Project Finance and Risk Management - Research Proposal Example

?Project Finance and Risk Management 0 In order for a country to develop efficiently, it requires various companies to finance her projects, as the sector is too large to be undertaken by a single government. Project finance particularly comes in handy when there is need to economically develop the rural areas and empower the rural folk to be at pat with their urban counterparts. By definition, project finance is the financing of industrial and infrastructural projects based on the anticipated cash flows out of such projects rather than the assets and liabilities of the sponsors. This expression brings out clear difference between project finance and traditional corporate finance in the sense that payment from the corporate finance comes entirely from the organization. In this case, the payment of the loans comes from the organization, backed by the organization’s entire balance sheet, as opposed from the revenues of the projects. Similarly, the lenders consider the strength of the balance sheet of the organization financing the project as a prerequisite for lending. The nature of financing projects is quite dynamic considering the fact that projects can be large or small and can be public or private projects. Despite the enormous benefits that come with project finance, it is vital to note that these projects do carry with themselves many risks, some of which may have far-reaching implications. In essence, special project vehicle (SPV) undertakes projects in project finance because the projects are off-balance sheet transactions. However, project managers have discovered the best way to counter the challenge through effective allocation of risks hence improving the performance of project financed by different companies. In fact, this project financing and risk management go hand in hand, as the former needs the latter in order to ensure efficient project financing and achievement of the project objectives. In this regard, this paper seeks to unearth the underlying factor of project finance and risk management especially considering the fact that most project are currently financed through various corporates amid scores of risks. It will evaluate a real case scenario of the gas field project in Mozambique that was financed by the South African petrochemical group Sasol. In this case, a number of risks ranging from political risks to feasibility risk and therefore this paper will take a close look at how to manage project related risks in the course of financing challenging projects. This will be especially significant because for every project being finance, there is a risk associated with the implementation of the project although the risks could be managed through proper mechanisms and expertise. Keywords: Risk allocation; project finance; Risk Management 2.0 Justification of the proposed research Undoubtedly, many of the successful projects receive their fiances from the dedicated corporates and non-governmental organizations depending on the nature and complexity of such projects. In this case, project financing may encompass the creation of a project that is independent and receives its due equity from one or more of the sponsoring entities with a view of making maximum investment in capital assets (Esty 2004, pp. 2013-224). More often than not, project financing involves large projects that cut across nations although some of the companies involved may finance projects on a small-scale basis. Indeed, project financing is the development model for the 21st century given that during the year 2001 alone, capital investments worth $ 200 billion were financed by various project companies across the globe. With an annual growth rate of 20 %, such projects have seen nations achieve unprecedented economic development rates amid domestic challenges (Kleimeier and Versteeg 2010. pp. 49-59). Although project finance works well in areas that are less prone to risks, it is obvious that the presence of risks in any project accentuates the significance of such projects. This means that project fiance companies together with project managers have to manage the risks associated with their projects in an effective and amicable manner. According to Esty (2004, pp. 2013-224), risk management is very important in all projects, as effective risk allocation has been proved to impact positively on project performance. In this regard, it is appropriate to mention that the allocation of project risks is normally a complex process and only the participants with the ability to tolerate high risks receive the allocation (Kleimeier and Versteeg 2010. pp. 49-59). However, the process of risk allocation can be very abstract especially during the incipient stages of risk allocation owing to the unpredictability of the risk tolerance ability of the project participants. Essentially, project finance is the financing of industrial and infrastructural projects based on the anticipated cash flows out of such projects rather than the assets and liabilities of the sponsors. Similarly, the lenders consider the strength of the balance sheet of the organization financing the project as a prerequisite for lending. The nature of financing projects is quite dynamic considering the fact that projects can be large or small and can be public or private projects. Despite the enormous benefits that come with project finance, it is vital to note that these projects do carry with themselves many risks, some of which may have far-reaching implications. In essence, special project vehicle (SPV) undertakes projects in project finance because the projects are off-balance sheet transactions. Therefore, it is vital that the project managers and the sponsoring companies follow the due steps of risk allocation that include risk identification, risk analysis, risk transfer, and finally residual risk management. Thus, the study of project Finance and Risk Management is very relevant even as this proposal seeks to delve into the whole process of mitigation risks in project finance (Shen-fa and Xiao-ping 2009, pp. 1757–1763) 3.0 Objectives of the research To study and explore the whole topic of project finance To find out various methods of risk management when conducting a project To find out the impact of risk allocation of project finance To establish the broad relationship between project finance and risk management To establish the impact of project finance on economic development 4.0 Hypotheses There is a strong correlation between project finance and risk management Effective risk allocation improves the performance of project finance Project finance often leads to improved economic growth. 