Things to know when financing a transaction in the Pacific

By Damian Kelly and Isabelle Jurukovski

Entering into financing transactions is a critical component of the financial industry, involving significant risk and requiring meticulous planning and analysis. There are complexities associated with these transactions that financiers, whether they are seasoned professionals or new entrants, must consider and understand. For financiers specifically looking to finance a transaction in the Pacific region there are added layers of complexity arising from the unique regulatory, economic, cultural and logistical factors at play.

Here we focus on four key considerations to guide financiers entering financing transactions in the Pacific:

1. Regulatory and Legal Compliance

One of the main regulatory issues financiers often face in the Pacific is the lack of comprehensive legal, regulatory and supervisory frameworks. This may discourage both financiers and investors given the increased risk, making it harder to obtain certain types of funding for transactions. This means that a lot of new or additional ground is being covered when it comes to doing and financing business in the Pacific.

Where there are relevant regulatory and legal frameworks in place, compliance is non-negotiable. Each jurisdiction in the Pacific has its own specific legal and regulatory framework that impact financing transactions, including usury laws, anti-money laundering (AML) regulations, and tax laws. Financiers must ensure that the transaction complies with all relevant local laws and that all necessary permits and licences are obtained. This may involve consulting with legal experts to understand the local regulatory landscape and ensuring that all documentation and processes meet the required standards, including local customary laws and practices. Many Pacific jurisdictions also have foreign investment requirements that must be adhered to, such as minimum investment thresholds and permitted investment activities. We have experienced transactions where non-compliance can result in penalties, legal disputes, the threat that the transaction is void and potential damage to the financier’s reputation.

2. Risk Assessment and Mitigation

Risk assessment is the cornerstone of any financing transaction. Generally, when it comes to financing transactions, financiers must thoroughly evaluate the potential risks associated with the transaction, which could include credit risk, market risk, operational risk, and legal risk. These risks may be heightened when the transactions are in the Pacific.

(Credit Risk) Credit risk involves the possibility that the borrower may default on their obligations. Conducting due diligence and financial analysis on the borrower is imperative to mitigating credit risk. Due diligence involves verifying the information provided by the borrower, assessing the financial health of the borrower, and understanding the collateral (if any) being offered. This process includes reviewing financial statements, assessing cash flow, evaluating the management team, and understanding the competitive landscape. Financial analysis helps in determining the borrower’s ability to repay the loan and the viability of the project or business being financed. Accurate due diligence and financial analysis can prevent future financial losses and ensure that the financing decision is based on solid evidence and realistic projections. We find that credit risk is also challenged given many Pacific jurisdictions do not have any central credit reporting agencies.

Given the governance challenges and lack of record-keeping (most documentation is not digitised and can only be obtained through manual searches) in the Pacific, due diligence can be a challenge to undertake effectively.

(Market Risk) Market risk involves changes in market conditions that could affect the value of the financed asset or the borrower’s ability to repay. To mitigate market risk, financiers might use hedging strategies or include covenants in the financing agreement that require the borrower to maintain certain financial ratios. Weather related events are often a cause of key asset value diminution in the Pacific, so ensuring there is adequate and effective insurance is also recommended. This particular issue is one all financiers will need to keep ahead of, given a reducing number of insurers in the region, and the challenges of securing effective reinsurance.

(Operational Risk) Operational risk is the risk of loss caused by flawed or failed processes, policies, systems or events that disrupt business operations. Some Pacific Island-nations have either limited, or insufficiently maintained infrastructure, such as roads, ports, telecommunications and internet connectivity which hinder economic development and increase the cost and complexity of financing projects. Again, we highlight the environmental and weather challenges faced by many Pacific countries as well as the geographical spread of not only the countries themselves but the islands that make up those countries, presents increased logistical challenges for business and investors particularly when digitisation and the use of technology is not widespread.

(Legal Risk) As outlined above, some Pacific nations have limited legal and regulatory frameworks and ineffective dispute resolution mechanisms which can complicate contract enforcement and investor protection. Further risks can arise from periodic heightened political instability or changes in government and which can affect the legal environment and the enforceability of contracts.

3. Structuring the Deal

The structure of the financing deal can significantly impact its success. Financiers need to consider the terms and conditions of the financing agreement, including the interest rate, repayment schedule, covenants, and collateral requirements in the context of the particular Pacific country which may have its quirks. We recommend that local legal and financial advisors who are familiar with the laws and regulations and tax considerations in the specific country be engaged to work out how best to structure the deal. In particular, collateral requirements must be clearly defined and assessed to ensure they provide adequate security. Not all Pacific countries have comprehensive or well-functioning secured transactions frameworks, which is a key consideration for financiers when structuring a deal; we have found that the matter becomes more complicated when one transaction is spread across a number of jurisdictions.

4. Exit Strategy

An exit strategy is essential for managing the end of the financing relationship, whether through loan repayment, sale of the financed asset, or refinancing. Financiers should have a clear plan for exiting the transaction in a manner that maximises returns and minimises losses. An exit strategy should also consider the legal and financial implications of ending the financing agreement and ensure that the financier retains the flexibility to adapt to changing circumstances.

Many financing transactions are complex and multifaceted, particularly so when the transactions are in the Pacific. By thoroughly assessing risks, ensuring regulatory compliance, conducting comprehensive due diligence, structuring deals appropriately, and planning exit strategies, financiers can navigate the challenges of financing transactions and achieve successful outcomes. For assistance regarding the facilitation and financing of transactions in any Pacific jurisdiction please contact us.

Pacific Legal Network Regional Banking and Finance Team