5 itself has particularly strong and secure cash flows, project finance may allow more debt to be employed in the financing mix, since creditors do not have to worry about project cash flows being siphoned off for other corporate uses.

Project finance may provide stronger incentives for careful project evaluation and risk assessment. Since the project's cash flows are key to obtaining financing, such projects should undergo careful technical and economic review and sensitivity analysis. This may lead to clarification of the nature and magnitude of project risks and what causes them. Having an detailed, objective assessment of project risks and potential may not only enable risks to be allocated to the appropriate parties, but in some cases, the project analysis itself may reveal ways to change the project to reduce the overall level of risks or to improve their allocation. For example, demand analysis of a toll road may show opportunities to delay expansion until certain traffic levels trigger new investments in capacity.

# **The Disadvantages of Project Finance**

Project finance transactions are more complex than traditional corporate or public financing, typically involving many more parties and resulting in significantly higher transaction costs. The complexity of project finance deals also makes them very expensive. The due diligence process conducted by lenders, legal counsel, and other technical experts results in higher development costs, with higher fees and interest margins than what is typically charged. It is not unusual for the total cost of a project finance transaction to cost twice as much as straight debt or equity finance. Total costs may reach 7 to 10 percent of total project value. When acting as a financial advisor to a project, investment banks will typically charge fees of $20,000 to $30,000 per month, plus all expenses. They also typically receive a success fee if the project reaches financial closure, which can range from .0025 to 1.0 percent of total project value.

Negotiations on various aspects of the project are usually protracted and may be quite contentious. This is especially true for transport projects, which typically are politically sensitive, have high visibility, and retain strong public interest and participation. Getting parties with diverse interests to agree on the nature and magnitude of risks is very hard, let alone getting them to agree on who should bear these risks. The documentation associated with project financing is almost always complex and lengthy.

Even after the financing is closed, the project will usually be subject to closer monitoring by all parties. Because lenders primarily rely on revenue flows to repay their loans, the degree of lender supervision of the management and operation of the project will most likely be greater than for an ordinary corporate loan. Likewise, public officials need an ongoing program to monitor contract compliance and potential exposure to any guarantees that have been provided, as well as regulatory oversight when deemed necessary.

# **Risk Identification, Analysis and Management8**

The identification and management of risks is essential in any project financing because of the non-recourse or limited recourse nature of project debt and the limited contractual

> " This section is drawn from P. K. Nevitt and F. Fabozzi, _Project Financing,_ Sixth ed., Euromoney Publications, 1995, chapter 2; Wilde Sapte, _Project Finance: the Guide to Financing Build-Operate-Transfer Projects,_ Euromoney Publications, 1997, chapter 1; Macquarie Corporate Finance Ltd., _Project Finance: The Guide to Financing Transport Projects,_ Euromoney Publications, 1996.