Framing the issue

In project financing, debt repayment is primarily ensured through the revenues generated by the project. Effective mitigation and allocation of the risks that may affect these revenues are therefore paramount for the ‘bankability’ of proposed investments. These risks include commercial aspects, for example linked to currency or interest rate fluctuations, or to changing demand for project output. But they also include risks of a non-commercial nature, namely political, fiscal and regulatory risks. Indeed, regulatory changes may significantly affect project revenues, through increasing costs or delaying implementation. Changes in tax regimes may have similar effects. Once the bulk of a long-term, capital-intensive investment is made, the balance of negotiating power tends to shift away from the project sponsor in favour of the host state; the project thus becomes vulnerable to host government action that may undermine project revenues or even the project’s financial viability.

This situation has led to the development of legal tools to manage regulatory risk. Such tools may be based on international investment treaties, as in the case of the regulatory taking doctrine; and on contractual commitments entered into by the host state, such as stabilization clauses. Under the regulatory taking doctrine, regulation that undermines the investment’s commercial viability may be deemed as a taking of property, and require the host state to compensate the project sponsor. Under commonly used stabilization clauses, the host government commits itself not to change the regulatory framework in a way that affects the economic equilibrium of the project, and to compensate the sponsor if it does so.