Resource Project Financing: Capital Markets Project Financing · Glenmurrin is an indirectly held...

Resource Project Financing: CapitalMarkets Project Financing

Rick Ladbury*

SUMMARY

Until recently, project financing ofresources projects in this country wasthe province ofbanks. The Murrin Murrin Project was the first greenfieldsmining project in Australia to be project financed by accessing the capitalmarkets. The paper looks at the Murrin Murrin Project and then considersthe differences and similarities between capital markets project financingand conventional bank projectfinancing.

INTRODUCTION

Until recently, project financing of resources projects in thiscountry was the province of banks. The Murrin Murrin Project wasthe first greenfields mining project in Australia to be project financedby accessing the capital markets. In this particular case, the marketaccessed was the US capital markets via r 144A.

It is useful to commence with an overview of the project. This willestablish a background for a consideration of the differences andsimilarities between capital markets project financing and conventionalbank project financing.

THE PROJECT

The Murrin Murrin Project is comprised of a nickel/cobalt mineand an integrated processing facility located in Western Australia. TheProject is expected to contain the Western World's sixth largest nickelmine and fourth largest cobalt mine, with an annual design production

• The author has an extensive practice in resources, major projects, project financeand banking. He is a former Director of AMPLA and a former Chairman of thernA Section on Energy and Resources Law. He has published and delivered papersat conferences and seminars in Australia, Asia, North America and Europe. He is aformer visiting fellow and lecturer in project finance at Melbourne University. Heis presently Co-Chairman of the Asia PaCific Forum of the rnA. He is a Director ofthe Centre of Energy and Natural Resources Law at the University of Melbourne.

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CAPITAL MARKETS PROJECT FINANCING 191

capacity of 45,000 tonnes of nickel and 3,000 tonnes of cobalt.The Project has a projected development and construction cost of

US$751 million and projected total Project requirements of US$960million, including capitalised interest, working capital andcontingencies.

The overall process technology for the Project has been licensedfrom Sherritt International Corporation (Sherritt) and comprises anacid leach plant, a nickel/cobalt refinery and associated infrastructure.Sherritt has also agreed to support the Project by providing certaindesign, construction, commissioning and operational support for afifteen year period.

STRUCTURE OF THE JOINT VENTURE

The joint venture comprises Glenmurrin Pty Limited (Glenmurrin)a company incorporated in Western Australia (holding a 40 per centparticipating interest) and Murrin Murrin Holdings Pty Limited(MMH) a company incorporated in Western Australia (holding a 60per cent participating interest).

Glenmurrin is an indirectly held subsidiary of GlencoreInternational AG (Glencore), a Swiss privately held company withglobal natural resources interests in mining, smelting, refining andtrading.

MMH is. an indirectly held subsidiary of Anaconda Nickel Limited(Anaconda), a publicly listed Australian company.

The Manager of the Project is Anaconda Operations Pty Ltd, whichis a wholly owned subsidiary of MMH.

The structure of the joint venture is set out in Annexure A.

PROJECT DOCUMENTS

Sale Agreement

Pursuant to a Sale Agreement, Glenmurrin acquired a 40 per centinterest in the Project assets from Anaconda.

An interesting feature of this agreement is that Glenmurrin acquireda 100 per cent interest in certain portions of the treatment plant usedfor the purposes of the Project. However, this. plant will be madeexclusively available to the Project at no charge and all non-acquisitioncosts in relation to the plant will be apportioned to the joint venturersin accordance with their respective participating interests. All otherproperty relating to the Project will be held by the joint venturers inaccordance with their participating interests.

192 AMPLA YEARBOOK 1998

Joint Venture Agreement

The Joint Venture Agreement is in reasonably conventional form.Its main purposes are providing for the creation of the joint venture,the regulation of internal joint venture issues and creating a regime formanagement of the Project. There is no separate ManagementAgreement.

Although the Manager is wholly owned .by MMH, the joint ventureis subject to the direction and supervision of a management committeewhich has exclusive carriage of, inter alia, approving and negotiatingmaterial-agreements, certain programs and budgets, certain litigation,selecting key Project personnel, selecting performance targets andtimetables and making any decisions with respect to the expansion ofthe Project.

Where one party defaults in paying a called sum the Joint VentureAgreement requires the other joint venturers to pay that called sum tothe Manager by way of a compulsory contribution. The Joint VentureAgreement contains two mechanisms which may be used by a nondefaulting joint venturer in these circumstances:

(a) the cross charges and cross mortgages by each joint venturerin favour of the other joint venturers and the Manager; and

(b) a mechanism whereby the participating interest of adefaulting joint venturer is diluted and a correspondingincrease is made to the participating interest of thenon-defaulting joint venturers.

