Contributed By Winston & Strawn London LLP
Project finance has been used to finance large capital-intensive energy and infrastructure projects in the UK since the 1970s. Project finance entails the raising of finance on a non – or limited – recourse basis by a special purpose vehicle (Project Company), with all repayments payable from the cash-flows generated by the project.
A typical project financing structure includes one or more equity investors as owner(s) of the Project Company and lenders (usually composed of a consortium of financiers, including commercial banks and, often, multilateral agencies or development finance institutions). In the wake of the financial crisis, continuing pressure on commercial banks’ liquidity and the tightening of regulatory requirements under the Basel III rules saw many banks reduce or cease their involvement in project financing transactions. In recent years, institutional investors have increasingly contributed to closing the financing gap in UK infrastructure projects.
Project finance in the UK is not subject to a specific legal framework and the applicable rules will often depend on the sector and location of the relevant project. In addition to UK legislation (ie laws of England and Wales, Scotland and Northern Ireland), the applicability of European law must be taken into consideration when structuring and procuring projects. Relevant European law provisions include the state aid rules under articles 107 and 108 of the Treaty on the Functioning of the European Union (State Aid Rules) and various EU environmental regulations. In addition, the planning and licensing regimes in the UK are also a prime consideration in project financing transactions.
The UK has long been at the forefront of public-private partnership (PPP) transactions. A PPP is a long-term contract between a private party and a government entity to provide a public asset or service in which the private party bears significant risk and management responsibility and remuneration is linked to performance. There is considerable precedent for this type of financing in the UK.
The IPA and NIC
The government established Infrastructure UK (IUK) in 2010 to co-ordinate and simplify the planning and prioritisation of long-term infrastructure projects, including PPP projects, and to promote private sector investment in infrastructure. In 2011 the Major Projects Authority (MPA) was established to oversee and assure the largest government projects, and in 2016 IUK and MPA merged to form the Infrastructure and Projects Authority (IPA), which is the government's centre of expertise for infrastructure and major projects. The core teams comprising the IPA include experts in infrastructure, project delivery and project finance who work with the relevant government departments and the various industry participants.
The UK National Infrastructure Commission (NIC) was established in October 2015 to provide advice to the government on major, long-term infrastructure challenges in the UK. In particular, the NIC is responsible for undertaking a National Infrastructure Assessment each session of parliament, making recommendations to the government and holding the government to account with respect to the implementation of such recommendations.
The procurement process for PPPs in the UK with a value in excess of the applicable financial threshold set out in the EU Public Sector Procurement Directive 2014/24/EU is governed by the Public Contract Regulations 2015. Formal tender processes (under these regulations) are viewed positively in the market and facilitate the financing of infrastructure projects.
The private finance initiative (PFI), traditionally used for capital-intensive projects, was previously the dominant PPP model in the UK. PFI projects entailed a private sector company, usually through a special purpose vehicle (SPV), financing, building, operating and maintaining a project in return for payment from the relevant public authority for the use of the project. Typically, at the end of a fixed period of time, ownership of the project was transferred to the public authority. In 2012, the government adopted a new approach to PFI known as Private Finance 2 (PF2) and all PPP documents followed the standard wording and guidance set out in the Standardisation of PF2 Contracts. In October 2018, in the wake of the collapse of construction firm Carillion, PFI and PF2 models were abolished as they were considered inflexible and overly complex and a source of significant fiscal risk to the government. Existing contracts under the PFI and PF2 models will be honoured but no new contracts under these models will be entered into. Given the crucial need for private sector investment in UK infrastructure, the market expects a new PPP model to be introduced, but it is not clear at this stage what form this will take.
The relevant government approvals, licences and statutory controls required for a project will depend on the nature of each project. For example, as described below in 8.8 Environmental , Health and Safety Laws, many commercial and industrial activities in the UK require a permit governed by the Environmental Permitting (England and Wales) Regulations 2010 (as amended). Furthermore, Project Companies involved in the generation, supply, transmission or distribution of electricity; or the supply, shipping, distribution or transmission of gas onshore in the UK; or the operation of an interconnector; require a licence from the Office of Gas and Electricity Markets (Ofgem).
The tax regime governing project finance transactions is generally the same as for other commercial loan transactions as set out above in Section4 Tax. In addition, there are a number of tax incentives in the UK to attract investments in energy and infrastructure projects, such as those under the Energy Act 2013 for low-carbon generation and enhanced capital allowance for specific energy-saving plants and machinery.
