Ten years ago Royal Bank of Scotland (RBS) was an unknown in a combined lending and arranging global project finance market dominated by Citibank and ABN Amro.

Today RBS is indisputably the biggest bank in project finance - the biggest lender, a top five arranger and a top ten advisor (according to Dealogic Projectware). The rise is in large part successful corporate strategy but, as Tom Hardy, global head of project finance, concedes, also part luck.

One of the first things RBS did after hiring Hardy from Deutsche Bank in 1994 to set up its project business was to establish Royal Bank Project Investments. "The intent was to take equity stakes," says Hardy. That was not all foresight, "but, with benefit of hindsight, it was brilliant because, in terms of timing, the PFI and PPP markets fell neatly into that. We were one of the first banks, certainly in the London market, to go out to sponsors and say we had the capacity and appetite to consider equity as well as syndicated deals."

What RBS stumbled on in 1994 was not the one-stop shop strategy that many banks pursued, but the one-stop niche - a PPP debt and equity capability which, although a fledgling niche then, has ironically since fuelled much of the diversity in project finance.

The strategies and participants in the project banking market have changed radically in the past 10 years - in part due to the overall lending policies of banks in which project finance has been overshadowed by the misconception that corporate lending is safer (a misconception that RBS has not suffered from and since proved correct by the S&P Basle study), but, more significantly, because project finance is no longer simply about traditional limited and non-recourse project debt.

In short, the financing of projects has become a multi-discipline, incorporating a range of different on- and off-balance sheet financial products and lending sources at both debt and equity level. The move has been spurred partly by sponsor demand, but also by the development of new sectors in PPP, in which banks like RBS have become equity players in their own right.

But the RBS move into equity was not the only significant stimulus to the bank's project growth. The global balance of deal volume has moved from heavily US power oriented to a more even continental spread - particularly between the US and Europe. And when RBS acquired NatWest in March 2000 in a £21 billion deal it became the second biggest UK retail bank, with the funding clout to take advantage of that change in deal spread.

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. We've never looked back."

However, other banks have looked back. Citigroup, still a top five arranging bank has dropped out of the project lending top 10. Bank of America, once a major lender and provider, has disappeared from the market. And many of the German and Japanese banks, having pulled back from the market, are only just beginning to build a presence again and buying market share: Deutsche Bank, for example, cut its entire project finance group but is again active.

All these banks demonstrate that staying at the top requires flexibility and a large deal flow. And with RBS number one in a market that is growing in liquidity and competition for fees - significant overall competitors include Halifax Bank of Scotland (HBoS), Calyon and BNP Paribas - the question of how RBS will continue to expand and adapt is as big as how it achieved so much in such a short time...

PF: You've come from nowhere to dominate project finance lending. Was it expected and what was the base you started from?

Tom Hardy: In 1994 the project finance market was burgeoning, but RBS was 25-30 years behind most banks. However the bank's commitment was convincing and I felt sure we could build a significant presence. That said, 10 years ago we never thought we'd be number one - we expected to have a good organisation that could compete - but not number one.

One of the first deals we did was a gold deal in Mali - a real test for the bank about its attitude to both project and emerging market risk and for the bank's credit process. We went through two committees - here were people with very little knowledge of mining or gold, limited information about Mali, and yet they got comfortable. As it turned out, the deal was a very good one.

But for us to make a real impact we had to find a niche, hence we set up Royal Bank Project Investments to take equity stakes. Let me stress, we were not about to take equity in a $500 million north sea project - what we were willing to take was equity in a $50 million start-up company looking to buy stranded assets in the north sea, or something similar. We quickly found within PFI that we could assist with equity and then structure it so that it was either delayed going into the project or became seed, pinpoint equity.

PF: What have been the defining moments and defining businesses in the past 10 years?

Tom Hardy: One of the defining moments was the merger with Natwest, which had both bright and dark moments ( many people resigned in the belief that opportunities were better elsewhere).