The Joint Venture Agreement contained a permitted chargingclause. It also deals with assignment and pre-emption.

Cross charges and cross mortgages

Each of the joint venturers have granted cross charges over theirrespective participating interests, its mineral product, its sales contractsand sales proceeds in favour of the other joint venturer and theManager. As the participating interest of each joint venturer includesan interest as a tenant in common in mining tenements, a crossmortgage of those tenements was also granted in the form required bythe Western Australian Mining Act 1978. This is required because adealing with respect to an interest in a mining tenement will have noforce or effect unless it is in the-appropriate form and is registered withthe Department of Minerals and Energy in Western Australia.

The cross charge is mainly designed to secure unpaid called sumswhether unpaid to- the Manager or unpaid to another joint venturer asa result of the -compulsory contribution. It may be of interest to notethat the cross charge -which has been widely used in Australia(including in the following projects: Argyle, Bengalla, Boddington,Camberwell, Collinsville, Cooper Basin, CQCA, Gladstone, Harriet,Jabiru, Kutubu, Loy Yang, McArthur River, Mt Newman, MurrinMurrin, North West Shelf, Ravva (India), Robe River, SE Gobe


(PNG) , Springvale and Worsley) was acceptable to the underwritersand their solicitors in the context of a capital market project financing.Priority issues are dealt with below.

Marketing Agreement

Under a Marketing Agreement Glenmurrin and MMH haveseverally appointed Glencore as their exclusive agent to market theirrespective share of nickel, cobalt and mixed sulphides produced fromthe operation of the Project for a period of 15 years.

The term of this agreement will terminate if Glencore ceases tohave, whether directly or indirectly, a participating interest in the jointventure of greater than 10 per cent.

An interesting feature of this agreement is that the credit risk undersales contracts are allocated to Glencore unless Glencore rejects thecredit risk in respect of a particular sales contract and a joint venturer,notwithstanding that rejection, directs Glencore to enter into that salescontract. Glencore is required to pay any invoice from sales topurchasers which is overdue by more than 30 days provided thatpayment is not disputed by the buyer. In such an event, Glencore isentitled to retain any funds recovered from the buyer. Glencore is paida commission for its sales as agent under the Marketing Agreement.

Offtake Agreement

Glencore has agreed (again for 15 years) .under an OfftakeAgreement to purchase any product of the Project that has not beensold by Glencore as agent on behalf of the Joint Venturers under theMarketing Agreement. Product which reaches the relevant loadportfor which there is no sales contract will be purchased by Glencorepursuant to the Offtake Agreement.

Access Agreement

Anaconda Pastoral Holdings (APH) is the holder of a pastoral leaseand a sub-lease of another pastoral lease relating to certain surfacerights. These surface rights are in addition to the rights of accessavailable under the projects minerals titles. Under the AccessAgreement, formal rights of access to such land are granted by APH tothe Manager for the purpose of operating the Project, with such rightsof access continuing in full force and effect until the earlier of thetermination of any pastoral lease or the cessation of operations of theProject.

Continuing Obligations Agreement

The Continuing Obligations Agreement provides a form of sponsorsupport for the Project.

This agreement includes:(a) guarantees by Glencore and Anaconda of the obligations of

their respective subsidiaries under the Joint Venture


Agreement, (this guarantee terminates upon Anaconda andGlencore fulfilling their respective equity requirementsunder the Joint Venture Agreement);

(b) an obligation for Glencore and Anaconda to use their bestendeavours to procure their respective shares of financingfor the Project;

(c) provision of certain rights of first refusal for Glencore inrelation to the sale or disposal of an interest in anynickel/cobalt project in Australia in which Anaconda or anysubsidiaries have an interest;

(d) restrictions on Glencore and its subsidiaries having aninterest in nickel or nickel/cobalt projects in Australiaexcept for portfolio investments in listed companies;

(e) an undertaking by Glencore as to supply of personnel forthe purpose of ensuring development of the Project; and

(f) undertakings with respect to the ownership of the shares inthe Manager.

EPC Contract

Fluor Daniel Pty Limited (Fluor Daniel) and the Manager haveentered into an engineering procurement and construction contract(EPC Contract) pursuant to which Fluor Daniel agreed to assumeresponsibility to complete the design, construction and completion ofthe facilities forming part of the Project.

This contract is a lump sum contract. However, this lump sum mayvary on the basis of a number of specified events including a variationof the facilities forming the Project, changes of law, defects accepted bythe Manager which Fluor Daniel has not, at its cost, rectified, or theactual cost of a certain contingent or provisional items being greater orlesser than the amount allowed. for in the contract price. Further,es~alation in specific price indices may increase or decrease the contractprIce.

