Introduction to Project Finance Law: Key Legal Principles

The form of a project business (SPV) to isolate risk, comprehensive contract law to describe relationships, and a security package to protect lenders are important legal concepts in project finance. The structure frequently employs limited-recourse or non-recourse financing, which means that the project’s assets—rather than the sponsors’ other assets—serve as the main collateral. For the legal framework to be successful, extensive due diligence and an emphasis on the project’s “bankability”—its capacity to be finished on schedule and under budget to produce adequate returns—are essential.

The concentration of project finance lenders and sponsors has significantly decreased in recent years as a far greater variety of lenders and sponsors from all over the world have started to actively participate in the market.

It has become more difficult for sponsors to raise funds for their large-scale projects without incorporating a wide range of lending institutions from all over the world in their financing plans due to increased pressure on commercial banks, the traditional source of project finance debt, as a result of the financial crisis of 2008 and the application of regulatory capital adequacy requirements like the Basel III standards. Additionally, the sheer amount of financing required to finance global infrastructure and energy in the context of the ongoing push to achieve a Net Zero carbon economy.

The market continues to witness substantial levels of activity on projects of ever-increasing magnitude and complexity despite the restriction on the availability of borrowing from commercial banks. Thankfully, a variety of things make this level of exercise possible:

• the central role taken by export credit agencies (ECAs) and development finance institutions (DFIs) in financing projects, in both OECD and emerging market economies;
• the emergence of creative solutions by sponsors to fill the funding gap left by the absence of liquidity in the commercial bank market (such as mini-perm structures, accessing mezzanine debt and senior sponsor loans);
• the increasing use of Islamic finance, particularly in the Middle East;
• the increasing availability of lending from infrastructure and energy debt funds;
• the possibility of incorporating project bonds (or sukuk, their Islamic equivalent) into the capital structure, either from the outset or as a pre-agreed refinancing option; and
• the intrinsic value of the firm foundations that the discipline of project financing imposes on the stakeholders (such as extensive due diligence, strong collateral packages, transparent financial structures and bankable risk allocation),

which have resulted in the project finance market continuing to be a feasible choice for funding significant infrastructure and energy projects worldwide.

1. Commercial Banks

Historically, the primary source of funding for projects has been commercial bank debt. With a few notable exceptions, commercial banks’ capacity to provide competitive pricing and long-term tenors has been severely limited in recent years. Despite the fact that the availability of cheaper refinancing debt has been declining in the current interest rate environment, commercial bank liquidity levels in recent years have given project sponsors the chance to refinance their projects at lower pricing and on more favorable terms and conditions.

Because of their experience in project finance, their desire for cross-border financing, their ability to manage construction drawdown schedules and multi-currency draws, and their ability to be a positive and responsive partner throughout the project’s life, commercial banks continue to be a desirable option for sponsors.

Regulatory restrictions

Any commercial bank’s choice to take part in project finance would have been impacted even before the financial crisis by how the regulatory system to which it is subject treated its loans. The U.S. and European regulatory response to the global financial market crisis has been one of the main causes of current loan limitations in the commercial bank industry. Due to an increased regulatory burden that focuses on capital adequacy and minimum capital requirements, U.S. and European commercial banks—who have historically been very active participants in project financings worldwide—have found it more difficult to participate in project financings in recent years.

Commercial bank liquidity

Under the conventional project finance funding model, which emerged in the 1980s, international commercial banks backed projects and frequently retained the loans they had made until they were paid back. The likelihood of a commercial bank originating a loan holding that exposure over time decreased significantly during the 1990s. Rather, it became standard practice for originator lenders to swiftly distribute their booked loans to free up space on their balance sheet so they could take part in more funding.

Commercial banks had a lot of options to distribute their exposure, whether through syndication, secondary market sales, or, to a lesser extent, securitization, which contributed to the high level of activity in the project finance market prior to the 2008 banking market downturn.