I chaired the group that oversaw integration of the Structured Finance business. At first glance I thought how do you go about this? We probably started out with 300-400 people of which 200-250 could have been under the project finance banner. But the cultures were different. For example in RBS we had a credit committee system - in NatWest they had a credit department/credit authority system - very different approaches. And then there was the specialised financing side of NatWest, which brought in products such as film finance - not traditional project finance but people who had specific skills. That said, it quickly became clear that there was almost a perfect dovetail between our respective strengths and weaknesses.

Another defining moment was the emerging market crisis that kicked off in Indonesia. There were a lot of knee-jerk bank reactions and the vulture funds fed well - they were in very quickly, taking out banks who, in my opinion, panicked and refused to rely on the strength of project finance structures to see them through. Those strengths have since been proven.

We took some hits on the corporate side, but the crisis was a defining moment in that it forced us to rethink how we used our people and resources in Asia. It catalysed the push into Australia, which started with a representative office and converted to full branch status earlier this year.

It is our success in Australia that especially pleases me. It was a logistical challenge to get into a market where the bank had no representation (we'd been there about 10 years earlier and pulled out) because competition there is so intense.

Infrastructure and PFI, headed by Jeff Thornton, has also been a defining business. Competition is still intense from other banks - HBoS in particular - but we are very close to government departments and enjoy a very high market profile.

PF: Since you started RBS project finance how much change have you seen in new products pressure on margins, new sectors? You are one of few banks to stick with small PFI for example.

Tom Hardy: In the past 10 years there have been a couple of lending cycles in project finance - both due to the impact of capital markets . And we are going through it again now. Five or six years ago the capital markets were very strong and an ex-colleague said to me back then that the future of senior secured project finance was probably limited to a couple of years. However, we are still here.

The problem with the bond approach is that when it goes wrong it is very messy - you don't have a syndicate of banks that are expert in the field. With a bond deal you get a trustee who is trying to manage and contact a myriad of noteholders. Many of those noteholders may have bought paper that has been sold on a number of times and are basically sitting as passive investors, as opposed to experienced banks that are capable of and willing to deal with the problem.

That said, the bond market is going to become more comfortable, through the role of the ratings agencies, with project risk. And that is a challenge for the project debt market. How do you deal with it? It is not that we don't do project bonds. In fact we have an excellent project bond department and our US colleagues have come across to look exclusively at project bonds. So it is both a threat and a opportunity.

From my perspective I would normally opt for a syndicated deal. But I'm there to be convinced that a bond can perform as efficiently and cost effectively as syndicated debt.

PF: So Are we going to see more miniperms - as in Spain for example?

Tom Hardy: I would have said exactly that up until a couple of years ago - but then we had the energy crisis. Banks are now more cautious about miniperm structures: if you ever had a lending crisis in Spain you could see the same sort of thing happening as in the US.

But that aside, I can see a place for more miniperms. Any banks wanting to be in the big ticket finance market - and that does not just have to be project finance, it could be leveraged - have got to be capable of change and dynamic in their approach to new products whilst monitoring risk aspects and making sure the risk profile fits with their overall strategy and ratios.

PF: Do you feel pressure to up the deal flow given corporate loan margins and hence those of project finance are down?

Tom Hardy: I'm not overly concerned, but I do see what's going on. Liquidity appears to be greater than it has ever been in the past 10 years.

There's more money coming out of the equities market and going into the bond market, particularly from a pension fund perspective. And bonds, as a percentage of project finance, have grown a lot ? 20% last year according to dealogic. To date this year they are down, but I would not be surprised to see a run of project bonds in the last quarter of this year.

In addition there is the bank market itself. Three to five years ago a lot of banks, particularly in the US, pulled back from project finance because of the energy crisis. But as with all bank cycles it is turning again and banks are returning to the market.

So liquidity, bank and product competition are combining to really squeeze the market. And its not just us ? my corporate colleagues also have to deal with this on a daily basis.