Fluor Corporation, Fluor Daniel's parent, has provided a guaranteeas to the payment and performance by Fluor Daniel of its obligationsunder EPC Contract. Further securities have been provided by FluorDaniel to the Manager upon payment of each progress payment in anaggregate amount not in excess of 5 per cent of the contract price inthe form of bank undertakings for the performance of its obligationsunder the EPC contract. Subject to the foregoing Fluor Daniel can beliable for daily liquidated damages if mechanical completion is notachieved on time. Fluor Daniel can receive a bonus if it achievesmechanical completion ahead of time.

Ramp Up Agreement

Fluor Daniel has also agreed under a Ramp Up Agreement to assistthe Manager in commission, production, ramp up and other operationssupport after the mixed sulphides plant and the refinery are


mechanically complete. .This agreement is payable on a scheduled rate basis.Under the Ramp Up Agreement, Fluor Daniel also warrants that

the facilities for the Project will achieve certain levels of productionmeeting specified chemical and physical standards during the 12 monthperiod following mechanical completion. If this does not occur FluorDaniel will be liable for liquidated damages.

Sherritt Agreement

The joint venturers, the Manager and Sherritt have entered into aCommercial Plant Licence and Technical Support Agreement (CPLTSAgreement) pursuant to which Sherritt has agreed to licence to theManager certain proprietary technology including an acid leach andhydro reduction processes. lJnder the CPLTS Agreement, Sherritt hasalso agreed to provide personnel for operational assistance and toprovide training to the joint venture's operations personnel.

Sherritt receives a licence fee payable in instalments together withcertain fees payable on the basis of the performance of the Project.

In connection with CPLTS Agreement the Manager, Anaconda andSherritt have entered into a Process Guarantee whereby Sherrittguaranteed to the Manager that the portions of the plant designed andconstructed according to specifications given by Sherritt will meetcertain performance parameter values.

FINANCING - STRUCTURE INVOLVED

There were in fact two separate capital markets financings for the. Murrin Murrin Project. Each joint venturer went to the US Markets in

1997 - Murrin Murrin Holdings went first and Glencore later. Thispaper will focus on the Glencore financing.

Financing for Glenmurrin's share of project expenditure wasachieved through a high yield US capital market bond issue. GlencoreNickel Pty Limited (GN) , a company incorporated in New SouthWales, Glenmurrin's direct holding company, issued US$300 million 9per cent Senior Secured Bonds in the United States.

The Bonds have a term of 17 years.The Bond issue was structured to take advantage of provisions of the

US Securities Act which exempt certain issues from registrationrequirements where the issue is:

(a) to "qualified institutional buyers" (as that term is defined inr 144A of the Securities Act);

(b) pursuant to offers and sales that occur outside the US topersons other than US persons in offshore transactionsmeeting the requirements in r 903 of reg S of the SecuritiesAct.


The security supporting the Bond issue was:(i) a fixed and floating charge granted by GN;(ii) a guarantee by Glenmurrin;(iii) a fixed and floating charge and a mining mortgage

granted by Glenmurrin;(iv) a security over certain bank accounts of Glenmurrin

and GN established in the us.Parent support is provided by way of revolving credit facility

granted by Glencore to GN (including a standby qualifying letter ofcredit issued for the same amount as the facility limit for the revolvingcredit facility for the benefit of the trustee for the Bonds).

A.diagram of the financing structure is set out as Annexure B.

US FINANCING DOCUMENTS

Offering Memorandum

The order and timetable for a capital markets raising is influencedby its place of issue. There are standard procedures in place, forEurobond issues in Europe and r 144A issues in us. In either case, onoffering circular or offering memorandum will be prepared. Thatdocument will contain the "term sheet" and other relevant informationthat potential investors would require. There are very strict disclosurerules especially in the us.

One of the very important documents in any capital markettransaction is the Offering Memorandum. In addition to the term sheetthis typically contains a description of the project, description of theparties, description of the documents both project and finance, ananalysis of risks and a large amount of technical and accountinginformation.

It is obviously important that any significant risks are drawn to theattention of potential investors. This goes under the heading of riskfactors. In the Offering Memorandum there are a large number of riskfactors identified.

These would deal with items like the operating history, the financialleverage, the technology risks, the operating risks, the holdingcompany structure, legal risks relating to potential invalidities of anydocuments, funding of cost overruns, potential for pre-empt rights andtermination of various documents, volatility and prices ofcommodities, exchange rate risks, government regulation issues,environmental risks, native title risks, title issues, key personnel issuesand the level of recourse.

The term sheet aspect of the offering memorandum willsubsequently find its way into the indenture and other financingdocuments.