5.0 Literature review Esty (2004, pp. 2013-224) asserts that project finance has been the main reason for improved economic growth especially in the developing nations. Through project finance, companies can be able to finance long-term projects that may require large-scale capitalization. Certainly, capital-intensive projects normally require the financing of more than one company and it is therefore appropriate to employ the services and finances of other interested parties in order to achieve the objectives of the project. The author goes further to highlight the fact that some of the most commonly financed projects under the program of project finance fall under the sectors of telecommunication, power, mining, and petrochemicals. Indeed, these are large projects that a single government may not be in a position to finance effectively especially in the developing nations. Therefore, all the companies involved in project finance especially in large projects ought to envision and put in place proper risk mitigation strategies to be on the safe side. In essence, the enormity of risks should determine the extent of financing such projects in order to estimate the degree of feasibility of such projects. Conversely, Shen-fa and Xiao-ping (2009, pp. 1757–1763) put great emphasis on risk allocation claiming that any project whether on a large-scale or small-scale has some element of risks depending on the nature and scope of the project. In this regard, it is important that project managers undertake the risk mitigation procedure for their projects in order to effectively and successfully complete their projects. This means that effective risk allocation to various projects will have a positive impact in such projects in the sense that the project will be highly successful. Hence, proper risk management in project finance should involve such steps as risk identification, risk analysis, risk transfer, and finally residual risk management. In the same context, Olsson (2008, pp. 60-71) evaluates the feasibility of managing risks in a multi-project environment where he comes up with findings that suggest that both cultural and organizational factors may affect the effectiveness of risk management especially within a project portfolio. This expression brings out clear difference between project finance and traditional corporate finance in the sense that payment from the corporate finance comes entirely from the organization. In this case, the payment of the loans comes from the organization, backed by the organization’s entire balance sheet, as opposed from the revenues of the projects. On the other hand, Hainz and Kleimeier (2012, pp. 287–314) claim that while development banks have embarked on robust project finance programs, political risks have escalated significant over the years thus limiting the extent to which the projects can be implemented. Owing to the laxity by the development banks to offer loans to countries with high political risks, project finance loans that are non-recourse offer the best option by enabling the development banks to participate fully in the syndicates. This helps mitigate the political risks as the project finance loans offer positive prospects. Parker and Mobey (2004, pp. 18-32) support this argument through their electronic document management system which helped them identify the major risk factors in projects and how best to mitigate such risks. In their article, they state that risk assessment and management in relation to project management is a key element to every project management scholar and professional. While some projects that contain high risks may attract high standards of approval, Gatti (2008, p. 2- 36) claim that the criteria for approval should not be based on the risks involved in the project but instead in the inherent ability of the project to pay back the loan. This according to the author of the book means that the financing of a project should only be approved if the rate of the returns on such an investment is commensurate with the significance of the risks involved. On the same note, Dey (2002, pp. 13-26) demonstrates the best quantitative approach used in the construction of risk management design through the decision tree analysis (DTA and analytic hierarchy process (AHP). The nature of financing projects is quite dynamic considering the fact that projects can be large or small and can be public or private projects. Despite the enormous benefits that come with project finance, it is vital to note that these projects do carry with themselves many risks, some of which may have far-reaching implications. In essence, special project vehicle (SPV) undertakes projects in project finance because the projects are off-balance sheet transactions. The author uses a case application of a cross-country petroleum pipeline project in India to explain the whole process whereby the use of AHP and DTA improved on the effectiveness of project management. 6.0 Research Methodology Since project fiance is a topic that has been widely researched by scholars, there will be ample scholarly material from which to do the research. In addition, the research design for this study will be unique but majorly using the qualitative approach to analyse case studies (Patton 2004, p. 56). In this regard, data will be collected through grounded theory practice that will include information gathering through Non-participant Observation, Semi-structured Interview, Participant Observation, and Reflexive Journals. These are the most appropriate methods of analysing qualitative data especially where case studies have to be evaluated (Jost, Nilakanta, & Willis 2002, p. 47) When it comes to data analysis, the data so collected will be majorly analysed through interpretive techniques. These data analysis procedures are quite efficient more so when there is little facts about the topic of study. In the interpretive data analysis, the observer evaluates the available data and from it makes the most preferable inferences based on the impression created by the data (Jost, Nilakanta, & Willis 2002, p. 47). Indeed project finance and risk management is a dynamic topic with unpredictable results mainly due to the unpredictability of the risks to be envisioned within a particular project (Patton 2004, p. 56). In this case, the most preferred data analysis method will be the interpretive technique owing to the numerous disadvantages of the coding process. Reference List Dey, P K 2002, ‘Project risk management: A combined analytic hierarchy process and decision tree approach’, Cost Engineering, 44(3), pp. 13-26. Esty, C B 2004, ‘Why Study Large Projects? An Introduction to Research on Project Finance’, European Financial Management, 10(2), pp. 213–224. Gatti, S 2008, Project Finance in Theory and Practice, Oxford, Elsevier Inc. Hainz, C, and Kleimeier, S 2012, ‘Political risk, project finance, and the participation Jost, M, Nilakanta, R, & Willis, J 2002, Qualitative research methods for education and instructional technology, Greenwich, Conn, Information Age. Kleimeier, S, and Versteeg, R 2010, Project ‘Project finance as a driver of economic growth in low-income countries’, Review of Financial Economics 19, pp. 49–59. of development banks in syndicated lending’, Journal of Intermediation 21, pp. 287–314. Olsson, R 2008, ‘Risk management in a multi-project environment’, The International Journal of Quality & Reliability Management, 25(1), pp. 60-71. Parker, D and Mobey, A 2004, ‘Action research to explore perceptions of risk in project management’, International Journal of Productivity and Performance Management, 53(1), pp. 18-32. Patton, M Q 2004, Qualitative research & evaluation methods, Thousand Oaks, Calif, Sage. Shen-fa, W, and Xiao-ping, W 2009, ‘The rule and method of risk allocation in project finance’, Procedia Earth and Planetary Science 1, pp. 1757–1763. Read More