For a project finance transaction to be deemed viable, different lenders may require different credit enhancement structures. Some of these structures may be used in combination with each other; for instance, project bonds can be credit-enhanced in whole or in part through various means, including:
Guarantee. In a Public-Private Partnership, a guarantee to cover the Private Partner’s obligations might be provided by a project sponsor (provided it has a suitably high credit rating), a bank or a multilateral agency. In some cases, a guarantee might equate to wholesale credit substitution, as distinct from credit enhancement.
Wrap. This is the provision of insurance commonly offered by monoline insurers, which are highly rated private sector financial guarantors, insuring the underlying principal and interest payments on a bond. In terms of creditworthiness, the guarantor’s credit rating is substituted for that of the wrapped bonds.
Sovereign Guarantee. In some jurisdictions, public procurement law may provide for the host government to issue a sovereign guarantee, which is contingent upon the default of the main obligor. This credit enhancement structure may be part of a concerted government program to facilitate infrastructure investment.
Multilateral Product. Multilateral Development Banks (MDBs) have a long track record of providing guarantees for bonds. These guarantees generally focus on specific risks (such as political risk) that the private sector is unable to manage. An example of multilateral product is the Non-Honoring of Sovereign Financial Obligation (NHSFO), which can be used to underpin a sovereign guarantee to achieve credit substitution, thus making the transaction viable. MDBs and multilateral funding agencies are the ideal channel to provide this support, inasmuch as they have both the credit quality and the political influence to stimulate investor appetite.