Indenture

The Indenture is a document between GN, as the issuer of thebonds, Glenmurrin, as guarantor, and the trustee for the bondholders(Bond Trustee). The Indenture:

(a) describes the terms on which the Bonds are issued andcontains procedural provisions relating to their registration,cancellation, transfer etc;

(b) sets out the events of default with respect to the Bonds andthe remedies of the bondholders upon default;

(c) defines the duties of the Bond Trustee;(d) provides for redemptions of the Bonds (both mandatory and

voluntary);(e) describes the security requirements in relation to the Bond

issue; and(f) contains covenants to be given by Glenmurrin and GN.

The covenants set out in the Indenture include covenants thatwould normally be expected in a standard project financing in relationto restrictions on indebtedness, transactions with affiliates, limitationon sale of assets and creation of security, maintenance of property,insurance and corporate existence.

The guarantee granted by Glenmurrin is also contained in theIndenture.

Note that there is also a Trust Indenture Act which regulatesindenturesin the us.Purchase Agreement

The Purchase Agreement is effectively the agreement which sets outthe terms and conditions upon which the underwriters (in theircapacity as the initial purchasers of the Bonds) (Initial Purchasers) agreeto purchase the Bonds. The agreement is structured as a Deed Pollm~de by Glenmurrin and GN to the Initial Purchasers. The InitialPurchasers then return a signed acceptance to Glenmurrin and GN ofthe conditions in the Purchase Agreement.

The main purpose of the Purchase Agreement is that it containsrepresentations and. warranties by Glenmurrin and GN. Theserepresentations and warranties extend to issues such as industrialdisputes, tax returns, accounting controls, effectiveness of choice oflaw, stabilisation and manipulation of the share price of Glenmurrin orGN, and projections in respect of the Project. The opinions given bycounsel in both the us and Australia for Glenmurrin are annexures tothe Purchase Agreement. This is because the opinions confirm thecorrectness of some of the material contained in the OfferingMemorandum issued by GN in relation to the Bonds.

The Purchase Agreement also contains certain covenants in relationto the Bonds, in particular covenants in relation to compliance withthe obligations of GN under the Securities Act.


Registration Rights Agreement

This agreement contains an obligation for GN and Glenmurrin toprepare an "Exchange Offer Registration Statement" and file it withthe US Securities and Exchange Commission (SEC). This will enableregistration of Bonds as securities with the SEC. This is requiredbecause securities exempt from registration contain restrictions ontransfer.

If registration is not achieved within a certain timeframe penaltyinterest rates are payable with respect to the Bonds.

Collateral Accounts Agreement

The Collateral Accounts Agreement is between GN, Glenmurrinand the trustee for the bondholders with respect to securities(Collateral Trustee).

This agreement requires certain bank accounts to be opened andmaintained.

It also contains complicated disbursement procedures from thosebank accounts and attaches certificates that are required to be given toenable a disbursement from a particular account. This agreement alsospecifies the purposes for which disbursements may be used.

Collateral Pledge and Security Agreement

This is a security granted by Glenmurrin for any assets held in theUnited States (including the bank accounts created under the CollateralAccounts Agreement).

This agreement was required to be registered with the ASC as acharge created by an Australian company.

Closing Memorandum

The Closing Memorandum is signed by GN and Glenmurrin andeffectively sets out all documents required as conditions precedent tothe issue of the Bonds. It attaches as exhibits the various certificatesthat are required to be given by parties such as officers of Glenmurrinand GN, the independent engineer, and the Collateral Trustee.

Subordinated revolving credit facility and irrevocable standby LC

These documents P!ovide a form of parent support to the financing.In effect, GN will maintain a subordinated revolving credit facility(including a standby LC) under which GN will be able to access fundsto pass on to Glenmurrin. These funds will be obtained from Glencoreor issuer of the LC. Under the subordinated revolving credit facility,Glencore agrees to lend to GN up to US$65 million on a revolvingbasis to pay costs over runs and principal on the bonds. Thesubordinated revolving credit facility is supported by a standby letterof credit for the same amount. The subordinated revolving creditfacility reduces an amount after completion.

CAPITAL MARKETS PROJECT FINANCING

AUSTRALIAN SECURITY DOCUMENTS

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Bond Collateral Trust Deed

This deed creates a trust whereby the securities are held on behalf ofthe bondholders by the Collateral Trustee.

Fixed and Floating charges

As discussed above, a Fixed and Floating Charge was granted byeach of Glenmurrin and GN. The charge granted by Glenmurrin was apermitted charge for the purposes of the Joint Venture Agreement.The charge granted by GN also contains a mortgage of the shares inGlenmurrin. Assets subject to the floating charge include the mineralproduct, the proceeds of sale of mineral product and, after completion,cash and permitted investments.

