Project bonds

A project bond is a bond used to finance a specific project, partially or wholly.
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  • Bond Issuance

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Municipal bonds 
Green, social, sustainable and sustainability-linked bonds (GSSS bonds)
Sukuk (Bonds) 

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Description

A project bond is a bond used to finance a specific project. Project bonds are typically issued by a special purpose vehicle to raise capital for either a portion or the entirety of the project. Various types of projects, including transportation, power plants, waste management systems, etc. can be financed through project bonds. Notably, project bonds that support renewable energy initiatives often qualify for the ‘green’ bond label set out in the International Capital Market Association’s Green Bond Principles. While traditionally employed to refinance existing projects, post-construction, there has been a growing trend of using project bonds to fund the initial construction phase of greenfield projects. The investor base for project bonds is diverse, encompassing insurance companies, asset managers, infrastructure debt funds, and local investors, reflecting the broad appeal and versatility of this instrument in mobilising capital for critical infrastructure development.

Enabling Conditions and Key Considerations 

  • Established legal framework. A city or local government must have a pre-existing legal framework to facilitate the issuance of project bonds. This framework should outline, among other issues, procedures for securing debt, specify the permissible types of security, determine the bond’s denominated currency, and establish remedies to safeguard lenders in the case of default.
  • Favourable credit rating. Project bonds intended for public investment would need to undergo a thorough rating process by credit rating agencies. A positive credit rating enhances the bond’s appeal, signalling to potential investors that the issuer maintains sound financial health, employs good governance practices, and has a history of meeting its financial obligations.
  • Credit enhancement mechanisms. The inclusion of credit enhancement mechanisms such as bond guarantees, can enhance the attractiveness of a project bond for investors. A bond guarantee serves as assurance to investors that their principal and interest payments will be honoured, even in the face of defaults or project-specific risks. These mechanisms help to mitigate risks associated with the bonds, rendering them more attractive to investors.
  • Due diligence and disclosure procedures. In preparation of a project bond offering, various third-party reviews will need to be conducted to compile the bond’s offering memorandum. These typically includes third-party technical reviews on the project’s operations and performance, independent audits to verify the project’s financial models, and evaluations by legal counsels to assess the issuer’s credit, structural, financial, and cash flow risk profile based on reasonable assumptions, and an evaluation by a legal counsel on the issuer’s credit, structural, financial, and cash flow risk profile.

Potential Challenges

  • Limited local government experience in bond issuance. The local government may have limited experience in navigating the complexities of bond issuance. Project bond issuances are not without risks, particularly the government’s inability to pay their interest and principal debt obligations as they become due under contract. If these risks are not properly anticipated or managed appropriately, the issuance of a bond can affect the local government’s finances in the future.
  • Bond issuance can be a resource-intensive process. The preparation of necessary documents for the due diligence and disclosure procedures for the project bond’s offering memorandum can be time consuming and costly. Underwriters and advisors involved in this process must exercise meticulous care, as both they and the issuer bear liability for any inaccurate statements or material omission in the offering documents.
  • Lack of experience in navigating intercreditor issues. Project bonds may finance a part of a project and represent only one of several tranches of financing, particularly in larger projects. The involvement of different lenders of various classes within a project funding structure raises complex intercreditor issues, such as which decisions require unanimous consent of lenders, which necessitate bondholders’ consent, and which class of lenders can invoke an event of default or accelerate facilities. A robustly designed intercreditor agreement is crucial to governing the decision-making process and enforcement mechanisms among these different layers of the project funding structure and the lack of experience in navigating such issues could serve as a roadblock.

Potential Benefits 

  • Long-term financing option. Project bonds offer local governments a long-term financing solution for large infrastructure projects by aligning the repayment schedule with the useful life of the financed asset.
  • Ability to raise capital for large-scale projects. Project bonds allow local governments to raise capital for crucial infrastructure projects that may be challenging to finance solely through direct transfers from the national budget.
  • Bond proceeds can be used to fund a variety of projects. Project bonds can be issued to raise funds for various projects addressing critical community needs, including waste and water management systems, energy transition projects, transportation projects, etc.

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