Belt and road project funding moves from buyers’ to sellers’ credit

The most popular method for financing BRI projects involves the use of ‘buyer’s credit’, where the contractor introduces the project sponsor to potential lenders, and the project sponsor then uses money borrowed from the lender to pay for construction materials and services.

But there has been a surge in the use of ‘seller’s credit’ on the BRI. This involves the contractor providing financing for the materials and services required for a project by agreeing to be paid at a later date.

Borrowers and lenders have been under pressure in the last 18 months, and quantitative easing by the US has resulted in lower USD funding costs outside of China, all of which contributed to a significant reduction in traditional BRI lending activities. During the same period maturing technology and concerns over climate change also led to a significant increase in global appetite for renewable energy. 

Certain types of renewable projects, such as distributed solar or onshore wind, often involve less capital investment and shorter construction schedule when compared to infrastructure and traditional power projects. These factors, combined with developments in the international capital market, have resulted in the rise in the use of seller’s credit. 

Seller’s credit structures

Seller’s credit refers to a financing arrangement where the seller finances the buyer’s purchase by agreeing to be paid at a later date. 

Where the project sponsor has limited financial resources, difficulty in obtaining financing or where the construction period is relatively short, seller’s credit may be an attractive option for the project sponsor.  Seller’s credit may also be attractive for the contractor due to the potential for additional revenue. 

A seller’s credit structure can be structured in a number of ways.

The simpler form of seller’s credit involves the deferral of payment under construction contracts, typically with payments starting after reaching certain milestone(s), on the date of practical completion or a certain period after practical completion. This gives the project sponsor time to either arrange financing or to meet repayments from revenues generated from the completed project. Under this structure, however, the contractor takes an increased risk for the project not completing and potential disputes affecting its debt claims, for which it will need to be compensated.

The contractor’s risks are further increased where the project is based on a concession agreement. If the concession is terminated by the host-government then the contractor will likely not be repaid unless the debt is covered by the termination payment payable by the host-government for terminating the concession. Contractors should pay special attention to whether unpaid construction costs fall within the definition of debt for the purposes of calculating termination payment.

A more sophisticated form of seller’s credit separates the construction work from financing. Under this structure the contractor performs the works and financing is provided by a separate contractor lender. Upon reaching certain agreed milestones under the construction contract and becoming entitled to payment, the contractor submits a drawdown request to the contractor lender for the relevant amount.

After receiving the drawdown request the contractor lender advance funds to pay the contractor, resulting in an independent debt claim against the sponsor by the contractor lender that is insulated from potential disputes or set-off under the construction contract which may arise as between the project sponsor and the contractor. This structure also makes the refinancing of the debt claim via the sale of receivables or securitization less problematic.

On the BRI, because of regulatory restrictions on contractors’ ability to lend, the financing component is often replaced by a deferred payment agreement, which combines different elements of the two types of structures.

Documentation considerations

Seller’s credit is a form of financing, whose key commercial terms including the amount of loan, interests, fees, conditions-precedent to drawdown, tenor and repayment profile must be clearly set out. Risk such as changes in law, moratorium, expropriation and taxes should also be addressed. For integrated projects which depends on the timely completion of other projects to be viable, tailored cross-default clauses may be appropriate. 

The inclusion of a right by the contractor lender to assign is essential for refinancing, and the inclusion of customary representations and warranties, covenants and events of default will help with bankability analysis. However, even if the contractor lender does not intend to refinance it should still consider including a basic set of such provisions as a matter of prudence and risk management. 

Security package

How seller’s credit can be secured depends on several considerations and may include asset security in the form of project land, equipment and special rights, assignment of major contracts and insurances, security over shares and others.

To improve the chances of a successful refinancing, it is essential that the security package is designed at an early stage to take into account the needs of potential lenders or investors.