CHAPTER 1 THE PROJECT FINANCING OF MINE DEVELOPMENT IN LATIN AMERICA: A LENDER'S PERSPECTIVE

• Jurisdiction: Derecho Internacional

International Mining Law and Investment in Latin America and the Caribbean
(Apr 2005)
CHAPTER 1
THE PROJECT FINANCING OF MINE DEVELOPMENT IN LATIN AMERICA: A LENDER'S PERSPECTIVE
Cynthia Urda Kassis
Shearman & Sterling LLP
New York, New York

Cynthia Urda Kassis is a Co-Head of Shearman & Sterling's Project Development and Finance Group. Her practice consists of representing U.S.-based and non-U.S.-based corporations and financial institutions in their general private financing activities, sponsors and lenders in project development and finance and restructuring transactions, U.S.-based and non-U.S.-based corporations in their joint venture activities, and U.S.-based and non-U.S.-based financial institutions in their letter of credit activities. She also represents various U.S.-based and non-U.S.-based corporations on general corporate matters.

Ms. Urda Kassis has extensive experience representing project participants worldwide in a range of transactions, specializing in mining and power. In the mining sector, Ms. Urda Kassis has represented a number of mining companies in a broad range of transactions, including in a number of project financings in Latin America. She has worked on transactions for major mining companies with assets located around the world as well as for mid-sized and junior mining companies with a more limited asset base and history of experience.

Ms. Urda Kassis joined Shearman & Sterling in 1984 and became a partner in 1992. She graduated from American University, Washington College of Law and she is a member of the American Bar Association.

Latin America continues to be a favored destination for exploration dollars. ¹ It is a geographic region with which foreign investors as well as providers of finance, in both the equity and debt markets, have demonstrated great comfort. As such, it has been and remains a jurisdiction in which activity relating to the development and financing of mining projects, large and small, has been and continues to be significant.

Structurally, one can finance a mining project in a number of ways. Factors such as the cost of development of the project and the capital resources of the company or companies developing the project, among others, will dictate the structure chosen. The structures available range from raising the funds wholly in the equity markets, to raising the funds in the debt markets based on the general corporate credit of the sponsoring company, to raising funds in the debt markets on a limited recourse basis using any number of structured or project finance products. A limited recourse financing is one in which the lenders do not have access generally to the other assets, or the general corporate credit, of the sponsoring mining company, rather their sole source of repayment is the specific asset being financed and the cashflow which it generates.

The sources of financing for a mining project in Latin America are many and varied as well. They include, notably, the international commercial bank market, the international bond market and multilateral and export credit agencies. Because of the amount of capital often required, many projects will combine several different sources of financing. In countries where political risk is still of concern to potential lenders, projects often combine export credit agency-supported financing or other multilateral agency financing (e.g. IFC financing) with financing from the international commercial bank market or the international capital markets.

Financing arrangements and negotiations become increasingly complex if the financing product employed is highly structured, or if multiple sources of financing are accessed to provide funding on a particular project. However, if a limited recourse project or structured financing is employed, the fundamental issues or risk factors which providers will analyze in determining whether to participate in the financing - and the structure and terms of such financing - generally will be the same regardless of the sources of such funding. ² In fact, those fundamental issues or risk factors are not all that different from those that the sponsoring mining company likely considered before determining to move from the exploration to the exploitation phase for the particular ore resource.

This paper is intended to provide an overview of one particular form of financing for the development of mining projects - limited recourse project financing of a single mining project. It is also intended to provide insight into the lender's perspective of the issues in this form of financing.

This paper is organized into three parts. The first part identifies and briefly discusses the main fundamental issues or risk factors which lenders of all kinds generally focus on in accessing and structuring a single-asset, limited recourse mine financing. The second part describes the documentation generally used for such a financing. And the third and final part reviews some of the key terms of such documentation, in particular noting how the fundamental issues are addressed by such documentation.

Fundamental Issues/Risk Factors

Fundamental issues or risk factors that all lenders consider in determining whether to participate in a particular mine project resurface again and again in the course of arranging the financing. They first surface during the due diligence process where they are the central focus. Assuming a positive decision is made to proceed with the financing, they will be important determinants in the structuring of the financing. Finally, they will be central to the detailed negotiation of the most significant terms of the definitive documentation for the financing.

As indicated, these fundamental issues are the same regardless of the source of financing being accessed - whether from the international commercial bank market, the international bond market or export credit agencies, multilateral agencies or other international development organizations. This is the case assuming the source of financing is in the international capital markets. Providers of financing in the local markets may well use a different methodology, as would a provider of vendor financing. This also assumes the financing is structured on a limited recourse basis for a single mining project. A financing based on the general corporate credit of the sponsoring mining company would be assessed on a very different basis.

Finally, it should be noted that, although all providers of this type of limited recourse financing will generally focus on these fundamental issues, different providers will have greater or lesser sensitivity to a particular issue. For example, multilaterals and export credit agencies have a much higher tolerance for political risks than do lenders in the international bank and capital markets. In fact, their involvement in a particular project is often precisely to provide political risk coverage to the other lenders and in some cases even the equity. Conversely, multilaterals and export credit agencies have traditionally been more sensitive than the international banks and capital markets to social and environmental issues.

These fundamental issues or risk factors generally can be grouped into eight basic categories. They are:

1. The Ore Body - "Is it There?"

2. Title - "Does the Project Company Own it, No Qualification?"

3. Construction/Completion - "Can the Project be Built in the Time, at the Cost and to Perform as Projected?"

4. Operations - "Can Performance be Sustained within the Projected Cost Parameters?"

5. Commodity Supply, Demand and Pricing - "Will the Cash Flows Generated be Sufficient?"

6. Environmental - "Will the Operations Comply with all Appropriate Standards?"

7. Political Risks - "Are They at Acceptable Levels?"

8. Governing Legal Regime - "Is it Sufficiently Transparent and Predictable?"

These categories of fundamental issues which lenders in the international capital markets focus on for these types of projects have been the same for decades. However, over time there have been dramatic changes in how the risks within a particular category or how particular risks are viewed. Since the mid-1990s, when the last large group of very capital-intensive, high-profile mining projects was financed on a limited-recourse basis in Latin America, there have been some significant changes in how several of these risk categories or risks within these categories are viewed.

Although these issues are listed below in the order in which they seem to logically arise and they are described as being addressed sequentially, in fact the issues are often assessed and addressed simultaneously.

1. The Ore Body: "Is it There?"

The first fundamental risk to be addressed is the ore body risk - that is, determining that an ore body of sufficient magnitude to be exploited in a financially feasible manner exists. As the ore body is actually the sole asset of the project and the sole source of cash flows, confirmation of its existence and of its characteristics is fundamental to the decision of lenders to participate in the financing.

How then do the lenders obtain comfort regarding the ore body's existence, character and its ability to be economically developed? Typically, the analysis of the ore body risk begins with the feasibility study prepared by the mining company. That feasibility study is usually subjected to careful review by an internationally recognized independent engineering expert which seeks to verify or test each element of the study. The independent engineer will review the estimate of proven and probable reserves, seeking to confirm that appropriate methodologies were used in determining the size and characteristics of the reserves and reaching the other conclusions set forth in the study. In addition, the independent engineer will analyze and "stress test" the elements of the feasibility study, for example, examining the cost of construction of the mine...