Mining mortgage

As the property of Glenmurrin subject to the Fixed and FloatingCharge includes interest in mining tenements, it was necessary for thereasons expressed above in relation to the cross mortgage forGlenmurrin to grant a mining mortgage in the form prescribed by theWestern Australian Mining Act 1978. As the property of Glenmurrinsubject to the Fixed and Floating Charge includes interest

Permitted Chargee's Deed ofCovenant

The Joint Venture Agreement provides that a charge over theparticipating interest of Glenmurrin in the joint venture is prohibitedunless the chargee enters into a Chargee's Deed of Covenant in theform annexed to the Joint Venture Agreement.

This deed regulates the priorities between the Cross Charge and thecharge granted to the Collateral Trustee. It also provides that theCollateral Trustee and its enforcement administrators are subject tothe provision of certain priority agreements (including the CrossCharges and the Joint Venture Agreement).

In effect, the Collateral Trustee agrees in return for being allowed totake as security to be bound by the terms of the various projectagreements to which Glenmurrin is a party as if the Collateral Trusteewere a participant. The obligation to observe the project documents islimited by a provision that this requirement does not require theCollateral Trustee to pay· any money to any person on any accountwhatsoever unless the Collateral Trustee were actually to succeedGlenmurrin as a participant. Amongst the material joint venturecovenants, which the Collateral Trustee could be obliged to observeare the pre-emptive rights, notices of default and payment of calledsums.

The cross charge secures all moneys owing to joint venturers byother joint venturers and thus went beyond securing called sums.


However, it was agreed that the priority that the cross charge hadahead of the charge granted in favour of the trustee for thebondholders would only extend to unpaid called sums, interest andenforcement expenses.

Custodian Deed

As a number of parties hold security over the title documents to thejoint venture property, a custodian arrangement is created by theterms of this deed for those title documents. The custodian holds titledocuments in safekeeping on behalf of security providers and securedcreditors. The custodian lodges documents and manages dealings withdocuments and has control over documents. The documents includedtitle documents.

This deed provides that in certain circumstances these titledocuments may be released to enable a party to enforce its security.

Loan agreements and subordination deeds

As GN is the issuer of the bonds, subordinated loans were put inplace to enable funds to flow through to Glenmurrin to meet itsobligations under the Joint Venture Agreement.

COMPARISONS BETWEEN CAPITAL MARKETSAND BOND PROJECT FINANCE

Traditionally, project finance for resources projects has beenfurnished by banks. The use of the capital markets is recent and new.There are still a number of issues to be worked out.

What has .driven this move into the capital markets for resourcesprojects? The attraction of the capital markets are:• Access to a larger investor base

The depth of the US investor base for high yield market issubstantial. The holders of project bonds are more likely to be largeinstitutions, funds and fund managers rather than "Belgian dentists".

The MMH issue took place in buoyant conditions before the Asianeconomic downturn and when Australia was the "flavour of themonth". The issue was heavily over subscribed. Glencore's issue, incontrast, went to the markets in November 1997 after the Asianeconomic downturn, with nickel prices at an all time low and someconcern about the impact on Australia of its proximity to the Asiancollapse. Notwithstanding this, the deal was successfully done. It isimportant to note in the context of a large investor base for this sort ofpaper that this is especially important in an environment in which thenumber of banks (especially Japanese banks) providing project financein this region has reduced. Nonetheless, the volume of bank· projectfinance continues to expand.


• Longer maturityMurrin Murrin got 10 year bullet repayment maturity on its fixed

rate paper and similar terms for the floating rate paper. Glencorestretched its maturity to 17 years. Thus the combination of long-termmaturity and significant interest only periods is a major attraction ofthis sort of financing.

• Faster executionThe methodology behind capital markets transactions is the

negotiation of, in effect, the term sheet with the underwriters. Theterm sheet is then included in the offering memorandum which is themarketing prospectus. There are usually two offering memorandums, apreliminary offering memorandum and a final offering memorandum.The preliminary offering memorandum is updated by any changes thathave taken place in the meantime and amended to become a finaloffering memorandum before closing. The period fromcommencement of negotiation of the terms with the underwriter tothe issuance would, in most cases, be faster than the period for a bankproject financing from start to close.

• More liberal covenantsWhilst this is true to a considerable extent, it should not be

overstated. The covenants provided will still be detailed, for example incomparison to a normal corporate capital markets issue. In some areas,they may be more complex and detailed. Overall, they are nonetheless,less detailed than one might expect from a bank project financing.

