In a precedent-setting transaction, Fujian Pacific Electric Company Ltd closed the financing in 1998 for the US$755m Meizhouwan project, one of the largest wholly foreign-owned power projects in China. Amid the ongoing Asian financial crisis, the definitive financing documents were signed in May 1998 and initial debt funding took place five months later. The Meizhouwan project, which was developed by InterGen and the Lippo Group, is the first, and so far only, wholly foreign-owned power project to be successfully financed outside of China's state-sponsored build-own-operate-transfer (BOT) programme.
For many years, developers have dreamed of applying true project finance in China. However, the necessity of local partners to ‘ease' the way, the lack of infrastructure regulations and the reluctance of lenders to rely solely on project revenues made this an elusive dream. As a fallback, developers often financed joint venture contribution obligations offshore, making their equity contributions to the joint venture and relying on local partners for continuing support for joint venture operations. Since the debt financing was often not at the project level, this alternative did not allow sponsors to derive the benefits of true limited recourse financing.
Arduous approval process
The Meizhouwan project is a useful model of how to create successful projects in China. But the successful closing did not come easily. From the beginning, the developers of the project took an approach that was new to China. They sought to have a wholly foreign-owned entity complete the development and obtain true limited recourse financing from international lenders. This required insisting .on world-standard documentation that would form the basis of true project financing. They fought to maintain the integrity of the documents through years of difficult negotiations.
Without the benefit of BOT regulations to fast-track any approvals, the sponsors under-took the arduous task of obtaining all appropriate approvals at state and provincial levels. Although changes in the project over the long life of development required much negotiation with government bodies and even a re-approval by the highest level of the central government, the entire approval process finally came to a successful conclusion. Ultimately, the project did not enjoy the benefits of any special government support or guarantees. It did, however, have (i) all necessary state and provincial approvals required by cross-border lenders (ii) 100 percent foreign ownership of the project, and (iii) a tariff protocol and project documentation that is likely to serve as a model for other power projects in China.
The power plant
The Meizhouwan power plant will be a two x 362MW coal-fired power plant located in Putian county, Fujian province. The project cost is expected to be about US$755m. Bechtel Power and its affiliates are building the plant under a turnkey arrangement, embodying offshore design and engineering and onshore construction contracts. The power plant will burn Indonesian coal sup-plied by PT Kaltim Prima as part of a long-term supply and transportation contract. China Coal Import & Export Company will provide coal procurement and other services to the project. The turbines for the power plant will be provided by Alstom and Foster Wheeler will provide the boilers.
The Fujian Provincial Electric Power Bureau (Power Bureau) will purchase the electrical output of the power plant under a 20-year power purchase agreement. Synchronisation of the first unit with the Fujian provincial power grid is scheduled for late 2000 and commercial operation of the entire plant should start in early 2001. The plant is designed to meet the stringent World Bank environmental standards.
To satisfy the needs of both lenders and the Power Bureau, the sponsors created an innovative operating and maintenance plan. Under a 20-year agreement, the Power Bureau will operate and maintain the plant under normal circumstances, taking responsibility for liquidated damages and other obligations usually borne by international operators. However, if any difficulties are encountered, the project can require Inter Gen to run the plant pursuant to a 20-year back-up operating and maintenance agreement. In addition, throughout construction and operations, InterGen will provide critical project management and oversight services.
The complexity of the Meizhouwan project is apparent in the diagram on page 23.
The dynamics of change
A project as large as Meizhouwan, with- a unique structure, is a huge challenge. From initial State Planning Commission approval in 1993, the project coursed through changes in developers, changes in law and changes in Asia's macroeconomic conditions.
The Meizhouwan plant was conceived in the early 1990s as part of a proposed mixed-use development called Tati City. The development includes commercial, industrial and leisure elements to be built by the Indonesian conglomerate Lippo Group in Putian, the hometown of its founder, Dr Mochtar Riady. Initially the project had four consortium members, including Bechtel Enterprises, with Lippo as the lead member. After many project delays and changes, two of the original members withdrew in 1996 and InterGen increased its investment. Currently, Inter-Gen, which is owned 50/50 by Shell and Bechtel, owns 70 percent of the project company, an affiliate of the Lippo Group owns 20 percent and the Asian Development Bank, one of the lenders to the project, owns 10 percent.
From the very beginning, the project received strong local government support. Riady, a successful overseas Chinese businessmen, built a special bond with his home-town, which was eager to receive substantial infrastructure investment. Sponsorship changes in the middle of project development raised questions about the commitment of the sponsors and led to sensitive discussions. The combination of InterGen's experience, its own shareholders' long-standing commitments to China and Lippo's continued interest eventually convinced the authorities that the ownership changes actually benefited the project. The necessary approvals and permits were issued even though owner-ship was materially different from the original 1993 State Planning Commission approval.
