The financing of the Patrind hydropower plant across three states in Pakistan reveals how to complete deals in the challenging frontier jurisdiction.
Although international investors question its political stability, Pakistan is fast becoming a market that attracts adventurous investors. And for good reason: in 2012 the Karachi Stock Exchange hit all-time highs.
But growth demands infrastructure, and the Patrind hydropower project, financed by multilaterals and an export-credit agency, provides much-needed power to remote areas of Pakistan.
Shearman & Sterling's Sanja Udovicic, who advised the lenders in this financing, explained that this is a complex cross-border PPA structure that follows that of the New Bong Escape hydropower project, which closed in 2009.
But she noted that this is the first time a hydropower project, spanning Azad Jammu and Kashmir (AJK), which has a unique political status in the region, and the Khyber-Pakhtunkhwa (KP) Province, has reached financial close.
"We had to navigate various integration issues and carefully analyze the risk allocations to ensure that political risks were appropriately addressed in the power purchase agreement, two separate implementation agreements, two water use agreements and multiple direct agreements provided by the Governments of AJK, KP Province and the Government of Pakistan, which also provided a guarantee in support of the obligations of the power purchaser," Udovicic said.
She added that the deal was financed by three multilateral development banks Asian Development Bank (ADB), International Finance Corporation and the Islamic Development Bank as well as the Korean export credit agency (ECA) Korea Export-Import Bank (K-EXIM).
The intercreditor issues were complex, especially the incorporation of an Islamic lease structure in the mix, she commented.
The project required interfacing with each provinces government as well as the Government of Pakistan.
Alfred Ng, a senior associate at Shearman & Sterling, said that there were intricate local issues related to the acquisition of land because the project straddled AJK and KP with diverse local procedures and various landowners, including local governments and individuals.
To resolve these issues, lengthy and complex statutory processes had to be followed to ensure that all stakeholders were consulted and treated fairly.
Counsel also had to be aware of intricacies regarding the National Electric Power Regulatory Authority (Nepra). Udovicic explained that the tariff for power generated by the project is regulated by Nepra and is essentially a 'cost-plus' structure.
It assesses the project at least twice during the course of the financing stage: once fairly early on, with another assessment pre-financial close, Udovicic explained. There is then a true-up assessment performed once the project is operational.
She added that the assessments are undertaken in accordance with complex regulations which specify which costs can be treated as project and financing costs for the purposes of the tariff calculation.
Some costs which might otherwise be treated as projects costs, such as funding of the debt service reserve account and cost overruns which are not approved by the regulations, are not taken into account in the tariff calculation, she said. Financiers must structure around the rules to ensure that the financing terms and the financial model address these quirks appropriately.
There have been several innovative project financings that closed in Pakistan in 2012. Aside from the Patrind hydropower financing, this year the ADB collaborated with the Islamic Development Bank to close its first wholly-shari'ah compliant financing of the Fauji Foundation's two wind farms.
Moreover the Patrind financing demonstrates the growing prominence of Korean sponsors and lenders in emerging jurisdictions.
Ng said that this deal is reflective of the success of Korean sponsors in Asia, including challenging jurisdictions and markets.
The Korea story is quite an important one for project finance in the region, and Korea Water and Daewoo both participated in the deal, with backing from K-EXIM, he added.
But a challenge may be attracting commercial banks, which remain wary of local politics and contract law from their experiences in the 1990s. Following the close of 19 independent power projects (IPPs) under the Private Power Policy in 1994, the Government of Pakistan terminated 11 IPPs by 1998 on alleged or technical grounds that resulted in a difficult three-year workout period.
Pierre Bailet, a legal expert at the ADB, said he expected that ADB recently completed Pakistan project financings would encourage commercial banks to support projects in the country.
This is especially key because many of the multilaterals have done a number of projects in Pakistan and may be reaching their country limits.
However Udovicic noted that some sponsors are looking to Chinese ECAs to meet part of this funding gap. She expected to see more Chinese developers and contractors make a push in these frontier jurisdictions.
Chinese developers and contractors, together with the Chinese ECAs and banks supporting them, may have a learning curve in relation to the solutions developed to address issues arising, she said. They will also need to be patient in terms of the time and challenges involved in getting a Pakistan financing off the ground
But Udovicic added that this could be an interesting new source of funding for the many projects still in the development phase in Pakistan.
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