Project Finance

CHAPTER 2Project Finance—Risk Analysis and Mitigation

Risk analysis and mitigation is one of the key lynchpins and critical skill sets of project finance. The risk analysis and mitigation methodology can be summarized by the acronym IAMA—Identify, Assess, Mitigate or Allocate. The guiding principle and approach to project finance risk mitigation is to allocate project finance risks to those project parties best able to bear them such that the residual risks that remain with the project company borrower are manageable and acceptable. The objective is to allocate away project risks to project stakeholders (project sponsors, construction contractor, operator, government, etc.) such that the project borrower retains sufficient but not excessive risks. Retain too many risks and the project will not be sustainable and will fail, while allocating too many risks to project parties will increase the required adjusted risk returns those parties will require. Another method to address project risks is to mitigate via insurance cover, contingent lending (e.g., cost overrun loans), or changes to project contracts. While many financial disciplines involve risk analysis and mitigation, project finance is unique in using contractual risk mitigation to achieve optimal identification and allocation of all project risks to those parties best able to bear them, such that the project achieves the optimal risk/return for all project stakeholders. This ensures the project is sustainable and able ...