With the notable exception of Japanese commercial banks, international commercial banks have found it difficult to maintain their competitiveness in terms of pricing and tenor in the global project finance market due to a lack of options for distributing their booked loans and making room on their balance sheet, high internal funding costs, and increased regulatory constraints. Furthermore, Chinese banks have emerged as important funding sources for large-scale project financing.

Local commercial banks

Local commercial banks are likely to play a significant role in a sponsor’s financing plan in nations with high levels of commercial and political risk because their familiarity with the local political and regulatory landscape can help reassure their co-lenders. Additionally, local commercial banks are frequently important players in project financing in nations where they have substantial liquidity. The liquidity levels of commercial banks in hydrocarbon-rich jurisdictions (such as many of the Gulf Cooperation Council countries in the Middle East) have improved as a result of the recent increase in global oil and gas prices.

Due to the fact that their funding costs have significantly improved and they are not subject to the same regulatory restrictions as their international counterparts, local commercial banks have become more involved in financing many larger-scale projects in the Middle East. As a result, they are able to provide loans with longer terms at lower rates.

Export Credit Agencies and Development Finance Institutions

The need for project finance is still high, but commercial banks’ liquidity is becoming more limited, which has accelerated the growth of the ECA and DFI in recent years. ECAs and DFIs have been playing important roles in financing projects in politically or commercially challenging jurisdictions for a number of years, long before the current credit constraints in the commercial bank market occurred. In these jurisdictions, commercial banks would not be willing or able to lend without some sort of political or country risk mitigation. The commercial bank market’s difficulties have led to a sharp rise in the role of ECAs and DFIs in project financing as sponsors have attempted to close the funding gap left by commercial banks with limited credit.

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Due to the growing significance of ECA funding, sponsors frequently spend time comparing the benefits of a bid from a contractor whose host country’s ECA can provide funding to a bid from a contractor whose bid may be less expensive but does not qualify for ECA funding. In order to obtain DFI funds, sponsors will also do a cost-benefit analysis of the extra cost of meeting the host nation’s development goals.

ECAs

ECAs are driven by the desire to increase the supply of goods and services from their nation, in contrast to commercial banks. ECAs are government agencies or financial organizations that receive direct funding or guarantees from the government and offer finance to boost exports from their nations. The majority of ECAs adhere to the guidelines set forth in the OECD consensus accord, also known as the “Arrangement,” which regulates the conditions under which they lend money to certain industries and nations (the most noteworthy exceptions being China and Russia). Similar to a gentleman’s agreement, the Arrangement allows ECAs to provide or support loans based on the export value of the relevant contract plus a significant portion of the project’s “local” expenditures. It is not legally binding.

“A/B loan” structures

In the past, DFIs have also helped commercial banks lend money to projects by offering debt guarantees or fronting a loan through “A/B loan” arrangements, in which the DFI serves as the loan’s lender-of-record but sub-participates in all or part of the loan exposure to commercial banks. DFIs and commercial banks have historically favored “A/B loan” designs because they enable DFIs to take use of available liquidity from commercial banks while maintaining their status as the loan agreement’s “lender-of-record.”

In addition to giving participating commercial banks the ability to hold an economic interest in loans that, because they are being administered by the DFI, may enjoy a “preferred creditor status” in the event that the host country experiences a foreign exchange crisis, this enables DFIs to commit more funds to a project in order to achieve its development priorities.

The DFI will engage into a single loan arrangement (the “A Loan”) with the project firm for the duration of the loan under the standard “A/B loan” structure, and it will also enter into a type of participation agreement with the commercial banks to offer participation in the A loan (the “B Loan”). Since the DFI is the project company’s only contractual lender, the DFI is exclusively in charge of managing the loan and obtaining payments from the project company under the terms of the loan agreement. The DFI is in charge of allocating the payments it receives among the commercial banks and itself on a pro rata basis in accordance with the participation agreement.

