Price of debt – austerity and the plight of a project finance partner

The Magic Circle has so far been able to hold off the advance of US firms in project finance, but how are teams faring in a market hit by European austerity and falling commodities prices?

‘Do not go where the path may lead, go instead where there is no path and leave a trail.’
Ralph Waldo Emerson

One of only a handful of westerners to fly into Erbil airport in Kurdistan on Monday 26 October, project finance lawyer Clive Ransome’s ride into town was accompanied by guards wielding Kalashnikovs. With security at an all-time high in the region following the rapid rise of the Islamic State in Syria and Iraq, the Milbank, Tweed, Hadley & McCloy partner passed through 20 armed checkpoints on his way to meet Kurdistan prime minister Nechirvan Barzani. It would have been fewer, had it not been for the violence forcing their meeting to move to Suli, taking Ransome 120 miles across a flat and featureless landscape broken only by gas flares and nodding donkeys.

Their fifth meeting in the last two years, Ransome has been hired by Barzani to help build a nation. With greater independence from Iraq slowly being accomplished, Kurdistan has passed new legislation allowing it to borrow money on the international markets as Barzani bids to fund new power and water networks for Erbil. Kurdistan is more than happy to hire one of the world’s most expensive law firms if it means getting the best in the business. ‘It was no mundane Monday,’ says Ransome, ‘but what binds the world together is London-based financing, so sometimes London has to go to Kurdistan.’

The onus is now on the City’s project finance lawyers to win business outside of Europe, with activity levels depressed by spending curbs and the UK government moving away from using traditional private finance initiative (PFI) and public-private partnership (PPP) structures. While Milbank’s largest project finance offering outside of the US is in the City, Ransome notes that ‘very few of our deals are actually in the UK. They’re in Abu Dhabi, Kurdistan, Turkey, Ghana or another developing country’.

Project finance in Russia
Year signed	Total value	Number of deals
2010	$16,298m	10
2011	$18,995m	10
2012	$1,522m	2
2013	$83m	2
2014	$3,723m	5
Source: Dealogic

Project finance in Sub-Sahara Africa
Year signed	Total value	Number of deals
2010	$11,087m	20
2011	$7,205m	23
2012	$16,513m	34
2013	$26,921m	62
2014	$12,470m	29
Source: Dealogic

Project finance teams in the City have experienced a sharp slowdown of work in their local and traditional markets, with the commodities slump killing off new mining projects in Australia and South Africa, economic sanctions against Russia bringing an end to the oil-fed boom of the 2000s and early 2010s and European austerity plans curbing activity levels. The marked drop in oil prices, falling from $105 to $40 a barrel in little over a year, has added to the woes with oil producers cancelling at least $150bn of investments this year. Gulf states reliant on oil revenues have also weakened infrastructure spending as a result.

These economic and political headwinds mean that 2015 is set to be the worst year for project finance in a decade. Up until mid-November, total project finance globally for 2015 stood at $297.5bn, some $132bn off what was borrowed in 2014 (see chart, ‘Global project finance activity’ below). Law firms have had to readjust their international strategies as a result, slimming down and even closing offices in eastern Europe, Russia and the Middle East. The shift in the project finance market towards Africa, South-East Asia and Latin America has also seen firms change their footprint to focus on these markets, with South Korea, Indonesia, Myanmar, Mexico, South Africa and Morocco all receiving investment from international firms.

‘What binds the world together is London-based financing, so sometimes London has to go to Kurdistan.’
Clive Ransome, Milbank

Darryl Murphy, a corporate finance partner at KPMG, says: ‘UK law firms built up big banks of PPP expertise but they have to diversify or internationalise as that market is dead in the UK. The bizarre thing is that infra has never been higher in profile than it is today. Many countries recognise it is now a given, even [David] Cameron loves wearing a hardhat for the cameras, but the Conservatives have been highly critical of PPP and PFI and see it as the unacceptable face of capitalism and poor value for money. If you’re a finance lawyer focused on the UK then you’re feeling the pinch, as all the big projects are government funded with no private finance at all.’

