Getting The Deal Through logo
Getting The Deal Through

Project Finance in Japan

An interview with Naoaki Eguchi , Pierre Chiasson and Kosuke Suzuki

Baker McKenzie

Naoaki Eguchi is head of Baker McKenzie’s banking and finance practice group in Tokyo and a member of the Asia–Pacific banking and finance steering committee. He focuses his practice on project finance, infrastructure PPPs, private finance initiatives and acquisition finance. His practice also covers finance with export credit agencies, real estate finance, limited recourse loans, distressed loan transactions, structured finance and securitisation. Mr Eguchi has significant experience representing Japanese and foreign financial institutions and sponsors.

Pierre Chiasson is a partner in Baker McKenzie’s Tokyo banking and finance group. He focuses on renewable energy project finance, acquisition finance and structured finance transactions. Mr Chiasson acts for Japanese and international clients on transactional and regulatory matters.

Kosuke Suzuki is a senior associate in Baker McKenzie’s Tokyo banking and finance group. His practice focuses on banking and finance law, project finance and export credit agency finance. Mr Suzuki has substantial experience advising on project finance, PFIs, acquisition finance, asset liquidation, finance lease and other structured finance transactions.

GTDT: What have been the trends over the past year or so in terms of deal activity in the project finance sector in your jurisdiction?

Naoaki Eguchi, Pierre Chiasson and Kosuke Suzuki: The 2018 update to the PPP/PFI Action Plan issued by the private finance initiative

(PFI) promotion department of the Office of the Cabinet sets a target amount for domestic PFI and PPP projects of ¥21 trillion (including ¥7 trillion for concession-style projects, where the operating rights of government-owned facilities are assigned to a private company and the private company recoups its investment through service fees charged) for the 10-year period beginning from 2013. This is a significant increase from the initial PPP/PFI Action Plan targets of ¥12 trillion (including ¥3 trillion for concession projects) and from previous years, considering that during the 14 years from 1999 to 2013, the total amount was ¥4.1 trillion. The PPP/PFI Action Plan stresses the importance of the treatment of ageing infrastructure, disaster prevention or mitigation and the leveraging of stand-alone PFI and PPP projects not reliant on tax as a source of funding. In addition, the PPP/PFI Action Plan mentions passenger ship terminals and meeting, incentive, convention, event (MICE) facilities as important new targets for concession schemes, stressing the importance of the tourism industry to Japan. Furthermore, the 2018 update to the PPP/PFI Action Plan added publicly operated hydropower generation businesses and industrial water supply businesses as important new targets for concession schemes.

As for projects outside the area of PFI and PPP, electrical power projects – including renewable energy projects – play an important role in the domestic project finance market. There has been an increasing focus on renewables such as solar power and wind power as energy source alternatives to nuclear power and fossil fuels.

The feed-in tariff (FIT) scheme introduced in 2012 in Japan has secured the prospects of recouping investments in renewable energy power generation projects, and as a result the number of such projects, particularly photovoltaic (PV) power generation projects, has increased dramatically (as of June 2018, the total electrical power generation capacity certified under the FIT scheme was approximately 87,898MW) and financing for these projects has increased accordingly. Japan introduced an auction system in 2016 as part of its renewable energy framework reforms, with the goal of lowering the consumer price of electricity generated from renewable resources, particularly solar power. However, the FIT scheme will continue to be the most important system used to promote renewable energy projects in Japan. Furthermore, as part of the liberalisation of the electrical power market, which began in April 2016, Tokyo Electric Power Company, Inc and other regional utility companies (which have essentially held monopolies over power production and transmission) have been encouraged to outsource the operation of new thermal power generation projects. Accordingly, there has been the development of a number independent power producer (IPP) projects in thermal power generation, being operated by the private sector. However, as the Ministry of Environment has expressed concern about the development of thermal power projects in light of their environmental impact, including carbon emissions, and some large Japanese companies have recently indicated they are withdrawing from coal-fired generation projects, the cessation of some thermal power generation projects that had been under development has been announced.

The demand for project finance is expected to continue – particularly for PFI and PPP projects and electrical power generation projects.

