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Taking the lead

Alexander V Zakharov, deputy chairman of the board of Sberbank, explains how the Russian bank has overcome various challenges to financing some of the country’s major domestic and export-oriented investment projects.
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Russia’s current investment and economic climate has shown a noticeable improvement in recent years. However, opinion prevails that a poor institutional environment, non-transparent state regulation in the economy and a risk-fraught legal framework turn project-financing in Russia into an extremely complicated, if not impracticable, undertaking.

True, all these factors are in play and do hamper project financing but more and more investment projects are being successfully project-financed.

Sberbank is one of the key players in Russia’s project finance market. Established in 1841, it has grown into the largest bank in central and eastern Europe by assets and Tier 1 capital with about $8bn market capitalisation. It was one of only a few Russian banks to launch long-term investment loans in the early 1990s and was named Bank of the Year 2004 by The Banker.

Currently, its long-term investment loan portfolio exceeds $5.2bn, so it is capable of single-handedly financing practically any investment project in Russia, thanks to its powerful funding base. Its current maximum exposure per single borrower is $1.3bn, and loans are made for up to 10 years.

Growth in demand

Sberbank developed project financing as a separate business in the mid-1990s, but it’s only in recent years that demand for this product has grown. Many Russian companies are entering into a new phase in their development, when taking more balance sheet risks is undesirable or impossible under their existing commitments. Sometimes a project can only be implemented through project financing when, for instance, several companies – possibly competitors – join forces.

Sberbank has faced some country-specific problems while undertaking past project-financing. At the time, many Russian companies were under the false impression that equity participation and proven loan repayability were sufficient to apply for project financing, whereas equity participation was understood as the reinvestment of shareholders’ future profit after investment stage implementation. Another typical problem was the sponsors’ reluctance to invest in equity, since they preferred lending.

Insuring risks was another issue. The global practice of fixing the contract price and contractor liability proved difficult to implement in Russia due to legislation shortfalls and non-competitive markets, which were dominated by monopolistic contractors who shunned additional obligations. Even when stipulated by contracts with suppliers and contractors and backed by bank guarantees, these were unenforceable because banks had low capitalisation and limited contractual liability. The same applied to long-term sales contracts.

Some of the complexities of project financing in Russia only affect non-resident companies and credit institutions. They can’t accept the risk associated with the substantial participation of domestic suppliers and contractors in domestic projects, which is sometimes required by law (for example, under production-sharing agreements).

Russian parties to a project often have neither a credit history with western banks nor International Accounting Standard (IAS) reporting. Moreover, some of the globally accepted techniques of hedging project risks are invalid under Russian law (eg, escrow accounts that are acceptable only in case-law jurisdictions). Hence the preference of western creditors for financing projects in the explicitly export-oriented oil and gas sector with profit centres set up outside Russian jurisdiction.

As a Russian bank, Sberbank can take such jurisdiction-related risks; and lack of IAS reporting is a not a deterrent. Furthermore, as the largest national bank, Sberbank co-operates with national legislators to harmonise existing regulations with international practices. One example is the agreement signed in 2001 by Lebedinsky ore mining and processing plant with a German bank consortium on blocked account and pledge of funds credited to its accounts with Sberbank. The arrangement – at that time impossible in Russian jurisdiction – was governed by German law. Sberbank’s active involvement facilitated the amendment of the licence that had been issued earlier by the Central Bank of Russia (CBR) to Lebedinsky, and contributed to CBR’s revision of its approach to safe custody accounts and related operations.

Domestic demand

Despite the challenges, Sberbank continues to be successful. Project financing in its aggregate long-term loan portfolio approaches 20%. A national-sized bank, Sberbank does not confine itself only to high-profit, export-oriented sectors and works with other companies, focusing on the projects aimed at sustainable economic growth backed by growing domestic demand. Its largest project finance milestones include a federal mobile communication network ($3300m); Russian satellite group upgrade (over $800m); gas condensate field improvement ($360m); instant coffee production plant ($60.2m); and international passenger airport terminal ($50m). The growth of the Russian economy calls for large infrastructure projects in energy, transport and other sectors. The importance of these projects sets unique criteria for participants, especially those banks providing finance, which must have adequate project finance expertise and funding opportunities. Sberbank meets all these requirements. Indeed, with its expertise in project financing, it can lead-manage the financing of any project. Currently, it is arranging finance for a number of projects of more than $1bn each, including development of oil fields, transport infrastructure and energy projects.

A specific feature of Sberbank’s project finance is limited recourse against project sponsors. Limited recourse strategy is dictated by the scale of projects handled by Sberbank. For example, full recourse against the sponsors of a $1.6bn project for Prirazlomny oil field development (Rosneft and Gazprom), with $0.9bn of intended Sberbank participation, would impair their ability to raise loans for further growth. In most cases, Sberbank finances projects with limited recourse or no recourse on a case-by-case basis, according to project features and the sponsors’ potential.

The scope of recourse typically changes with the progress of the project. Recourse against sponsors during the construction phase minimises risks over this particular phase. Sometimes sponsors take up risks at the investment phase to reduce financing costs. However, as full recourse would hamper their further growth once the phase is over, Sberbank will consider a limited recourse option (including total release) when the project achieves the target figures. Major project parameters relevant for liability reduction purposes normally include meeting the deadlines for commissioning; achieving rated capacity; product quality; and target parameters.

Sometimes limited recourse is exercised during the investment phase, either through the limited liability of sponsors in various periods of the investment phase or by their commitment to increase financing if project costs increase. Thus, sponsors reduce their balance sheet liabilities and maximise their capacity for concurrent projects.

Project handling

Once the investment phase is over and basic parameters are confirmed, Sberbank normally handles the whole project, requiring no additional guarantees from sponsors. In exceptional cases where commercial risks cannot be managed, recourse against sponsors may be required. (Such recourse usually results from the inability to sell products as planned or at the planned price.) When the risks are low, Sberbank may agree to finance with no recourse against sponsors. In that case, sponsors’ risks will be limited to standard Sberbank requirements (sponsors contribute at least 30% of the total project cost).

Sberbank makes a point of developing co-operation with the Export Credit Agencies (ECAs) and banks that provide ECA-covered finance in countries that are Russia’s major trade partners. Sberbank has established and continues to develop relations with a number of ECAs worldwide, including EDC, Euler Hermes, COFACE, IFTRIC, SACE, SEC, ÖKB, NEXI, JBIC, US EX-IM Bank, Hungarian Eximbank, Export-Import Bank of Korea, KEIC and others. Long-term credit lines opened on Sberbank by prominent foreign banks widen the range of its banking products and provide additional attractive tools for financing investment programmes of the Russian companies.

Its positive experience in project financing justifies Sberbank’s further increase in its long-term loan portfolio to 35%–40%. The growing number and scale of projects in the pipeline testifies to that. Doubtless the improvement of the investment climate will boost project financing, which will become a major tool for Russian companies in their investment projects.

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Read more about:  Central & Eastern Europe , Russia