The transaction documents do not need to be registered or filed with a government body, with the exception of any document creating a security interest. To be enforceable, any such security documents must be registered with Companies House in exchange for a minimal fee, in addition to being registered at the Land Registry.
The governing law of transaction documents for projects in the UK will generally be the laws of England and Wales. However, depending on the location of the project, Scots law or the laws of Northern Ireland may govern some project documents.
Several government bodies are responsible for projects in the UK. Most central government departments have a private finance unit responsible for overseeing projects in their sector. These include the Ministry of Defence, the Department for Transport, the Department of Health, and the Department of Energy and Climate Change, which deals with oil and gas exploration or production projects. In addition to these government bodies, PPP and PFI (where still applicable) policies are driven from within HM Treasury and the Cabinet Office. Furthermore, PPP and PFI are devolved matters and are regulated by the Strategic Investment Board in Northern Ireland, the Scottish Infrastructure Investment Unit in Scotland and the Welsh Assembly in Wales.
Certain regulated sectors are also administered by government bodies, such as the Water Services Regulation Authority (the economic regulator of the water sector), Ofgem (the regulator of the electricity and gas market) and the Office of Communication (the regulator and competition authority for the communications industry). These bodies are, among their various functions, responsible for issuing licences to operate in their respective sectors.
There has been a history of state ownership in the UK, but most of the energy and infrastructure industries have been privatised in recent years.
The first issue to be considered when structuring a project is the bankability of the project and the related contractual arrangement. As part of the assessment of the bankability of the project, a comprehensive risk analysis will be conducted and the various risks, once identified, should be appropriately allocated in the transaction documents to the parties best placed to bear such risks.
The equity investor(s) and owner(s) of the Project Company can be a single party but are more commonly a consortium of sponsors. Project Companies in the UK are commonly an SPV incorporated as a limited liability company.
Funding sources available to Project Companies include commercial lenders, export credit agencies, international institutions such as the European Investment Bank and project bonds investors. Project bonds have become increasingly popular in recent years for infrastructure projects in the UK, such as motorways, and attract greater investment from institutional investors. The financing is provided on a limited recourse basis which means that the lenders’ only recourse in case of default is to the assets and cash flows of the Project Company. It is, however, not unusual for lenders to require contingent equity and/or some form of completion guarantees from the sponsors. Project financing in the UK is typically highly leveraged with a gearing ratio in the range of 80/20, but it is not uncommon for the gearing ratio to be as high as 90/10.
Restrictions may apply to foreign investors in relation to certain regulated business sectors in the UK, such as energy and defence. For example, the EU Third Energy Package, which aims to separate generation and transmission of gas and electricity, requires Ofgem to certify as independent the holder of electricity transmission and interconnection licences. If the certification application is made by an entity controlled by a person outside the EEA, Ofgem is required to notify the secretary of state of the UK government and the EC of such an application. The secretary of state and the EC may make a recommendation against the grant of such certification if the security of electricity supply in the UK or any EEA state would be put at risk by the certification, in which case Ofgem may follow the recommendation and decline to grant the certification. Ofgem also enforces the Competition Act 1998 and Articles 81 and 82 of the EC Treaty in the electricity and gas sector, which prohibits any prevention, restriction or distortion of competition within the common market.
Investors from outside the EU may also be affected by EU sanctions, which may be autonomous or reflect measures imposed by resolutions adopted by the UN Security Council. These restrictive measures may prohibit such foreign investors from being involved in project financing in the UK.
Typical sources of finance in project finance transactions include long-term limited-course loans from (conventional and/or Islamic) commercial banks, development finance institutions and/or other financial institutions. In addition, project bonds have increasingly been utilised, often in conjunction with limited recourse loans, as an alternative source to meet the financing requirements of large-scale capital-intensive projects.