However, the majority of social infrastructure developments and renewable energy projects are small to medium-sized in scale, and concession and stand-alone projects, for which large-scale projects are anticipated, are limited in number. Given this situation, the domestic project finance market is limited in scale, and many Japanese banks are actively participating in offshore project finance transactions. The Japanese government has adopted a policy of enhancing assistance through official development assistance loans and export credit agency financing, aiming to achieve infrastructure exports in the amount of approximately ¥30 trillion in 2020 (compared with ¥10 trillion in 2010), as set forth in the 2013 Cabinet decision ‘strategy for the revitalisation of Japan’. According to the Japanese government, Japanese infrastructure exports hit ¥20 trillion in 2015. This initiative continues to be one of the most important government policies in the infrastructure space and it is anticipated that there will be a corresponding increase in project finance transactions related to infrastructure projects in developing countries, particularly in the Association of Southeast Asian Nations community.

Historically, major banks such as the MUFG Bank, Ltd, Sumitomo Mitsui Banking Corporation and Mizuho Bank, Ltd have been the major Japanese players participating in the overseas project finance markets. However, a number of regional banks and other financial institutions have also recently expanded into this area.

GTDT: In terms of project finance transactions, which industry sectors have been the most active and what have been the most significant deals to close in your jurisdiction?

NE, PC & KS: With respect to PFI and PPP projects, the majority of transactions have been service payment social infrastructure development projects (primarily for educational and cultural facilities, medical facilities, government offices and rehabilitation facilities), ranging in value from a few hundred million yen to a few billion yen. It has been said that many of these PFI social facility development projects merely defer the payment of infrastructure development costs by the government using tax as a source of funding, and PFI and PPPs’ original purpose of utilising private sector know-how to efficiently develop social infrastructure and provide less expensive and better quality services to the public is not being sufficiently realised.

Other than the Haneda Airport development project, there are hardly any stand-alone PFI projects where the operator bears market risks, such as demand risk and price fluctuation risk, without using tax as a source of funding. On the other hand, the government has set a specific numeric target for the advancement of projects based on the concession scheme introduced in 2011 (in addition to the target amount for total value mentioned), including six airport projects, six water projects, six sewage system projects, one road project, three passenger ship terminal projects, six MICE facilities, three publicly operated hydro power generations and three industrial water supply projects. To date, the Sendai Airport and Kansai International Airport/ Itami Airport concession projects and the toll road project in Aichi Prefecture have started operating under concession schemes. Other concession projects, such as Takamatsu Airport, Kobe Airport and New Chitose Airport, have also seen significant progress. Hamamatsu City also launched a concession to manage part of its waste water and sewage facilities, whereby a consortium including Veolia won the first long-term concession contract (20 years) for a municipal sewage project in Japan.

In addition to those mentioned above, the PFI Act lists a wide variety of sectors as targets for PFI projects, such as railways, ports, rivers, parks, rental housing, waste treatment facilities, information and communications facilities, tourist facilities, research facilities, vessels, aircraft and satellites, and, in the future, PFI and PPP methods may be employed in a wider range of fields.

Although the number is limited, there have been cases of project financing for infrastructure projects executed outside the scheme of the PFI Act, such as tourist facilities, including Universal Studios Japan (1999) and the public-private cooperation for the reconstruction of Nakano Sun Plaza (2004). It is also worth mentioning that the Integrated Resort Promotion Act was enacted in December 2016, legalising casinos in Japan for the first time. Osaka and several other prefectures are enthusiastic about integrated resorts, including casinos. Project finance is expected to be one of the main financing sources for the development of these facilities.

In the field of power generation, project financing for PV power producers has been increasing under the FIT scheme. However, the government has been decreasing the pricing under the FIT scheme and reviewing the related framework to address over-concentration in the PV power generation market and to promote offshore wind power, biomass energy, geothermal energy and other renewable sources. As such, greenfield projects are expected to increase.

Furthermore, as we previously noted, due to the liberalisation of Japan’s domestic power market, which began in April 2016, the number of thermal power generation IPP projects that rely on project financing are being developed. These and other IPP projects are expected to be on an availability payment basis, with electricity utilities as off-takers. However, as noted above, some thermal power generation IPP projects have ceased development in light of environmental and other concerns.

Project financing in Japan has traditionally been used primarily for infrastructure development projects, and although there has recently been some discussion on the mining of methane hydrate around the Sea of Japan, progress remains at the surveying stage and potential commercialisation is expected to take a number of years.