The Power Bureau also experienced changes during the development of the project. This complicated finalisation of the main agreements the Power Bureau had to j sign. When the project was first discussed in the early 1990s, the Power Bureau was a government utility in dire need of new generation capacity. By 1997, it had constructed new power plants and refurbished older plants, relieving some of the supply pressures. The Power Bureau was corporatised between 1995 and 1996 like other Chinese entities evolving towards a private sector model, leading to a greater emphasis on profitability. This in turn led to a more aggressive negotiating stance by the Power Bureau in the later stages of discussions of project agreements.
Although final completion of the documentation did not take place until a month before closing, the resultant agreements rep-resented a balanced sharing of the risks between the Power Bureau and the project. In the end, the project lenders viewed the risk allocation beneficial to the long term viability of the project.
When the sponsors first began negotiating the power purchase agreement with the Power Bureau, it was the Power Bureau's first glimpse of an international standard document. The bureau expressed concern about the length and drafting style of the document. For months, these concerns overshadowed the commercial terms contained in the draft.
Between 1993 and 1997, other foreign power developers undertook project negotiations with the Power Bureau. These contacts led to fresh approaches to negotiations, but delayed the ability of the bureau to reach a final conclusion as to approach.
At one point, the Power Bureau presented the sponsors with its own draft power purchase agreement, resulting in a classic battle of the forms. The Power Bureau draft reflected a Chinese approach to written agreements – it was considerably shorter and relied on open-ended and more ambiguous language.
Although it meant delay, the sponsors fought hard for a finance-able version. The final power purchase agreement was an amalgamation of the sponsors' drafting in English (then translated into Chinese) and the Power Bureau's drafting in Chinese (then translated into English). The power purchase agreement, dispatch agreement and operations and maintenance agreement were formally signed with the Power Bureau in April 1998, demonstrating that the sponsors had successfully bridged the different expectations of the Chinese power industry and the requirements of international sponsors and financiers.
Detailed tariff formula
One of the most important issues faced by the project sponsors was how to get paid sufficient revenues. This required developing a tariff formula that would provide acceptable economic returns to the sponsors and comfort to the project lenders that debt service payments would be met.
Unlike other tariff arrangements at the time, the sponsors sought a detailed tariff protocol under which the Fujian Provincial Price Committee would approve tariffs. This detailed tariff protocol, including an interim adjustment mechanism for fluctuations in certain cost components, mitigated some of the concern with the annual tariff review process, which resets the price of electricity for the project every year.
The tariff protocol also included a foreign exchange indexation mechanism that provided further comfort to the project lenders, many of whom endured bad experiences with Thai and Indonesian borrowers during the Asian financial crisis. Central government authorities have indicated that the structure embodied in the tariff protocol may become a model for other projects across the country. Although the concept of a tariff protocol was not new, the Meizhouwan approach was unique in its comprehensiveness and interim adjustment mechanism. The detailed formulas were designed to minimise subjectivity and future disputes in arriving at the annual tariff.
As with many Chinese projects, translation became a substantive and logistical problem. Many project agreements are composed of equally binding English and Chinese versions. The dual language negotiation and documentation added considerable complexity and costs to the development process.
In the early stages, the sponsors thought the acquisition of the site had been agreed. However, after the parties executed the Meizhouwan land-use rights transfer agreements in 1997, the central government issued a moratorium on the granting of arable land. The local land bureau held up the issuance of land-use rights certificates – which are required for the project to mortgage the land use rights to the project site – until it sorted out the implications of the moratorium on the Meizhouwan project.
The Meizhouwan project does not rely on the state-sponsored BOT programme. The sponsors therefore were deprived a comprehensive concession agreement with the provincial government. They also had to make do without a pre-assembled regulatory approval and government support package, such as those that benefit the Laibin B and Changsha BOT projects.
On the positive side, however, the sponsors had the freedom to design project arrangements and a financing package tailored to the project. For instance, the sponsors put in place various support and clarification letters that demonstrated the commitment of the numerous government bodies to support the project and carry out the intent of the underlying project documents.
Over the course of the Meizhouwan project development, several Chinese laws related to power projects and project financing came into effect. The sponsors and their advisors had to study the provisions of each law before coming into effect, analyse the applicability to the project and determine how this changed the overall substantive rules applicable to the project or the scope of required approvals.
The Meizhouwan project is the first large, wholly foreign-owned project to be financed by limited recourse financing in Fujian province. Not surprisingly, the local authorities had no relevant experience in dealing with the project's application for approvals and permits. This resulted in a longer educational and processing period than expected.
As with many projects, Meizhouwan received various provincial government sup-port letters. Such letters provide comfort to lenders, but do not create much by way of I legally enforceable obligations. However, especially for a project that is looking to provincial rather than central government authority, local support was welcomed by the lenders.
There was relatively little central government involvement in the project other than the approval and reapproval by the State Planning Commission (now the State Planning and Development Commission) and Ministry of Foreign Trade and Economic Co-operation approval of the establishment of the wholly foreign-owned enterprise. In connection with the due diligence process of the lenders, central government authorities orally confirmed the central government's support of the project. The Meizhouwan project has no explicit guarantees or even support letters from central government ministries or authorities. It can be assumed, however, given the path-breaking nature of the Meizhouwan project, that provincial government compromises and solutions were vetted by the central government.
