24 August 2018

Financing Cross-Border Infrastructure Projects - Currency Risk

Written by Stephanie Barker
24 August 2018

Risks can be hard to define, manage and mitigate. In infrastructure projects that cross regional or national borders and involve multiple parties from both the public and private sector, these risks may be amplified.


Risks are evaluated on the magnitude and likelihood of their impact on project cash flows.


Lenders focus on certain risks more critically because they play a large role in the certainty of project cash flow.  Investors often require certainty that market instruments and regulatory support are available to better align the risk profile of investment with their own risk tolerance before investing in a cross-border project.


Multiple currencies can further complicate a cross-border project, with multiple currency fluctuations to manage, as well as risks associated with currency convertibility and transferability. Some governments impose restrictions and/or limits on investors that receive their revenue in a local currency on converting that revenue to a foreign currency or transferring it abroad.  


Even when a project receives revenue in a foreign currency, there may still be restrictions on transferring it abroad. Political risk insurance cover may be available to mitigate currency convertibility and/or transferability risk, although this can be expensive[1].


Currency fluctuation risks will depend on asset type, project costs and the project revenues available.  As an example, if project revenues are available in foreign currencies and debt finance is available in that same foreign currency, this provides a natural hedge against the currency exchange rate and convertibility risks depending on the volatility of the foreign currency revenue. However, where project revenues are only available in a local currency and the only debt finance available is in a foreign currency, this currency mismatch creates an exchange rate risk.   


Hedging instruments may be a solution to currency risk in these circumstances, but they rarely offer a cost-effective solution in many markets due to the costs involved and the lack of long term hedging options for many local currencies. In this case, lenders will have to settle for the maximum tenor the local market will offer and then renew the maturity of the hedge in due course. 


An example of successful mitigation of foreign exchange risk is the Nam Theun 2 hydropower project in Laos[2].  With a project cost of USD 1.58 billion, it is the largest ever privately financed hydropower scheme, and involved the sale of 995MW of generating capacity and electrical energy to the Electricity Generating Authority of Thailand (EGAT). 


Currency risk was mitigated in this project by structuring the currency profile of the financing to match that of the project costs (pre-completion of the project) and the revenues (post-completion of the project). This also provided a natural hedge against the tariff structure, which required half of the underlying long-term debt structure to be denominated in Thai baht, and the other half in US dollars[3]


The World Bank recommends arranging financing to match the dollar/local currency split of the revenue stream to the extent possible in large projects that have an expected revenue stream in multiple currencies to help mitigate currency risk.


To aid investors, the Global Infrastructure Hub has produced the PPP Risk Allocation tool, which helps in understanding how to best allocate risks in PPP projects between public and private sectors. It covers the transport, energy, and water & waste sectors currently, including risk types such as exchange risk, interest rate risk, insurance risk, and inflation risk. In addition, the tool will be updated and expanded to include social infrastructure sectors later this year.


The World Bank has also developed the Public-Private Partnerships Fiscal Risk Assessment Model[4] tool to assist governments and country analysts in assessing potential fiscal costs and risks arising from a PPP project.


This blog concludes our six-part series on Financing Cross-Border Infrastructure Projects. To recap, we first looked at what is ‘bankability’ and why it matters to investors who are interested in investing in infrastructure.


Next, we explored project planning and prioritisation and the importance of having a clear pipeline of well-planned, and economically and financially viable priority projects to help attract investors.


Political cooperation and a coordinated enabling environment is needed in all infrastructure projects and is even more crucial when undertaking cross-border projects. This theme was covered in part three.


Part four looked at scale and certainty of returns. Financing and procurement of cross-border projects will often be more complex than national projects due to the scale of the project and compounded risks, and the financial returns may be more uncertain than for national projects.


Our penultimate blog delved into the sharing of responsibilities and benefits between parties and why these details need to be ironed out relatively early in the planning process.


We sincerely hope you enjoyed this series and we would welcome any questions or feedback. In the coming weeks, we’ll be releasing a new series on our recently launched PPP Contract Management Tool



[1] International energy and infrastructure projects – financing and risk allocation issues, Dentons (March 2014) - https://www.dentons.com/en/insights/alerts/2014/march/20/international-energy-and-infrastructure-projects

[2] For more information on this project, please read: http://documents.worldbank.org/curated/en/200041468044952974/pdf/584400PUB0ID161Better09780821369852.pdf

[3] Nam Theun 2 powers ahead, Project Finance International (March 2013) - http://www.pfie.com/nam-theun-2-powers-ahead/21073485.fullarticle

[4] http://www.worldbank.org/en/topic/publicprivatepartnerships/brief/ppp-tools#T2