While the Conservative government has reviewed hundreds of PPPs since 2012, securing £2.1bn in savings through renegotiated contracts and targeting another £2bn in efficiencies, Chancellor George Osborne has provided some optimism with a promise of £100bn in government funding to reboot the UK’s infrastructure development and the creation of the National Infrastructure Commission chaired by Lord Adonis. But there is a sharp corner to turn, with infrastructure investment falling by 5.4% since Osborne became chancellor in 2010. A report by Treasury unit Infrastructure UK found that this decline has continued in 2015, with the pipeline shrinking by 12% to £411bn in July 2015, a £55bn drop from December 2014 largely caused by a fall in oil and gas investment. But while energy and social infrastructure investment is down, transport spending is set to go up, with £15bn earmarked for new London rail link Crossrail, £43bn expected to be spent on high-speed rail line HS2 and the government tripling 2012/13 road spending, with a £28bn pot set up for enhancement and maintenance. Renewable energy projects have become increasingly important for bread and butter work.

Hogan Lovells partner Andrew Briggs, a project finance veteran of over 20 years, says the work hasn’t dried up so much as moved around.

‘Many people who call themselves project finance lawyers are actually energy lawyers or mining lawyers who will say the market is dead for them,’ he says.

‘But if you’re a project finance lawyer in rail, road, airports or low-carbon energy, you will have seen a huge amount of activity in the UK. This is project finance 2.0 as all the investors have redefined what it is. Pretty much every bank has renamed their project finance team as infrastructure and energy. The old days of dedicated teams don’t exist anymore. Project finance has morphed into development and acquisition financing, as companies don’t want to put their entire business at risk if something goes wrong, so they borrow.’

Market leaders

The leading players in the project finance space have largely remained the same with Allen & Overy (A&O), Linklaters, Clifford Chance (CC), Milbank, Latham & Watkins, Shearman & Sterling and White & Case having been dominant for the past two decades. But the gap between the top and the rest of the market has widened, with regional UK firms experiencing a famine of commoditised PFI work after the feast of social infrastructure mandates provided by the Labour government in the decade following its election in 1997.

However, Charlotte Morgan, a project finance partner at Linklaters, says: ‘Rumours of project finance’s demise have been greatly exaggerated. The market is not the same as it was ten years ago when you had a lot of smaller commoditised deals coming to the market, but we’re now seeing a flow of long-term, big-ticket projects due to growing populations and the more challenging places to extract oil and gas. This change plays to our strengths but the run-of-the-mill PFIs have dropped off so mid-ranking firms have seen a huge trailing off of business.’

While the Magic Circle has been affected by the drop off in project finance work, those firms have been best positioned to shift strategy towards emerging markets and the acquisition finance and refinancing work that has followed the oil and commodities crashes. A&O, Linklaters and CC – the three Magic Circle firms with top-tier project finance teams – have all leaned on their corporate brands to pick up asset sell-offs from the oil majors and refinancing mandates on operations that are no longer as profitable. For example, Glencore turned to Linklaters and CC in September as it rushed through plans to slash $10.2bn from its $30bn debt pile in September through disposals, mine closures and an equity raise.

‘Rumours of project finance’s demise have been greatly exaggerated. We’re now seeing a flow of long-term, big-ticket projects.’
Charlotte Morgan, Linklaters

The trio were also in prime position to shift away from Europe and Middle East towards Asia and Africa, where they could also relocate City lawyers due to the dominance of English law on those continents.

A&O has for many emerged as the leading brand in project finance, controlling 10% of the market between January 2012 and December 2014, according to Dealogic. The firm advised on $109.3bn worth of project finance deals in that period, more than Latham and White & Case combined ($100.1bn).

The firm’s core client base includes Shell, ExxonMobil, Total, Gazprom and Saudi Aramco, while the likes of JP Morgan and Goldman Sachs feed its large lender-side finance business. More than half of A&O’s project finance partners are now based outside New York and London, and the firm’s launch in Seoul in September was fronted by two project finance partners, Matthias Voss and Jean Lee.

While lateral hires are rare at A&O, with head of projects Gareth Price noting that ‘a lot of our investments are people that have come through the firm because we find they’re better than what’s out in the market’, the firm has made investments to plug gaps and expand into Africa. The most significant hire arrived from Freshfields Bruckhaus Deringer, with Americas head of energy and infrastructure Kent Rowey and fellow partner Dolly Mirchandani moving across in 2012. Project finance partners have also arrived in Morocco and South Africa to launch the firm’s first offices on the continent in 2011 and 2014 respectively. Jason van der Poel, who joined in Johannesburg from Linklaters ally Webber Wentzel, is the firm’s most high-profile hire to arrive in Africa to date.