Financing the final months
Originally, the International Finance Corporation and the Asian Development Bank (ADB) were to provide most of the financing. After about two years, the sponsors decided not to go forward with the IFC component of the financing. The project subsequently proceeded with only ADB support and strong commitments from the four arranging commercial banks – Banque Paribas, Bank of America, Credit Suisse First Boston and Tokai Bank.
The financing demonstrated how public and private lenders can successfully co-operate to fund infrastructure projects in Asia. The final financing commitments came from export credit agencies, Compagnie Francaise d' Assurance pour le Commerce Exterieur (Coface) and Compania Espagnola de Seguros de Credito a la Exportacion (CESCE)), a multilateral development agency (ADB) and private commercial lenders from the US, Europe and Japan.
The Meizhouwan financing has become a model for closing financings in the turbulent Asian environment. It weaves together a strong commitment of reputable and reliable exports credit agencies, multilaterals and private lenders, adding the necessary level of equity support and involvement of world-class participants and documenting the transaction to international standards.
Unlike many current Sino-foreign joint venture financings, the sponsors tried to reduce financing costs by relying only on US dollar debt facilities. This had the added advantage of minimising lengthy inter-creditor negotiations with yuan lenders.
The final debt financing consisted of six tranches of senior debt for the project totalling US$566m. There is an ADB direct loan and a complementary loan, which provides a form of political risk coverage for the participating commercial banks. The direct loan is US$40m with a 16-year tenor and the complementary loan is US$150m with a 12-year tenor. In addition to ADB, there is a Coface and CESCE facility. The Coface facility is US$53m with a 16-year tenor and the CESCE facility is US$76m with a 16-year tenor. There is also an uncovered commercial loan tranche for US$218m which has a tenor of 12 years. The final tranche is a US$30 million working capital facility with a 10-year tenor. The Coface facility provided both political and commercial risk cover, while the CESCE facility provided political risk cover only.
Despite continuing weakness in the Asian financial markets and pessimism surrounding yuan devaluation, the lead arrangers closed syndication and the project company achieved initial loan drawdown in late October 1998. In addition to the four original arrangers, 11 other banks joined the financing, bringing the total to 15 banks in the syndicate. This successful syndication demonstrated the attractiveness of the financing structure and the soundness of the project.
As is typical in other financings, the project lenders raised many legal and other issues which had to be addressed before closing. One concerned the enforceability of arbitration in China. The project agreements entered into between the project company and the Power Bureau provided for onshore arbitration with the China International Economic and Trade Arbitration Commission (Cietac). The project lenders had doubts about the jurisdiction of Cietac over disputes between two Chinese entities, since the project company, notwithstanding its 100 percent ownership by foreign interests, is an entity established under Chinese laws.
The lenders expressed a desire for the Meizhouwan project to duplicate as far as possible the back-up central-level support for Cietac arbitration given to BOT projects. It would have been difficult for Meizhouwan to duplicate such central-level support since the project did not have the state-sponsorship enjoyed by BOT projects. The problem was resolved when Cietac amended its arbitration rules in May 1998 to explicitly give Cietac the jurisdiction over disputes between domestic Chinese entities and foreign investment enterprises.
The Meizhouwan project had such a long gestation period that the Asian economic crisis probably did not have a significant impact on its financing. In some ways, the downturn in the rest of Asia may have helped the sponsors close the deal because in the later stages of negotiations there appeared to be a heightened willingness by the Chinese authorities to accommodate the requirements of international lenders. This was very likely the result of the Chinese government's desire to demonstrate success in a turbulent Asian market. Also, the absence of other attractive project finance deals in Asia may have increased the interest of lenders to invest in a well-structured Chinese deal.
The significance of the Meizhouwan project is that it demonstrates that true international limited recourse project financing can be achieved in China outside the BOT scheme. Unlike projects such as Laibin B and Changsha, the Meizhouwan project does not have any special concession agreement with a Chinese governmental authority. This is important for the future of project financings in China since it is unlikely that the government will continue to provide the benefits seen in prior BOT projects. The trend will be for less government support, requiring sponsors and lenders to structure deals more like Meizhouwan.
The hard-learned lessons from Meizhouwan will be drawn upon by future developers, lenders, advisors and their legal counsel for years to come if China is to be successful in attracting international limited recourse financing.
This article was prepared by Gary Wig-more and Desiree Woo of Milbank, Tweed, Hadley & McCloy LLP. Gary Wigmore is the head of project finance in Asia resident in the Singapore office and Desiree Woo is resident in the Hong Kong office. Milbank, Tweed, Hadley & McCloy LLP acted as international counsel to the project company, Fujian Pacific Electric Company Ltd, a limited liability company established under Chinese laws.