“Project financing in Japan has traditionally been used primarily for infrastructure development projects, and although there has recently been some discussion on the mining of methane hydrate around the Sea of Japan, progress remains at the surveying stage”

GTDT: Which project sponsors have been most active in driving activity? Which banks have been most active in providing debt finance?

NE, PC & KS: The primary sponsors of PFI and PPP projects have generally been domestic construction companies, trading companies and

real estate companies. However, in relation to the large-scale concession Kansai International Airport/Itami Airport project, foreign enterprises including the Macquarie Group, as well as overseas airport operators such as the operator of the Changi Airport in Singapore and that of Heathrow Airport in the United Kingdom, showed strong interest. The concession right to operate the Kansai International Airport/Itami Airport was ultimately awarded to a consortium led by ORIX Corporation and the French firm Vinci Airports.

On account of the high FIT price, overseas renewable energy companies have been actively involved as sponsors of renewable energy projects, alongside domestic sponsors such as the trading companies SoftBank Corp and ORIX Corp. Recently, next generation renewable energy projects, such as wind power, geothermal and biomass energy, have been drawing the attention of these sponsors as alternative investments to solar power.

Regarding non-Japanese sponsors involved in Japan’s infrastructure projects, the Macquarie Group has been active in this field and is displaying a strong presence, including serving as a financial adviser to the Tokyu Group, which won the bid for the Sendai Airport concession project. Japan does not have particularly strict foreign investment regulations, but it should be noted that, in the past, there have been discussions about strengthening regulations on foreign investments; for example, when the Macquarie Group increased its equity holding in the operating company of Haneda Airport, and when the Children’s Investment Fund tried to increase its shareholding in J-Power Systems Corp. In the latter case, the Ministry of Economy, Trade and Industry actually requested that the proposed increase be reconsidered. Save for these exceptions, there have been no particular moves to regulate foreign investments, and foreign investments are normally allowed without any problems after the completion of relatively simple procedures, such as the submission of a prior notification under the Foreign Exchange and Foreign Trade Act.

As for lenders, in addition to major private sector financial institutions such as Mizuho  Bank Ltd, MUFG Bank, Ltd and Sumitomo Mitsui Banking Corporation, the Development Bank of Japan (DBJ), which is a public financial institution, is active in both PFI, PPP and power generation projects. Of these projects, major banks and the DBJ tend to play a central role in state and large-scale projects, and regional financial institutions tend to play a central role in regional projects. Except for certain limited cases, participation by overseas lenders in domestic PFI and PPP transactions has been limited. This is not necessarily due to schematic hurdles, but may be because sufficient debt liquidity is maintained with domestic banks. However, recently, an increase in foreign lenders lending, especially to international sponsors for PV power generation projects, has been observed, along with an increase in the number of international sponsors.

“Recently, an increase in foreign lenders lending has been observed, along with an increase in the number of international sponsors.”

GTDT: What are the biggest challenges that your clients face when implementing projects in your jurisdiction?

NE, PC & KS: Among PFI and PPP projects, facility development PFI projects have relatively low project risks, but also low profitability. In addition, with regard to regional projects that constitute the vast majority of domestic PFI projects, many municipalities are inexperienced in PFI. They also are not incentivised to use PFI for facility developments, as financing public projects through municipal bonds is less expensive and they have a less complicated structure. Thus, PFI projects that are attractive investment targets have been rare. From this standpoint, there is growing attention being given to concession projects. As we noted earlier, multiple airport concessions are expected to be granted after Sendai Airport and Kansai International Airport/Itami Airport. Other important areas are water and sewage system projects and toll road projects, although to establish concession rights to toll roads, amendments to laws allowing operators to collect fees for the use of toll roads will be required (the toll roads concession project in Aichi Prefecture is an exceptional case, as this project is based on a special law).

Regarding renewable energy projects, a drop in the number of new PV power generation projects is anticipated, mainly because of increasing difficulty in securing land for large-scale PV projects, and a downward trend in the FIT price (although there have recently been innovations in PV power generation, such as water-based PV plants, it is still unclear to what extent these will be used). In addition, new rules announced by the Japanese Ministry of Economy, Trade and Industry to address delayed development of solar projects that hold FIT prices of ¥40, ¥36 and ¥32 may have a substantial negative impact on a range of solar projects in Japan. In the future, an increase in alternative power sources such as offshore wind power, biomass energy and geothermal power is expected.