We've seen mining deals in Latin America, that have progressed very well through development and operation and been refinanced on a corporate basis. We'll look at participating in such deals on a corporate basis,but some of these deals are being refinanced at very low margins - despite the inherent threats and pressures of metals cycle.

The metals cycle has been on a high for so long and projects have enjoyed such high levels of cashflow that debts are being paid down early or being refinanced on a much stronger balance sheet ? that potentially takes us out of the market and makes it difficult to lend even on a corporate basis.

We have a return on capital which is adjusted internally and if a deal doesn't get there we are unlikely to do it, although there are extenuating circumstances.

But there are clearly other banks around that are not only able to do it, but are willing to do it. It is symptomatic of banks that are not only coming back to the project finance business, but have come to a conscious decision that they want to buy themselves back up the ladder.

In a way it paints a bleak picture, but it's no different to many of the challenges we've faced in our 10 years of operation.

PF: Given your history of PFI equity is there a likelihood of RBS getting into funds in the same manner as Macquarie for example?

Tom Hardy: This is an issue we are considering. RBS is a wholesale bank delivering measured solutions to its relationship clients. But we recognise that the volume of "funds" and the amount of money they manage is increasing, seemingly exponentially.

You have to answer a number of questions: Is this worth us getting into? Does it fit with our portfolio as it is? We are thinking about it. The bank is already in the Star Fund with SCH, which has been successful for us. I admit that it was an investment decision taken by another part of the bank - but it suited us fine and PFI business often falls out of that.

But the MIG-type vehicle is one step on - management and attracting third party money. We are in a position to throw assets at a start-up, but on the fund issue we remain undecided.We are also looking at other options - securitisation for example. Our Structured Finance group now includes Principal Finance - this is a recent addition that brings them much closer to our Project Finance activities.

PF: Do you foresee funds as a way of getting into US PPP ? like MIG?

Tom Hardy: The US has always been a core market since we set up in New York in 1996. But the kick-start came with the NatWest merger. Today we have three teams over there: power, structured oil and gas, and midstream. PFI is a business we are looking at adding.

Traditionally, US infrastructure has been tax-exempt bond funded. But recently we have seen deals brought to the banking market. I can see this as potentially a large additional leg for us. From a strategy perspective, PFI has suited us well. We've shown we can step out internationally into European PFI. And the US is far more akin in many ways to the UK market than Italy or Spain for example. Initially we will pursue these opportunities through the combined efforts of our US and UK people. But once we get to a critical mass of deal flow, then we'll put more people into the market.

PF: With growth comes pressure from on high to continue to ?feed the beast'. Do you have the structural flexibility to absorb a global downturn in deal flow?

Tom Hardy: Yes. I can't say I start off with a blank piece of paper thinking about spreading the risk via the number of businesses we have, but we are structured on the basis of industry and can adjust to downturns and upturns both geographically and by sector. Our structured finance activity also now includes our principle/equity finance business. These parallel products are important to us - we swap notes and look for interconnects.

We also have our overseas offices with strengths and weaknesses according to the size of the market and our focus. In France we are looking at the infrastructure market more than power; in Spain we are looking at both; in Italy the focus is on structured power, oil and gas, and even some mining; and in Australia we are looking at the full range of sectors . Thus, we are in a position to react to opportunities and aim for continued growth.

PF: Do you feel the competition biting at your heels in your biggest markets - whether from boutiques like Babcock & Brown in niche sectors, or heavy duty banks like Calyon and HBoS?

Tom Hardy: I would be fooling myself if I said no. However, our philosophy is to work with the bank market, not "compete" with it - you have no option in the syndications business. I've never wanted to see RBS set itself on a pedestal - we've got to the top of the tables but in reality, it is fairly meaningless. When you get there you have new challenges - you have to keep building the business and your not going to do that if you've alienated bank after bank over deals in the process.

Just look back at the energy crisis in US and more so in the UK. A lot of these deals got worked out simply because of the strong relationship between the banks.