Domestic development organisations

Numerous nations have set up financial organizations with a particular specialty or that help a certain industry or community. For instance, in the Kingdom of Saudi Arabia, the National Development Fund (NDF) and the Saudi Industrial Development Fund (SIDF) actively lend money to support the nation’s industrialization and economic development initiatives.

Capital Markets

Project bonds have generally been a less popular source of funding than commercial bank, ECA, or DFI debt, even though sponsors have been using the capital markets to obtain money for projects since the 1980s. Unsurprisingly, when, as in recent years, the comparative cost and availability of funding from commercial banks, ECAs, or DFIs makes it difficult or more expensive to build a financing plan based only on those sources, the capital markets become more appealing to sponsors. As of March 2025, the financial markets continue to be a viable source of funding for sponsored and well-structured initiatives.

However, the volatility in the capital markets has decreased the market’s predictability given the current interest rate environment and the uncertainty brought on by the bailouts of Silicon Valley Bank, First Republic Bank, and Credit Suisse. However, $4.5 billion in traditional project bonds and sukuk were placed for some issuers, such BlackRock’s Greensaif Pipelines, in February 2023, demonstrating a sizable market appetite for well-structured and highly rated issuers.

Project bonds

This method has a lengthy history in the United States (in fact, to date, the majority of project bonds have been issued to the U.S. market for primarily U.S. projects). The pricing and tenors available in the capital markets have made this a financing option that sponsors looking to maximize their financing plans cannot ignore, despite some sponsors’ perception that issuing project bonds can be a labor-intensive process and dealing with a large pool of bondholders during the life of a project (rather than a group of lenders accustomed to the demands of a project financing) can be problematic.

While project bonds are undoubtedly widespread in project financing, sponsors have opted to fund their projects through the loan markets whenever feasible due to a number of features of the capital markets. Therefore, a sponsor does not make the decision to issue project bonds lightly, notwithstanding the advantage of (currently) competitive debt costs and longer tenors available from the capital markets.

Regulatory and rating requirements

Due to the documentation and regulatory work involved, issuing a project bond will unavoidably be more time-consuming than taking out a loan because of the securities rules that apply, which do not apply to loans. Since the U.S. market has historically been the biggest market for project bonds, issuers—both domestic and foreign—will typically try to structure their bond offering so that they can make offers and sales into the U.S. market to guarantee access to adequate investor demand and competitive funding terms for their bonds.

Raising cash from the public markets in the United States is subject to strict state and federal regulations, just like in any other jurisdiction. The Securities Act of 1933 and the Securities and Exchange Act of 1934 are the main laws that govern offers in the United States, and the United States Securities and Exchange Commission (SEC) is the agency that oversees these issues in the country. This law places significant disclosure and reporting requirements on the issuer before and after the offering, and it mandates that all offerings be registered with the SEC.

Underwriters must acquire so-called “10b-5” disclosure opinions for project bonds sold to U.S. investors under Rule 144A, which necessitates thorough due diligence on the part of both sponsors and underwriters’ counsel.

Typically, a project bond issuer must ensure that the bonds receive a credit rating of BBB+ or higher. The inability of many project firms in emerging jurisdictions to secure a suitably strong credit rating is one of the main reasons why sponsors have historically found project bonds to be less appealing than loans.

Consent issues

One benefit of a project bond for sponsors is that bondholders will usually have less strict documentation requirements, giving the project company more freedom to build and run the project (though it should be noted that a sponsor will not benefit from this flexibility if the project bond is part of a multi-sourced financing). Even though the project participants’ relationships are governed by extensive documentation, problems that were not considered at the time of signing can (and frequently do) arise during the life of any financing. In such cases, lender consent is typically required for an amendment or waiver of the pertinent terms of the finance documentation.

This procedure can be challenging for sponsors when it comes to project bonds because it is typically harder to get the approval needed to change (or obtain waivers of) finance documentation from a large pool of bondholders than from a group of lenders used to the requirements of a project financing.