‘Revenue is growing in areas where we’ve made strategic investments,’ says Price. ‘What frustrates us is that we get painted as a lender law firm. Our lender clients are very important to us, but the truth is that we’ve done more sponsor-side deals than any other law firm and more lender-side deals than any other law firm. We’re the busiest for sponsors and lenders and it’s interesting that competitors want to paint things a different way.’

With few new projects beginning in Europe, A&O repositioned its City operation five years ago to focus on what Price tags a ‘cradle to grave’ approach, which focuses on the sale of assets or their refinancing. It is this work, alongside mandates sent from Africa, that is sustaining the 60-strong team in London. Some critics argue that A&O is still too heavy in London and that with so many mouths to feed, its associate-to-partner leverage has become too high at a time when projects are larger, more complex, but few and far between.

Price, however, is adamant that the firm can sustain its current model: ‘If you’re waiting for things to tip in at the top then you will be in trouble, but we train people to be adaptable across asset classes and the sectors, so you could take an A&O lawyer and they’d be as comfortable on a JV agreement as they would be on a loan agreement, a project bond or a power purchase agreement. That breadth means we can deliver on cradle to grave, so we can deliver on assets that aren’t traditional project finance.’

A&O and Linklaters are the biggest players in the City market, but Linklaters has been slower in diversifying its project finance practice. Nonetheless, the firm has adjusted well to market pressures by moving its focus from London to Asia, relocating experienced City partner John Maxwell to Tokyo and US-qualified Tessa Davis to Singapore. The Asia practice has also been boosted by the return to full-time fee-earning of Hong Kong-based project finance head Stuart Salt after a stint as Asia managing partner.

While the firm has yet to open its own office in Africa (although it has an alliance with leading South African firm Webber Wentzel), Linklaters has enjoyed a strong run of African work, winning instructions on three of the continent’s largest projects: a $10bn floating LNG project off Mozambique for a consortium led by new client Eni; a $1.55bn fuel pipeline between Ethiopia and Djibouti for developer Black Rhino Group; and lenders including the Japan Bank for International Cooperation (JBIC) and the African Development Bank on a $4.4bn pit-to-port project in Mozambique for Vale and Mitsui & Co’s coal mines. The firm, which has traditionally acted more in the private sector than on government work in the UK, has surprisingly made gains in London with an appointment to a string of panels for projects work, including the Ministry of Defence a year ago.

Morgan argues that Linklaters has seen this work increase ‘as the government is doing more complicated deals so they are coming now to the bigger firms because of their capability to manage that complexity’.

But while A&O has handled its departures well – with the practice largely uninterrupted by the retirement of head of projects, energy and infrastructure Anne Baldock – Linklaters was hit by Ransome’s move to Milbank in 2013 and the double exit of energy co-head Matthew Hagopian and Manzer Ijaz earlier this year that left it without a senior US-qualified projects lawyer in London.

A&O and Linklaters have made gains in Africa, but it is CC which has handled the most project finance mandates there this year. Arguably the best placed of the trio to take advantage of the boom in African projects, the firm has acted on four major financings signed in 2015, the most of any international firm. The African Development Bank is a major client, with Delphine Siino Courtin in Paris controlling that relationship, and its longstanding work for Standard Chartered and Barclays has seen CC push on in Africa as those banks ramp up their lending in the region. The International Finance Corporation, The World Bank Group’s private sector lending arm, is a major client and has also fuelled CC’s African ambitions.

Russell Wells, global co-head of projects at CC, says: ‘We want to solidify and expand what we have built in Africa and we’re targeting opportunity in Latin America.’

The firm also has the strongest US platform of the Magic Circle and has brought in Garrigues’ former head of projects José Guardo in Spain and DLA Piper’s New York partner Gianluca Bacchiocchi to boost its Latin America push.

Freshfields, meanwhile, has never fully recovered from the restructuring of its partnership during the recession, when the project finance team in the City shrunk from eight to two partners (it now has four in London). While the firm managed to hold on to its strongest projects partner, Nick Bliss, and made a rare lateral hire to bring in Shearman’s big-billing partner Tim Pick in 2013, it remains some way behind its peers in this practice area. Its strong portfolio of corporate and private equity clients has kept the team busy, but with Bliss retiring in April, it seems unlikely the firm will be challenging A&O or Linklaters any time soon.

