Since the 1970s the Saudi Arabian economy has transformed its social and physical infrastructure. In the more recent past, the Saudi government has changed the way that transformation is funded, actively encouraging the growth and participation of the private sector in key sectors of the economy. This has largely been motivated by the government's desire to diversify and provide additional depth to the economy, but it is also recognition of the demands placed on basic services such as power, water and telecom by the growing population, as well as the business opportunities spawned by sustained high oil prices and market liquidity.

There has been a paradigm shift in the financing requirements for such investments toward modern financing strategies, and Saudi Arabia has shifted from projects funded by government allocations to project financings provided by external sources – commercial banks, export credit agencies and increasingly, the equity and debt capital markets.

There are certain specifics of the Saudi economy and its business environment that should be understood and considered by international project lenders to enable them to take advantage of the opportunities that the booming Saudi economy represents. This article touches upon some of the unique features of the Saudi environment and the innovative structures developed by project lenders in recent years.

Legal environment

The primary source of Saudi Arabian law is grounded in Islamic jurisprudence (Sharia). Therefore, the general principles of Islamic law most pertinent to the counterparties involved in project financing include the following:
• promotion of financial structures on profit-sharing, leasing or sales-based principles as opposed to structures that involve the payment or receipt of money in the nature of interest (or riba)
• There should be no element of deception or uncertainty (or gharar) in any contract
• Contracting parties must maintain the basic principle of fairness in their dealings. As such, Consequential Loss representing loss of profit or indirect losses or limitation/exclusion of liability are generally not recognized.

Key lender considerations for project financings in Saudi Arabia

Shift in due diligence focus
As is customary in international non/limited recourse project financings, lenders have sought to incorporate a security package which will typically include security over
•  fixed (land and buildings) and floating (receivables, bank accounts, etc.) assets,
•  share pledge, and
•  Assignment of contractual rights (insurance, project agreements, Regulatory consents, etc.)

While such security types may be normally documented in Saudi Arabia, a number of unique characteristics exist in structuring financings, which relate to the concept of security itself and which may differ from other jurisdictions. At the same time, the environment has enabled a broad range of innovative structures that have evolved over time, that have given lenders sufficient comfort to extend financings supporting a significant number of large projects.

A key aspect of the specific approaches taken by lenders in the due diligence process is a more intensive focus on the quality and reputation of project sponsors and control over the cashflows rather than security over physical assets.

Furthermore, to protect lenders interest against third party creditors (especially in insolvency scenarios), Direct Agreements with key Project Company counterparties assume a greater importance. For instance, lenders typically seek to enter into Direct Agreements with the key project counterparties such as the EPC and O&M contractors, offtaker/marketing agents, etc. wherein these parties acknowledge a suspension and in some cases, a subordination of their rights against the Project Company vis-à-vis the senior lenders.

In some cases, these Direct Agreements acknowledge the right of the lenders to "step in" in place of the Company and deliver notice/instructions to these counterparties on behalf of the Company. In the case of power projects, lenders reserve the right to novate a "substitute obligor" in place of the Project sponsors (this is normally effected through the share pledge provisions described below) which the Direct Agreement counterparties accept in place of the Project Company.

Share pledge

While security can be created over the shares of companies (typically Joint Stock Companies), thanks to the recently issued Commercial Pledge Law ("CPL"), there is also an alternative structure which has evolved for Saudi projects (particularly in the power sector) involving an offshore SPV which in turn own the Saudi Project Company. The shares in the offshore SPV are granted to the lenders which give them an additional layer of comfort.

Interest payments

As part of its efforts of enhancing the conditions for the development of financial infrastructure in the country, the Saudi Arabian Monetary Authority (SAMA) has established a SAMA Committee, a body, which has been empowered to settle disputes of a banking nature between banks and/or their customers. With regard to disputes relating to an interest bearing loan agreement, the SAMA committee may award an amount to a lender which exceeds the principal amount of the loan.
In most cases, interest obligations of the borrower are further secured through a promissory note which gives the lenders the right to approach the Negotiable Instruments Committee.
Insurance

Until recently, most construction and operating period insurances for Saudi projects were directly placed offshore. Following the implementation of the Control of Cooperative Insurance Companies Regulation in November 2003, insurance cover for any activity within Saudi Arabia is provided by Saudi companies. However the policy guidelines allow only a certain portion of the insurance cover to be obtained and held offshore. Also, SAMA has been very supportive through waivers to this requirement on a case to case basis in the event of temporary unavailability of locally sourced insurance cover.

Sufficiency of Sabotage & Terrorism (S&T) insurance cover at a commercially reasonable cost is also a key lender consideration. Availability of cover has not always followed the global increase in capacity since 9/11 given the insurers reluctance to underwrite large amounts in the region, given the Event risk associated with the region. Based on recent market estimates, insurance industry specialist are of the view that there is availability of up to $300-400 million of cover on a per project basis. Apart from the Power Sector where the fallout of a terrorist act is effectively allocated to the power and water offtaker (usually a government entity), other projects leave the residual risk with the lenders. In some cases, lenders require an Estimated Maximum Loss (EML) study which uses a probabilistic approach to the maximum damage which could be incurred by an explosion. This is then used as a basis for requiring the company to constantly reassess the insurance market to procure sufficient cover.

Going forward

Due to the positive Saudi business environment and the progressive approach by Saudi government institutions, international financiers are increasingly prepared to commit substantial capital to the kingdom. Consequently, a number of innovative structures have evolved that are meeting the standards and requirements of regional and global lenders. SAMA has played a key leadership role in this process by facilitating important enhancements to the legislative framework and by instituting a number of committees/ boards with specific jurisdiction over lender related matters which have been very supportive in addressing lender concerns. This has also been aided by a number of new progressive Saudi regulations as part of a process of increasing transparency, and fulfilling requirements of the World Trade Organization, to which Saudi has recently acceded.

Contact: Irfan Said, Head of Project Finance, Samba Financial Group, Email: irfan.said@samba