the bank to fulfill the energy financing, while on the other governmental instrumentalities like Department of Electricity Development, Nepal Electricity Authority are not well versed with the valid concerns of the banks on bankability.
Banks are creatures of the norms they are built on. As banks have a macroeconomic impact on the national economy, they cannot advance loans without mitigating all foreseeable risks. Therefore, if the state indeed wants to promote the financing of infrastructure, not only banks but the entire regulatory ecosystem must appreciate the bankability crisis that the infrastructure sector is currently reeling under.