Projects may be purely private (such as independent power projects), may involve a partnership between the public and private sectors (PPPs), or may be built and operated entirely by the public sector. Generally, PPPs are long-term contracts (eg, 20–30 years) under which the Project Company constructs the project, such as a road, using financing obtained on a project finance basis and, thereafter, operates and maintains the project in return for:
Natural resources in the UK include oil, natural gas, coal and minerals. Ownership of oil and gas within the land area of Great Britain is vested in the Crown by the Petroleum (Production) Act 1934 and the Continental Shelf Act 1964. The ownership of almost all coal in Great Britain resides with the Coal Authority, while ownership of gold and silver is vested in the Crown. Other minerals are in private ownership, with the owner of the land entitled to everything beneath or within it. Details of land ownership are held by the Land Registry. The Minerals Development Act (Northern Ireland) 1969 vested the ownership of most minerals in Northern Ireland in the Department of Enterprise, Trade and Investment.
The natural resources sector in the UK is regulated by a number of statutory bodies, depending on the mining activity and the location, including the Environment Agency in England, the Scottish Environment Protection Agency, Natural Resources Wales and the Northern Ireland Environment Agency, together with the Health and Safety Executive and the Department of Energy and Climate Change (DECC).
Planning Permission and Licences
Planning permission and licences are required from the relevant authority for the extraction of natural resources in the UK in addition to the rights of access granted by the landowner (for onshore natural resources), unless the land is owned by the Project Company. The Oil and Gas Authority (an agency of DECC) is responsible for issuing licences for oil and gas exploration onshore (excluding Northern Ireland which issues its own licences) and on the UK Continental Shelf, for regulating field development and oil and gas pipeline activities and monitoring environmental impact, including decommissioning. The Energy Act 2008 introduced further requirements for licensing, including for the offshore storage of natural gas and carbon dioxide, and additional requirements relating to the funding of the decommissioning of offshore installations. The Coal Authority (sponsored by the DECC) is responsible for issuing licences for coal exploration and extraction. The Crown Estate Mineral Agent is responsible for granting exclusive leases and licences for exploration and development of Royal Mines to mine gold and silver. There is no specific licensing requirement for the exploration and extraction of other non-fuel minerals.
Planning authorities play an important part in the regulation of mining activities in the UK. In England and Wales, planning permission is granted by the mineral planning authority, commonly the county council, and under the Planning Act 2008. The Planning Inspectorate makes recommendations to the DECC, which makes the final decision on applications to develop significant projects. In Scotland, planning permission is granted by the local planning authority and in Northern Ireland, planning permission is granted by the strategic planning unit.
There are no restrictions to trading most natural resources with other EU countries as the EU operates as a single market. Natural-resources exporters may, however, need a licence for the export of a number of strategic controlled goods, such as goods with a potential military use listed in the Export Control Order 2008 (as amended) which applies to certain metal fuels and alloys.
The environmental impact of natural resources extraction should be a prime consideration of project sponsors. The main source of environmental control in the UK is the planning permission regime. Most planning permissions impose environmental restrictions and obligations on the permit holder, including upon decommissioning. In addition, the Environmental Permitting (England and Wales) Regulations 2010 (as amended) requires environmental permits for most natural resources-related activities. Any impact on local wildlife may also give rise to the requirement to obtain a licence under various conservation legislation.
As highlighted in 8.7 The Acquisition and Export of Natural Resources, the main sources of environmental laws applicable to projects in the UK are the Environmental Permitting (England and Wales) Regulations 2010 (as amended) and the planning permit obtained by the Project Company. The regulatory bodies overseeing environmental issues in the UK are the Environment Agency in England, the Scottish Environment Protection Agency, Natural Resources Wales and the Northern Ireland Environment Agency. Projects in the UK are also subject to EU environmental laws in many areas, such as air pollution, sustainable development, waste management, water protection, soil protection and noise pollution. On 12 March 2014 the European Parliament adopted the Environmental Impact Assessment Directive 2014/52/EU (EIA Directive), which substantially amended the Environmental Impact Assessment Directive 2011/92/EU (implemented in the UK as the Town and Country Planning (Environmental Impact Assessment) Regulations 2011). The EIA Directive was transposed into UK legislation in May 2017 and imposes, among other things, requirements for the assessment of the impact of projects on biodiversity, climate change, landscape and disaster risks and imposes monitoring obligations during both the implementation and operation of the project.
The Health and Safety Executive (HSE), together with local authorities, is responsible for overseeing health and safety in the UK. Project companies (and their management team) that breach health and safety legislation in the UK risk being prosecuted, with penalties with respect to the HSW Act ranging from a GBP20,000 fine and/or 12 months’ imprisonment to an unlimited fine and/or two years’ imprisonment.