Money maker

Milbank has been the most expansive firm in project finance over the past five years. Having traditionally operated a lean international network, the New York-based firm has ditched the conservatism that defined the leadership of Mel Immergut between 1995 and 2013 and made project finance the focus of its overseas push.

Since litigator Scott Edelman took over as chairman, Milbank has hired seven partners into its project finance group. It tapped Linklaters for three of its highest billing project finance partners in London – Ransome, Hagopian and Ijaz – and added A&O’s Tokyo managing partner, Aled Davies, in 2013, who has strengthened the firm’s grip on JBIC mandates. Milbank has also expanded into Korea, with Young Joon Kim relocating from Hong Kong to launch a Seoul office earlier this year.

While it operates a highly profitable business model – with just five projects partners in London overseeing around £20m a year in business – Milbank has also begun to add depth to its practice. Highly rated associates Seyda Duman and Suzanne Szczetnikowicz arrived from A&O and Shearman & Sterling respectively this year, with Szczetnikowicz’s exit seen as a blow to Shearman after she spent years working alongside Europe managing partner and project finance veteran Nick Buckworth.

In the City, Milbank has repositioned its practice away from lender-side work to attract more sponsor-side mandates. While this does bring increased client conflicts, it is a smart move in a market that has seen greenfield projects dry up and firms move towards more M&A-related financing in the infrastructure, telecoms and energy markets. A changing of the guard in London from a group established and built by Phillip Fletcher, Cathy Marsh and John Dewar, contributed to the shift in the firm’s City clientele. With Fletcher assigned to Washington DC to assist America’s export credit agency US Exim after the lender was shut by Congress in June, and Marsh having retired from the partnership this year to work on a consultancy basis, the onus is now on the former Linklaters trio to originate new business and bring through the next generation of partners.

‘Within my first two months at Milbank we’ve captured mandates we wouldn’t have even been made aware of while at Linklaters.’
Matthew Hagopian (left), Milbank

It hasn’t taken long, with Hagopian and Ijaz teaming up with Fletcher in their second week to win what may become the world’s largest ever project financing, a $65bn project by ExxonMobil, BP and ConocoPhillips to export Alaskan LNG to Asia. Hagopian says: ‘It is so hard for the English firms to break New York and I don’t see that trend being corrected. Within my first two months at Milbank we’ve captured mandates we wouldn’t have even been made aware of while at Linklaters. One was Alaska. It was the right combination of the experience I have in the sector and the legitimacy that Milbank has in the US.’

Ransome argues that the arrivals have helped to balance out the practice and accelerate growth in Asia and Africa, given the preference for English law in those continents. While its project finance group has been hit by the freeze on US Exim, that client relationship and its ties to JBIC and Korea Eximbank have helped to push Milbank into new territory.

‘The cross-border credit markets are sticky so you must have export credit agency cover for everything in emerging markets at the minute,’ comments Ransome. ‘Africa is coming on, with US institutions putting money into Africa, which is a first.’

Milbank arguably has the strongest collection of leading project finance partners of any firm, with Fletcher still a regular presence in the City and Marsh maintaining her key relationships, but needs greater depth if it is to become the most dominant force in the market. While its decision to not take on increasingly commoditised PFI work is uncontroversial, the firm is still absent of offices and associations in Africa. A stronger corporate showing outside the US would also support the expansion of project finance and the wider firm. Ransome says: ‘We’re still very much in expansion mode and will be significantly bigger across Europe and Asia in five years. The London office has been a huge success but we realise we’re still light when you compare us to the New York heart. We operate with fewer bodies but we don’t do cookie-cutter deals, so every single person has to be top drawer.’

Off the pace

The leaner, more profitable models run by US firms should have been well suited to the downturn in activity levels, but the leading firms have been reliant on subdued markets. Shearman and Latham have been overexposed to the Middle East, with Bill Voge’s ascendance to chair at Latham in January, denting what was an already fragile set of offices in the region, while White & Case was heavily hit by Russian sanctions. Although these firms have been quick to adapt – Latham closing two of its four offices in the Middle East and concentrating its lawyers in Dubai and Saudi Arabia, and White & Case offloading large chunks of its CIS business to rivals – these firms have nevertheless been hit by shifts in the market.