The other side of capital markets covenants is that although theymay be more liberal to some extent, they are also less flexible. This isbecause of the difficulty of obtaining consents. Traditionally, bank'project finance has a mechanism for obtaining consent through theagent. The agent in turn acts on the instructions of the majority banks.This is not a practical course with capital markets issues.

Whilst these attractions are significant, there are also disadvantageswhich should be acknowledged.

• DisclosureThe first significant potential disadvantage is that it would be

necessary to produce an offering memorandum that discloses thetransaction's characteristics and corporate and contractual structure.The matters that are described above would be described· in muchgreater detail in the offering memorandum. As mentioned above, therisks would be analysed. These documents can become very complex asdoes the verification process in relation to them. The document mustnot contain any material misstatements or omit or state any materialf~ct necessary to make the statements therein not misleading in theCIrcumstances.

In this area beware of confidentiality issues. If you haveconfidentiality clauses in third party contracts with suppliers orcontractors you will need the consent of that third party to disclose


information relating to the contract. The third party may well want toknow what is in it for it. It may well not want to disclose informationto the market place. It may not be prepared to offer the same terms toother people and may not want the terms generally known. Thus theconfidentiality clause. A number of transactions in the capital marketsarea have fallen over for this reason. Thus this area needs to beaddressed at a fairly early stage in the capital markets process.

• RatingThe second significant issue that needs to be appreciated with a

capital market transaction is that the project paper would have to berated. That means that the rating agencies will need to· examine boththe project and financing documentation and the project itself. Theywould then form a view as to an appropriate rating for the paper. Thatcan take time, although it should not unduly extend the timetable if itis built into the timetable appropriately. Nonetheless, it is an issue ofconcern to some companies. The ratings process is considered in moredetail under practical differences below.

• Work out problemsFinally, the ability of lenders to work out project problems is

something that is inherently easier to do in the project bank structurethan it is with a capital market transaction.

PRACTICAL DIFFERENCESThere are some important practical differences between capital

markets and bank project finance.

Draw down

In bank project finance, the borrower issues draw down notices tothe agent to enable it to meet cash calls that it has to make to theManager of the joint venture to meet capital and operating costs.During construction, these costs will be large and progressive and mayneed to be supported by certificates of the Manager, the borrower orindependent engineers. It is likely that the banks would have imposeddebt-equity ratios that may also require equity to be progressivelyinjected as well as debt.

In contrast, capital markets transactions are typically drawn downin whole and up front. In a development project this means that themoneys are advanced up front before they can be spent. The intention,nonetheless, is that the proceeds of the issue be spent on theconstruction of the project which may be over an 18 month period.

This issue may be addressed by requiring the issuer to pay theproceeds into particular accounts (for example construction accounts;there may also be other accounts). See the reference earlier in thispaper to the Collateral Accounts Agreement. (For example, there maybe revenue accounts, maintenance accounts, capex reserve accounts,debt service reserve accounts.)


Once the moneys have been paid into the construction account theycan be disbursed from there in accordance with constructiondisbursement procedures. In general, this would mean that certainconditions would have to be met before any disbursement could bemade from· a construction account or a revenue account to payconstruction expenses. Typically, this would include certificates by thecompany and possibly an independent engineer to the CollateralTrustee.

The role of the independent engineer would be to certify, amongother things, the approved construction disbursement amount and hemay also be asked to certify as to the then current estimated date of thecompletion.

Rating

In practical terms, it will be necessary to have the paper ratednormally by two of the rating agencies. This will obviously influencethe pricing terms. In the case of the Murrin Murrin Project, theMurrin Murrin paper was rated Ba3/BB- and the Glencore paper wasrated Bal/BB+. In each case, the deal was rated by two rating agencies.

My understanding is that the divide between investments grade andspeculative grade is an important divide. Working with the agencieshas been described as an "art not a science". There are three mainrating agencies. Each of them is stronger in certain areas. Standard &Poors and Moodys were the two used on the Murrin Murrin Project.

The ratings process us~ally involves an initial presentation bysponsors and their advisers. The rating agency will undertake its duediligence including a site visit and meetings with the sponsors and areview of the documents. It will then issue preliminary ratings subjectto review of independent experts reports and review of finaldocuments and some additional due diligence. Its final ratings will issueprior to closing.

The rating agencies will review all the risks which one would expectto be reviewed by a bank and a project financing. They will look attechnology risks, construction risks, offtake contracts,competitiveness, fee stop risks, structure, product economics, soverantissues and market risk and offtaker profile.

Each of the rating agencies publishes material from time to time.Standard & Poor's rating process concentrates on credit analysis,payment analysis and legal analysis.

Under the first of these, they conduct a review of the assets. Underthe second of these, they analyse the application of the cash flow ormarket value derived from the assets. Under the third of these, theyconsider lead access to security.