Construction risk

One of the primary barriers to project bonds being used more frequently in project finance has been bondholders’ reluctance to assume construction risk on a project, however this can be lessened by completion support. The investor base for project bonds, which usually consists of insurance companies, bank treasuries, pension funds, and asset managers searching for long-term assets with steady revenue flows, is the reason for this hesitation.

Therefore, hardwiring the possibility of refinancing the initial loans with project bonds—which will probably become available on more favorable terms once the project is fully operational since bondholders will no longer be taking a project’s construction risk into account when pricing the debt—into the initial finance documentation is a very popular option for sponsors.

Islamic Finance

The rise in the economic prosperity of the Middle East and Asia has contributed significantly to the expansion of the use of Islamic finance, or money that adheres to the precepts of Islamic law. Both the number of projects undertaken in these regions and the growth of the Islamic finance sector have been fueled by this prosperity. In fact, the Middle Eastern project market boom has fueled the development of Islamic financing structures that could be integrated into the region’s more conventional project financing templates. An Islamic finance tranche is now typical in any large-scale multi-sourced project financing in the Middle East as the Islamic finance market has grown and sponsors have come to view Islamic finance as a crucial source of funding.

Finance that is organized in accordance with the tenets of Islamic law—also referred to as Sharia law in Arabic—is referred to as Islamic finance. The two main tenets of Islamic financing are that conventional interest cannot be applied to any financing and that profit and loss must be divided between the financier and the project company (since Islam believes that the ideal relationship between contract parties should be that of equals where profit and losses are shared). Because of these principles, Islamic facilities cannot be produced using ordinary methods. As a result, a variety of financing structures that function similarly to conventional financing structures and processes have been developed to construct Sharia-compliant financial arrangements.

It should be mentioned that Islamic banks are commercial organizations and will take into account many of the same factors as a traditional commercial bank when determining whether to participate in the financing of a project, even though they are required to make sure that any proposed funding complies with Sharia principles.

The introduction of Islamic bonds, or sukuk, into the Middle East project finance market is a relatively recent and interesting phenomenon. SATORP, a refinery project supported by Total and Saudi Aramco, closed the first sukuk issue. As part of the $12.5 billion limited recourse finance package, the Sadara Petrochemical Project (sponsored by Saudi Aramco and Dow) issued an unprecedented $2 billion in sukuk in 2013 after the $1 billion SATORP issue was repeatedly oversubscribed. Most recently, in February 2023, an affiliate of BlackRock’s Greensaif Pipelines issued a very creative $1.5 billion sukuk.

Final Thoughts

Large-scale project financings are now frequently financed by several distinct lending groups, despite the fact that it is widely acknowledged that organizing a project financing that combines several funding sources can be challenging. The Amunet Wind Farm in Egypt was one of the most prominent recent multi-sourced project financings. Because it was the first time the Japanese ECAs, JBIC and NEXI, had co-financed with the IFC in decades, this funding establishes a significant precedent.

The Agencies’ decision to apply the IFC’s preferred creditor status, which grants it preferential access to foreign currency when such currencies are not typically accessible to settle foreign debt, made this possible. As a result, these agencies will now be able to collaborate on project funding, which will be crucial in the context of developing markets in Africa and other regions.

Despite regulatory changes that limit commercial banks’ capacity to offer long-term financing, project finance has consistently shown itself to be a reliable method of funding vital infrastructure and commodity projects, and there is no reason to think that this will change. Therefore, a modern project finance lawyer must be somewhat knowledgeable about a variety of financial instruments, such as commercial bank loans, traditional capital market instruments, domestic government-funded loans, ECA and DFI loans and guarantees, and Islamic Sharia-compliant financing structures.

Despite today’s difficult global economic conditions, sponsors can still finance projects of ever-increasing size and complexity thanks to the willingness of various lending groups to co-finance today’s large-scale “mega-projects” and the participation of sponsors with track records.