Financial institutions have been preparing for the implementation of Basel II for some time. Those that operate in the project finance market have an additional incentive to be prepared because, unless they qualify for the advanced internal ratings-based (IRB) approach, from January 1 2008 the capital reserve requirements for those loans are likely to increase beyond the 100% reserve requirement under Basel I. In addition to motivating financial institutions to develop the risk management systems required to qualify for advanced IRB, the imminent implementation of Basel II has also led to the development of other methods for offsetting Basel II's impact on project finance assets.
Solution 1: securitization
One way of freeing up regulatory capital is to issue collateralized debt obligations (CDOs) for project finance debt. CDOs involve pooling together a portfolio of loans and securitizing the repayment obligations. The rated notes or bonds are then placed with investors either privately...