The Moody publication states "as these projects are varied andcomplex transactions with unique characteristics, there are no simpleformulae or standardised risk priorities that can be unilaterallyapplied". In effect, each project has to be considered on its own merits.


Covenants

The significant difference between this and bank project finance isthat there will be no consent mechanism. The terms contained in theoffering memorandum and repeated in the indenture will be differentin this respect from bank project finance. Typically in bank projectfinance there will be a mechanism for obtaining the approval ofmajority banks by making an application to the agent. The borrowerwould apply to the agent in written form with a submission and anysupporting papers that were necessary. The facility agent would thenget the views of the banks.

Normally for consent, there would be a majority bank requirementor something significantly less than all the banks. This lack of consentmechanism has been criticised by some. It suggested that it does notprovide the requisite degree of flexibility, monitoring and control ofthe debt providers' interest in the project. It also suggests that it makesit difficult for the financing to deal with changing circumstances. Thereare clear advantages in being able to deal with a facility agent on behalfof majority banks. (See also the Sutton Bridge debate below.)

A similar or related concern is the concern as to what would happenin the event of a workout. It is well known that it is difficult to getbond investors to vote and to make decisions on restructuring. It hasbeen suggested that at the first sign of trouble, bond-holders would sellout to some sort of workout specialists.

DUAL TRACK APPROACH

There is always a substantial lead-time in a greenfields resourcesproject between the time of initiating a feasibility study and thefinancing stage. There is no reason why the developer should not, inconjunction with its advisers, pursue both bank and capital marketalternatives until it reaches the point of needing to make a finaldecision. This preserves flexibility.

In a paper like this, there is a tendency to highlight differences. Thisis right and proper. However, it is also right to remember that thereare a number of similarities. The fundamental issue here is that theproject's underlying financeability will have to be established. Theunderwriters and their counsel and the rating agencies and theircounsel will examine the same risks as the banks and their counsel. Theunderlying documentation must be compatible and permit theimplementation of the relevant financing. At the legal and contractuallevel it must be bankable. The security structure in Murrin Murrin, asoutlined above, is very similar to what could have been in place hadthe project joint venturers gone the bank route. In addition, theunderlying joint venture, cross charges and chargees deed of covenantare similar to what would be in place for a bank project finance. Theunderwriters and their lawyers will be as concerned about native title


or environmental issues as banks and their lawyers although it mightbe argued that the driving force in the former is disclosure rather thana concern about the bank's own loans.

INTER-CREDITOR ISSUES

The Murrin Murrin financing was entirely capital markets based andaccordingly, inter-creditor issues did not loom large. However, it isinevitable that there will be resource financing where some of thefunds are provided by banks and some from the capital markets. Someof the further inter-creditor issues which will need to be resolved are:• Draw down

Rationalisation of the two systems described above and who has thebenefit of security over the lump sum funds from the bond-holders.• Sharing of security

Should this be shared pari pasu, equally and rateably or is .someother sharing appropriate?• Acceleration and enforcement

Who has the right and what are the voting mechanisms?• Consents, waivers and amendments

What voting is required to grant consents or waivers?Can either form of financing be amended without the other?

• ProceedsHow are revenue proceeds to be shared and how are proceeds on

enforcement to be shared?What is the impact on this if either facility is subject to indexation

or exchange rate variation because the facilities are ·in differentcurrencies?• Maturity of bonds and loans

Especially given the longer life of bonds and the possibility ofperiods of interest only payments (and bullet repayment) referred. toabove.

One should observe that one technique that has been utilised onoccasions is to tie the bond-holders' decision-making to the bank'sdecision-making. This addresses one of the concerns discussed above. Itremoves the difficulty of trying to get a decision from bond-holders.

THE SUTTON BRIDGE DEBATE.IN THE UKAND THE PROJECT AGENT PROPOSAL

The first· of the UK project bond financings (for the Sutton Bridgefor a power plant construction) has created some controversy inEngland. Two partners from Wilde Sapte, a law firm not involved inthe transaction, have produced a paper criticising the structure. Theargument is that the lack of mechanism to allow for amendments or


waivers create dynamic risk for the Project. This, they argue, iscompounded by the diverse and anonymous nature of bond-holders.

Wilde Sapte propose a project agent to serve as a middle man tomanage risk, to act as a conduit and have authority to act for the bondholders. Linklaters & Paines who acted for the lead managers haverejected this because the fees required would be ridiculous. The earlyproject bond deals were credit enhanced by a monoline insurer.Linklaters & Paines argue that if the transaction required a projectagent you would be better procuring a monoline wrap. The criticismof the project agent proposal is therefore twofold. First no one willtake it on. Secondly sponsors would have to pay monoline type fees tothe project agent without the monoline benefits.