For offshore wind power, a long-awaited new law was enacted in November 2018 that establishes procedures for Japanese general waters to be used on a long-term basis for offshore wind power generation. As such, a number of offshore wind power projects are expected to come to market in the near future. However, there remain significant challenges for offshore wind power developers in Japan, including in particular that the cost of transmission lines must currently be borne by the developers. As for biomass energy and geothermal power, issues such as fuel procurement risks and development restrictions based on the Natural Parks Act and other laws could also be a concern. These items require attention from a bankability standpoint.

Thermal power generation IPP projects to be outsourced by regional electricity utilities will be on an availability payment basis, and while the sponsors will not bear any market risk, they will take the credit risk of the electricity utilities (which are structured as normal joint-stock companies rather than public agencies) as off-takers.

Also, the underdevelopment of power grids (both in terms of wide-area interconnection and capacity) has led to some issues for the domestic power industry as a whole. In particular, one issue arising with the recent surge of PV power generation is that certain electricity utilities with insufficient interconnection capacity (for PV power generation, seven utilities including Hokkaido Electric Power Co Inc and Kyushu Electric Power Co Inc; and, for wind power generation, five utilities, Hokkaido Electric Power Co Inc, Tohoku Electric Power Co Inc, Hokuriku Electric Power Company, Kyushu Electric Power Co Inc and Chugoku Electric Power Co Inc) are permitted to enforce limitless output restrictions, without providing compensation, for demand and supply adjustment if the amount of power transmission reaches a predefined threshold. This is expected to create material development challenges, including in relation to the bankability of these projects.

“The amendment to the PFI Act will likely promote concessions in some sectors, including water and sewage, by eliminating time-consuming and complicated procedures and attracting more private operators.”

GTDT: Are there any proposed legal or regulatory changes that may give rise to new opportunities in project development and finance? Do you believe these changes will open the market up to a broader range of participants?

NE, PC & KS: An amendment to the PFI Act was enacted in 2018. The key changes are:

  • the government will create a contact point led by the Prime Minister to receive enquiries relating to PFI and PPP in order to provide faster integrated support with the local governments and investors; and
  • the government will enable the local government to pay off loans from the government without a prepayment penalty when it assigns a newly created concession right in relation to water and sewage services.

This will likely promote concessions in some sectors, including water and sewage, by eliminating time-consuming and complicated procedures and attracting more private operators.

Regarding PFI and PPP projects, the guidelines were revised to simplify procedures applicable to facility development PFI projects, which may lead to an increase in regional PFI projects. In the field of concessions, certain types of concession projects including airports, water and sewage systems, with the applicable regulations in place are gaining momentum.

Pursuant to the 2013 amendments to the PFI Act, a public-private infrastructure fund was established with the government’s injection of ¥10 billion in 2013 to assist certain market risk-bearing PFI and PPP projects such as stand-alone PFI projects and concession projects.

It is anticipated that contributions of risk money, such as subordinated loans and investments, will be the catalyst for private sector funds in the market risk-bearing PFI and PPP projects. The infrastructure fund has provided support to multiple concession-type projects, including the Kansai International Airport/Itami Airport project, the Sendai Airport project and the Aichi Prefecture toll road project.

With respect to the power generation sector, the FIT price will be modified annually, and minor adjustments to the scheme for the establishment of renewable energy power production projects will continue. For offshore wind power, as mentioned above, a long-awaited new law was enacted in November 2018 that establishes procedures for Japanese general waters to be used on a long-term basis for offshore wind power generation. As a result, a number of offshore wind power projects are expected to come to market. We have recently been approached by a number of developers including foreign developers for advice on such offshore wind power projects.

Furthermore, electricity market reform, including the deregulation of the market and the separation of power production, and transmission and distribution, is currently in progress, and grid management and power transmission and distribution businesses along with privately operated thermal power generation IPP projects are on the increase. Electricity company bonds were the main mode of financing for these businesses. However, project financing by private banks and the DBJ has become an important financing source for these IPP projects and it is expected that this trend will continue in the future.

GTDT: What trends have you been seeing in terms of range of project participants? What factors have influenced negotiations on commercial terms and risk allocation? Are there any particularly innovative features?

NE, PC & KS: As noted earlier, the main sponsors for project finance transactions in Japan are domestic enterprises, and the main lenders are domestic commercial banks and the DBJ. However, we have seen an increase in foreign investors in renewable energy projects and large-scale concession projects.

