Mitigating Commercial Risks in Project Finance Essay

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Privatesector P U B L I C P O L I C Y F O R T H E The World Bank February 1996 Note No. 69 Mitigating Commercial Risks in Project Finance In project finance, risks are allocated to the parties best able to manage them. However, the risk mitigation instruments incorporated in the project’s contractual and financial arrangements need not be all-encompassing to provide the security investors require. Commitments may be limited in scope (restricted to geological risk, labor and equipment productivity, operation and maintenance, market demand, or force majeure), amount (limited to a percentage of project debt or capital costs, contract price, or operating budget), and duration (applicable only during construction, performance testing, start-up, operation, or on failure to achieve certain milestone dates or operational or financial indicators). This Note provides a checklist of commercial risk mitigation instruments commonly used in project finance by private lenders and sometimes by equity investors. The checklist is structured around a project’s development cycle, which, for simplicity’s sake, is divided into the construction (including start-up and testing) and operating phases. (See tables 1 and 2 for summaries of possible risks and coverage.) curement, performance testing, obtaining permits and insurance, provision of required services (water, electricity, fuel), and relief under force majeure events. The contractor may be responsible only for bringing a project to mechanical completion according to the owner’s design and specifications, transferring to the sponsors responsibility for start-up and testing. Under an engineering, procurement, and construction contract, however, the contractor accepts full responsibility for delivering a fully operational facility on a datecertain, fixed-price basis. If the contractor fails to meet its obligations, it may be

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