But the trio remain formidable challengers for top-tier work, with White & Case acting opposite Linklaters for the sponsors on the $4.4bn project in Mozambique. The group also have strong ties to the export credit agencies, with JBIC one of Shearman’s biggest clients and the firm having made investments across its nuclear group as Japan looks to export resources it can no longer use domestically following the 2011 reactor meltdown at Fukushima. White & Case also has strong ties to JBIC and US Exim, while Latham has links to Korea Eximbank and insurer Ksure.

The US firms have historically not made the most of their geographical advantage in Latin America but have shifted strategy in recent years to hunt work in a region familiar with US law and dependent on US finance. Bill McCormack, global head of the project development and finance at Shearman, says: ‘We have some advantages in Latin America that the Magic Circle doesn’t have and advantages in jurisdictions, such as Indonesia, Malaysia and the Philippines, where New York law is common. We’ve also done a better job projecting ourselves as capable of practising English law than the Magic Circle have done projecting that they can do New York law.’

‘Some of our competitors have struggled because they haven’t kept pace with changes in the market, but we will be coming into the next boom with the best brand in project finance.’
Gareth Price, A&O

However, the sparser resources at US firms in London have also led to succession issues, with some clients questioning Nick Buckworth’s ability to service deal work since becoming Shearman’s Europe managing partner and Pick’s exit hitting the City practice, while project finance guru Voge’s appointment has left a void in Latham’s practice. One rival argues that Voge’s move out of the project finance group ‘has left the firm with a very different profile and a bit of a vacuum’.

At Shearman, McCormack gives suggestions that Buckworth’s time is taken up with management short shrift: ‘It’s a misconception, the way we are structured is no full-time management roles, so Nick’s position doesn’t impact the client. He’s been busy advising JBIC on a major project in Qatar for example.’

Despite its struggles in eastern Europe and Russia, White & Case has maintained its bench strength in the City with Jason Kerr, Philip Stopford and Peter Finlay three highly regarded names in the market. The firm has also proved far more resilient to shifts in the market than international rivals. White & Case is on track to act on as much project finance work this year as in 2014, when it advised on $13.4bn worth of project finance, while Latham has so far achieved just a third of the $21bn of deals it advised on in 2014, according to Dealogic.

With stalwarts of the project finance market being challenged, it comes as no surprise that the squeeze on the market has hit the next tier of firms even harder. Norton Rose Fulbright and Herbert Smith Freehills, which sought out mergers in Australia and the US to position themselves as energy and natural resources-focused firms, have seen the market move away from them as the oil majors and commodities conglomerates seek out firms with premium corporate teams to repair their balance sheets. Ashurst’s revenues have also suffered by running a similar strategy, but its market share in projects has so far held strong, with a consistent showing in deal tables in recent years. However, the departure of its Tokyo managing partner and JBIC relationship partner, John McClenahan, to King & Spalding as part of a four-partner move suggests that the firm may struggle to cope with the constrictive market over the coming years.

DLA Piper and Hogan Lovells have made gains in project finance, utilising strengths on either side of the Atlantic through their cross-border deal platform. Says Briggs: ‘We’re busier than ever and our revenues reflect that. Our revenues have grown to over £90m in project finance, which is our highest ever.’

However, the pecking order is long established and tough to break. If anything, the market is consolidating around the biggest players, A&O and Milbank, with lawyers leaving the likes of Linklaters, Freshfields and Shearman to strengthen those brands further. Despite a lack of project finance deals coming out of the UK and the commodities crash impacting infrastructure development globally, the main players are building, not retrenching.

Price concludes: ‘We are investing and are looking to grow our projects practice, not shrink it. Our clients need us more than ever as they seek to develop finance and exit assets. With the evident pressures of demographics, decarbonisation and urbanisation, governments are focused on and being judged on their ability to keep the lights on and clean water flowing in an affordable way. Some of our competitors have struggled because they haven’t kept pace with changes in the market, but markets work in cycles and we will be coming into the next boom with the best brand in project finance.’

An ominous prognosis for those currently jostling for market share. LB

tom.moore@legalease.co.uk