When Royal Bank of Scotland recently partnered with Riyad Bank, rather than Saudi Hollandi – in which it holds a shared 40% stake with Santander and Fortis after the recent joint takeover of ABN Amro – to bid for the financial advisory on the $26 billion Ras Tanura petrochemicals project, the move added fuel to the rumour that a Saudi Hollandi sale was imminent.

To date, Standard Chartered and Emirates NBD have been linked with a potential buy-out, but there has been no decision yet. For Tom Hardy, current global head of project finance at RBS and future global head once the RBS share of ABN Amro assets have been fully merged, the uncertainty over the future of Saudi Hollandi was not an issue in the Ras Tanura decision: "The move was practical – Saudi Hollandi does not have a big project finance department and is more capital markets-led."

But while Saudi Hollandi is not on Hardy's radar in a big way, the interaction with ABN Amro's project finance departments over the coming months proffers significant opportunity – the latest in a long list of growth events since RBS hired Hardy from Deutsche Bank in 1994 to set up its project finance business.

One of the first innovative steps was to establish Royal Bank Project Investments – a one-stop niche, initially providing PPP debt and equity capability. This strategy has since fuelled much of the diversity in project finance, becoming a multi-discipline funding approach, incorporating a range of different on- and off-balance sheet financial products and lending sources at both debt and equity level.

The RBS move into PPP/project equity was followed by the acquisition of NatWest in March 2000. For Hardy, the merger was not just about funding but a defining moment in the bank's investment banking know-how. "It brought us Greenwich NatWest Structured Finance as well as the NatWest lending business. Suddenly we went from a business of about 40 people to a business of about 140 – with complementary skill-sets and markets experience."

RBS/ABN Amro merger

Although similarities have been drawn with the RBS takeover of NatWest, the ABN Amro deal is of a different nature, on a different scale and is also subject to longer regulatory scrutiny.

To get approval for the deal, the RBS/Fortis/Santander consortium agreed a structure whereby – for regulatory purposes – ABN Amro initially became an RBS subsidiary. As a result, separating out ABN Amro businesses required further approvals. Furthermore, integrating ABN Amro required RBS to get to grips with countries where it had not historically had physical presence or, indeed, operated. In all, the RBS global footprint has expanded from around 20 countries to more than 50 following the merger.

Furthermore, unlike the post NatWest merger environment, the size of the merged ABN Amro/RBS project finance team will change very little this time. First, because the pure project finance activities of ABN Amro have been relatively small in comparison to those at RBS and, second, because the structured trade activities at RBS are moving over to a larger commodities and trade finance-based ABN Amro group.

But if staffing levels at RBS project finance are going to remain roughly the same, the geographic spread spawned by the merger gives the team real inroads into a number of significant new markets. For example the deal brings a branch in Johannesburg, giving RBS the ability to fund in rand; and banking licenses in India and across Latin America, Russia, Ukraine and Kazakhstan.

In Russia, ABN Amro has been strong in commodities and pre-export finance which is a good fit. Adds Hardy: "In the emerging markets the merger will elevate us in the league tables and I am particularly interested in work in progress at ABN Amro in Turkey and central and Eastern Europe for instance."

RBS project finance already dominates the global project finance lead arranging league tables – the bank was No1 for global project finance lead arranging in 2007 and the first quarter of 2008 according to Dealogic, No 3 global provider of project loans and No 3 global project financial advisor. ABN Amro is a No 1 global project bond bookrunner (click here for full league tables 2007) – as Hardy says, "an excellent complementary product offering in the project finance market".

Add to this the new RBS Sempra Commodities business, and the contours of a truly global, one-stop project finance shop are obvious. "Taking the tremendous strength of the RBS Sempra Commodities business to our clients will not only introduce them to a world-class commodities trader but also allow us to offer financial and risk management products of a kind that we could only dream of before," says Hardy.

Impact of market conditions

While the banking industry has been hard hit by the market turmoil, RBS project finance is "busier than ever," says Hardy. "The impact of the liquidity and capital challenges on the financial sector has been quite dramatic, but the reality is that, in project finance terms, we've got more mandates this year than last year."

The project team has also benefited from the dramatically reduced risk weighting on its book as a result of Basel 2 and has set up a dedicated team to manage its portfolio from an equity and capital perspective. "We're being parsimonious with capital and require the maximum return – it's a simple return on capital usage equation," says Hardy. "With margins significantly up across all project sectors – coupled with the impact of Basel 2 – earnings potential within the project finance market is looking very healthy. At the end of 2008, I would expect many banks to be reflecting project finance returns on risk weighted assets of 50% or higher than at the end of last year."

Hardy expects the current market turmoil to continue for some time and is not optimistic of any real recovery until the end of the first quarter 2008. "Economic recovery will start at the earliest next year if GDP output shows signs of sustained growth. But even with such evidence, banks will be nervous and are unlikely to commence significant expansion of their lending activities. In such a scenario, project margins could yet go higher and in particular if the current liquidity and capital challenges were to be exacerbated by a credit crunch."

Hardy is also faced with managing a merged project portfolio with combined ABN Amro and RBS exposure to some of the same deals. For example in 2007 ABN Amro took a sub-underwriting role, and RBS a co-lead arranging role, in the Eu1.52 billion Budapest Airport financing; ABN Amro also co-lead arranged, with RBS participating, on the $2.875 billion Mobily financing.

Having trawled through the portfolio, Hardy has "no concerns from a credit perspective on deals where both banks appear". He adds, "Moving forward, we need to be mindful of deals where RBS and ABN Amro are both involved but we are, independent of each other, continuing to look at club deals and bilaterals as part of our ongoing activity.

More significant for Hardy are the large number of potential refinancings on the books – not only at RBS but all banks. "Some of the miniperms completed in recent years [primarily a European infrastructure tool] have defaults to term-out, but there will be refinancing shocks for many sponsors. That said, alignment will mean everyone is talking about it and it is in no-one's interest for deals to go wrong."

If anything, Hardy foresees a continuing upwards correction in project finance debt pricing through to 2009, a correction that many argue – not least the ratings agencies – has been needed for some time. The basic banking risk-reward equation was not even being paid lip-service to by the end of 2006. Deals, particularly highly-leveraged infrastructure acquisitions, were done at asset pricing and margins that were untenable. This was with a view to take-out, in the long-term, in bond markets that were expected to remain buoyant throughout. With the majority of bond-wrapping monolines in trouble and no evident current appetite for project risk in the bond markets, those take-outs are no longer readily available – the BAA refinancing by Ferrovial being a high-profile example.

Hardy is also not convinced that claims that Asian economies will not be hit by the current turmoil are correct. "If western markets suffer long-term decline, demand for Asian manufacturing will inevitably shrink and with that the demand for, and price of, commodities. The consequence of all that could be cheaper project feedstock and EPC costs, less demand for project debt and the risk that deals written now go wrong down the road. It's not simple conservatism that keeps most banks pricing oil and gas reserve-based lending facilities at $50-$60 per barrel."