Tips for Sourcing a CAP Guarantee
For project owners and developers that cannot bring forward their own guarantee, or don’t already have one lined up via a sponsor, it can chew up a lot of time if not properly oriented. This practical article will help anticipate (recognize the impasse before reaching it) to expedite results.
Here are telltale signs that you could be wasting time trying to finesse or engineer a usable instrument that is just not going to be forthcoming:
- First, eliminate any “providers” (leased or purchased instruments) that are set on charging initial fees before delivering the guarantee instrument. Paying for a usable guarantee from funding proceeds is fine, but unless you know the party personally, or know someone that does (with accountability to mitigate your risk), and can thus be certain they will do what they promise, paying ahead of instrument delivery is a bad idea because it could very well be a fee scam.
Also avoid anyone that uses any bank that does not have a reputation for delivering what they promise. There are about a dozen such banks in the world. Not sure? Ask us for the password to this list. - Check if there’s alignment on the Type/Purpose of the Guarantee: The party backing or authorizing the guarantee may not recognize that it is to be used for PROJECT FUNDING, so often the reason they insist on certain wording is to protect their interests (with different risk exposure than In3CAP project funding), trying to negate or offset their perceived risk, and/or to avoid making a mistake. They might assume the transaction is for trade finance (using a Documentary LC that gets cashed to complete a trade transaction) or posted by an EPC/GC/OEM as a type of performance bond or insurance, which rarely works as a usable bank-involved instrument for several reasons, depending on things like a) the size of the project relative to the available guarantee, typically far too modest proportion of guarantee coverage relative to total funding, or b) how well established is the sponsor, and whether or not they truly have the financial depth to make such sponsorship work.
- Is crucial information missing? How can the parties agree to this instrument with so many unknowns? CAP funding eventually puts binding terms into a funding agreement with the client that governs the use of the guarantee, which will be issued before the guarantee gets committed. But at the start, the involved sponsor or banker(s) have not yet seen that document, so they can get stuck with making up a story instead of asking for clarification of the facts.
This is solved by explaining that CAP funding uses a 2-stage “pre-qualification” process – to first stage lines up a feasibility funding transaction, using a “specimen” or sample of the actual instrument (defining all the essential elements), then once accepted, in the final stage, the client gets under contract, and can offer to share the Funding Agreement, which bankers track internally via a code. This 2-stage process serves as a personality test: some simply won’t have the patience to approach this as 1) test, 2) go. Only when the party is willing to listen and learn (letting in some new information, if unfamiliar with “demand” guarantees used for project finance, such as provided in In3’s FAQs on this topic) will they typically come to the conclusion that the instrument is at once industry standard (within Private Banking, at least), balanced and safe. Otherwise, it won’t work to try to convince a mule. - Not every culture is going to be compatible for bank-involved instruments: Although we have few restrictions based on countries where we can do business, the issuing bank’s culture (branch location more than the bank’s parent/headquarters) can have a strong influence on guarantee wording and compatibility. For example, guarantees from Chinese banks with branches situated in China cannot make our guarantees work, history shows. Of course, the US and other countries have sanctions in place for Russia, N. Korea and presently Venezuela, so eliminate those, too. Save yourself time by recognizing when there is such an engrained and immovable obstacle.
- Financial feasibility: Guarantee fees are on an annual basis, typically, although renewal of a guarantee is usually less than the initial cost to deliver it. Third party guarantees where a “provider” delivers the guarantee as a service are even more expensive, where fees can add up. Look at the project’s IRR to reckon with this: can the project afford a more expensive guarantee or should an entirely different approach be used?
- Begin with a simple test to determine feasibility: Start with In3’s template (“specimen” or example of what works) and ask if the banker(s) can agree to something close to that language, with any revisions needed redlined, filling in the basic facts such as the proposed face value in US$ or Euros, the name and location of the issuing bank, the proposed maturity date (365+1 days, a year, is standard), and then have that routed to In3 or your Affiliate for review.
Usually, if there’s a will, there’s a way, but these points are taken from In3’s “Practitioner Series” where Registered Affiliates and Regional Practice Managers are trained to recognize these and other signs.
To explore further:
- Guide to communicating with bankers for their part in the CAP guarantee.
- CAP Frequently Asked Questions on guarantees
- Ask a question of your own or make a customer service inquiry here.