Facility PFI projects usually involve post-construction completion financing where the completion of construction is one of the conditions precedent to financing. After the completion of construction, debts may be collected from the purchase price to be paid by public authorities, and thus normally no sponsor support for ongoing business risks is required. Given the low risk profile, a debt-equity ratio of approximately 9:1 is seen in many cases. As for force majeure risk, this is typically borne mostly by the public sector, with only a small portion being borne by private operators. Regarding regulatory change risk, the public sector will generally bear the risk of changes in specific laws and regulations directly related to a project, while the private sector bears the risk of changes in other general laws and regulations.

On the other hand, government support for revenue risks is generally not expected for stand-alone PFI projects and concession projects in Japan. However, in airport concession projects such as Sendai Airport and Kansai International Airport/Itami Airport, force majeure risk not covered by insurance is borne by the government (in the case of the Kansai International Airport/Itami Airport project, by a government-affiliated operating company), and an approach similar to that taken in facility PFI projects is adopted for regulatory-change risk.

Most new thermal IPP projects are expected to operate on an availability payment basis with electricity companies as off-takers, and hence no revenue-risk support is envisaged. However, depending on the creditworthiness of the engineering, procurement and construction contractor, construction completion support may be required. Although off-takers have strong relationships with the government, they are ordinary joint-stock companies, and their creditworthiness should be taken into account.

“The Tokyo Stock Exchange has opened a market for listed infrastructure funds investing in renewable energy projects and concession projects.”

GTDT: What are the major changes in activity levels or new trends you anticipate over the next year or so?

NE, PC & KS: We mentioned earlier that multiple airport concession projects and the toll road project in Aichi Prefecture – the first toll road concession project in Japan – are now operating, and the water concession project in Hamamatsu City and several other airport concession projects are in progress. In addition, tourism-related sectors such as terminals for passenger ship and MICE facilities are drawing attention as new target for concessions. Furthermore, publicly operated hydropower generation businesses and industrial water supply businesses have been added as new targets for concession schemes.

In the field of renewable energy, there are limited prospects for new investments in the crowded domestic PV market. However, the market for the acquisition and restructuring of existing PV power plants is still active, as investors look to capitalise on the stability provided by favourable pricing levels previously secured under the FIT scheme. By contrast, onshore wind power, biomass and small-scale water power production are gradually increasing. Following this trend, a shift towards geothermal energy and offshore wind power production is expected. However, these alternative energy sources have higher business risks compared with PV power production and it may take time for standard practices to be established.

In addition, the Tokyo Stock Exchange has opened a market for listed infrastructure funds investing in renewable energy projects and concession projects, and with the development of this market, we hope to see an increase in the number of financial investors investing in infrastructure projects, as well as the development of a secondary market for domestic infrastructure. Infrastructure investments are also receiving increasing attention as alternative investments for institutional investors such as insurance companies and the Government Pension Investment Fund, which manages over ¥140 trillion in public pension funds.

The Inside Track

What three things should a client consider when choosing counsel for a complex project financing?

  • Knowledge and long-standing experience of working in the local market;
  • government connections, which bring first-hand knowledge of front-line market issues; and
  • a well-balanced team of local and international experts with proficiency in handling complex matters on a dual-language basis.

What are the most important factors for a client to consider and address to successfully implement a project in your country?

A clear understanding of local market practices and expectations, and how they differ from other markets, is crucial to successfully implementing a transaction in Japan.

What was the most noteworthy deal that you have worked on recently and what features were of key interest?

We are advising the sponsors (consisting of Fukuoka Airport Holdings Ltd, Nishi - Nippon Railroad Co, Ltd, Mitsubishi Corporation, Kyushu Electric Power Co, Inc, and Changi Airports International Pte Ltd) on the Fukuoka Airport concession project. This project is one of the important concession scheme targets under the PPP/PFI Action Plan issued by the PFI promotion department of the Office of the Cabinet. In addition, we are acting for banks on two 75MW and four 50MW biomass power projects and for sponsors on a 75MW biomass power project in Japan.

Naoaki Eguchi, Pierre Chiasson and Kosuke Suzuki
Baker & McKenzie (Gaikokuho Joint Enterprise)

Back to Project Finance

Follow Getting the Deal Through for the latest updates on law and regulation worldwide

Follow us on LinkedIn