WITHHOLDING TAX CHANGES

Recent amendments to the interest withholding tax (IWT)provisions contained in s 128F of the Income Tax Assessment Act 1936of Australia have facilitated the viability of using the capital markets asa funding mechanism for resources projects. Section 128K provides anexemption to the 10 per cent IWT otherwise required to be deductedby an Australian company making payments of interest to offshorelenders. The exemption is available for issues of notes, bonds or otherdebt instruments which are issued in a manner which satisfies a "publicoffer" test. The public offer test is capable of being satisfied in anumber of ways. In the case of this transaction, this was done byselling Notes to at least 10 "qualified institutional investors" under theUS Securities Act 1933, being entities not associated with the borrowerwho are in the business of providing finance, or investing in or dealingin securities, in the course of operating in financial markets.

There have been even more recent changes to the IWT provisionsintroduced into parliament earlier this month. These changes, ifpassed, will effectively permit an IWT exemption to be available incircumstances where notes, bonds or debt instruments are sold toresidents as well as non-residents. This will have the effect of wideningthe potential investor base and thereby make the use of capital marketinstruments even more viable when considering possible fundingoptions.

PROPOSED TAX LAW CHANGES

Whilst this paper does not attempt to deal with the myriad tax issuesthat arise in relation to any project financing there is one particularAustralian tax issue that warrants particular mention.

This is the proposal contained in new Div 243 (to be introduced intothe Tax Act in Taxation Laws Amendment Bill (No 4) 1998) thatlimited recourse debt arrangements that are terminated after 27February 1998 c~ give rise to tax adjustments to the borrower at that


time in respect of depreciation and other capital allowances claimed bythe borrower in respect of property "predominantly" acquired withthe limited recourse debt. The proposed rules do not impact anydeduction for interest on the debt.

In broad terms the provisions are intended to "claw back", by wayof including an amount in assessable income, depreciation and othercapital allowances previously allowed on certain limited recourse debtfunded property if the limited recourse debt is not repaid in full. Thusthe rules require an analysis of depreciation and other capitalallowances claimed by the borrower against the amount of debtremaining unpaid at the time it is "terminated".

However the proposed provisions go much further than would seemreasonable. Various parties, including the Australian Council forInfrastructure Development, are liaising with the Tax Office in anattempt to have them clarified before finalisation. ·The draft provisionsare currently before a Senate Economics Legislation Committee forreport by mid-August 1998.

The critical points to note about the proposed new rules are that:• the concept of limited recourse debt is very broadly drafted (its

similar to the definition already contained in s 51AD of the TaxAct) and, for instance, includes a highly geared special purposecompany whether or not the debt is specifically limited recourse,

• the "termination" of a limited recourse debt arrangement (that cantrigger the adjustment provisions) does not only mean the releaseby the creditor of the debtor of some part of the limited recoursedebt at the end of the loan term, and

• the amount actually repaid on a terminated debt can be disregardedin some circumstances.

Thus the provisions can be triggered when:• one limited recourse debt is refinanced with another limited

recourse financed debt - by deeming the amount of the debt repaidfrom the proceeds of the refinancing to remain unpaid (this raisesissues as to whether the rollover of ordinary commercial paper,bills of exchange and other tradeable debt can trigger theprovisions);

• a creditor ceases to have an entitlement to recover a limitedrecourse debt - without any corresponding requirement that theborrower is released from having to repay the debt (which raisesissues as to whether the substitution, or sell down, of financiers inordinary syndicated transactions can attract the provisions); or

• the financed property is sold to repay the limited recourse debt by treating any amount of the debt repaid from the proceeds of thesale to remain unpaid (which seems completely unreasonable).


JOINT VENTURE STRUCTURE

r-----------------I Glencore International AG i

I I

GlencoreInvestment AG

1000/0 19%

(approximately)

I AnacondaI Nickel Limited

II

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Holdings PtyLimited

100%

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Glenmurrin PtyLimited

400/0

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(approx im ateIy)

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Operations

1000/0 1

I •

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r---i\.I Holdings Pty II Limited

'-------_(M_a_n_a,-----g_e_r)__1 L-__~-------l

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TheJoint

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BondHolders

Indenture

Bond

US$65 millionQualifying LJC

- Bonds- Fixed and

FloatingCharge Bond

Glencore Nickel 1------1..1 Trustee/Pty Limited Bond

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1Trustee

US$300,OOO,OOO

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Subordinatedloan

~ GlencoreIInternational AG

I

US$65 Subordinatedmillion loan (in lieu

Subordinated of dividends)Revolving

CreditFacility

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