The Hindu Business Line : Banks want equipment performance guarantee for power projects

On guard
Very few Chinese suppliers offer performance guarantees and even when offered they are not enforceable in India.
In absence of guarantees, especially in non-recourse funded projects, credit risk is on project cash flows.

C. Shivkumar

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Bangalore, May 27 Drawing lessons from their western counterparts, domestic banks have now begun insisting on equipment supplier performance guarantees for infrastructure projects.

Top bankers said they have begun including minimum performance guarantee clause in power projects as one of the covenants for financial closure. The move comes as Chinese suppliers have increased their presence in the country by under quoting in international competitive bids floated by Indian companies. Some Indian power project promoters have increasingly taken to rooting for Chinese equipment, in view of the low quotes. The discounts by Chinese equipment suppliers were as high as 50 per cent as compared to bids by global or domestic companies.

However, very few Chinese suppliers offered performance guarantees. Other international suppliers, including public sector majors such as BHEL, offer performance guarantees of up to 85 per cent plant load factor, on power equipment supplied by them. In the event of equipment shortfalls, EPC contractors are bound by tight contractual agreements that entailed high compensation. Even if such performance guarantees were offered by Chinese suppliers, they were seldom enforceable in India. In most cases, arbitration jurisdiction was in China. Western and Japanese suppliers on the other hand use Indian jurisdiction for arbitration.

The absence of such supplier guarantees was beginning to make bankers nervous, especially in projects that are funded entirely on a non-recourse basis. Non-recourse funding implied that the credit risk was entirely on the project cash flows. Plant deficiencies therefore put project debt servicing at risk, they said.

Consequently, project financiers have become more circumspect in the funding non-recourse projects. Besides, bankers said, since plant and equipment were covered under the physical asset cover, financiers were interested in knowing the track record of EPC contractors. Under current regulations, the prescribed physical asset cover is 150 per cent. Funding is available up to 80 per cent of the project cost.

The Bank of Baroda Chairman and Managing Director, Mr M.D. Mallya, said, “We need to know the track record of the EPC contractors for power projects, before financial closure.”

This is the first time that domestic banks are looking at EPC contracts closely. Such close scrutiny of EPC and fuel supply contracts is normally done only by cross border financiers. In the event of the equipment deficiencies, power distribution companies were likely to invoke penalty clauses on generating companies, as mandated in the power purchase agreements. The increase in liabilities would in turn impact the debt servicing ability of generation companies.

In fact, banks have now begun employing the services of credit rating agencies and consultants for conducting due diligence on suppliers especially foreign suppliers that make low bids. The bankers said that the moves were intended to eliminate the risks of any substandard asset build up on their balance sheets, especially in big-ticket project finance assets.

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