The project financing used in P3 transactions consists primarily of privately sourced debt, which usually makes up over 80 per cent of the overall financing requirements, and a small equity tranche. Equity is the most expensive part, since it requires a return that exceeds the cost of private debt. This is why it is used sparingly in infrastructure investments that generate steady revenue streams for investors. It is widely accepted that equity financing plays a positive role by placing private investors at risk and providing a strong commercial motivation for effective project management. Some have argued that there is not enough equity in P3 transactions.27 However, more equity would make private financing even more expensive and thereby reduce the scope for applying P3s to public infrastructure projects. Private debt financing can also be an important driver of efficiencies in a P3 transaction if the debt is not government-guaranteed.28
The real controversy is about private debt financing and the incremental cost of this type of private financing relative to government bond issues of a similar term (i.e., the "spread").
For example, the cost of bank debt is usually at least 100 basis points higher than equivalent-term Canadian Treasury bills, although the spread rose as high as 200 to 300 basis points during the financial crisis in 2008. When the public sector relies on financing obtained by the P3 partner, it pays for the higher cost of private financing through service payments to the P3 partner. This has led some authors to argue for P3s with debt financing from the public sector.29 We discuss the role of private financing and private debt financing as drivers of efficiency gains for P3 projects in the next chapter.
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27 Glaister argued that "there simply wasn't enough equity at risk to give incentives for Metronet to perform." See Glaister, "Mind the Money Gap."
28 Ninety per cent of the debt was government-guaranteed in the Metronet P3, which covered the infrastructure requirements for two-thirds of the London Underground network. See lacobacci, Steering a Tricky Course, for a case study of the three London Underground P3s.
29 Palmer, "Contract Issues and Financing in PPP/PFI."