To date, the preferred bidder for a PFI project has raised long term bank or bond finance, with a maturity almost as long as the term of the contract, typically 20-30 years. Debt for PFI projects is usually structured on a ringfenced, project finance basis although, in some cases, the contractor has funded the project from corporate borrowing arrangements. The provision of long term privately raised debt finance underpins project risk transfer to the private sector contractor; and lender due diligence and monitoring of project risks has increased confidence of investors and the public sector in project deliverability.
For the majority of PFI projects, the cost of long term project borrowing has been fixed through long term interest rate swaps, which has enabled a proportion of PFI costs to be fixed, supporting long term budgetary certainty of the contracting authority. However, long term fixed rate bank or bond finance raised at the outset of long term projects has impacted on the flexibility of contracts by locking in the term and profile of debt service commitments, including in the context of termination liabilities.
Current regulatory changes (including Basel III, Solvency II and the Independent Commission on Banking) are reducing the appetite of bank lenders and bond investors for long term lending. In general, bond finance for PFI projects has not been cost effective since the demise of a functioning monoline credit insurance market or alternative credit enhancements which helped investors to achieve the necessary investment grade credit rating.
In the past, bidders were required to submit bids that were fully underwritten with a commitment from lenders to provide the required debt finance. Since 2006, Treasury guidance has been in place on the use of privately led and publicly overseen debt funding competitions after the appointment of the preferred bidder for debt raising greater than £50 million, to provide a transparent process for the selection of debt providers under competitive conditions and to give lenders sufficient information to make a commitment to lend to the project.
Question 12: What alternative approaches to the debt finance of projects should be considered that would address regulatory pressures on the market, while maintaining current benefits of lender due diligence and risk monitoring - thinking about both bank finance and capital markets solutions? Question 13: What is the view of respondents to an approach which financed the construction period of projects separately from the operational phase? Question 14: What impact would a shorter term debt finance approach be expected to have on financing costs? What if any implications would there be for the lenders' due diligence approach and for the transfer of asset design, construction and maintenance risk? What factors would enable the transition from bank debt funded projects to capital markets refinancing? Question 15: What factors are relevant to consideration of the appropriate allocation of refinancing risk between the public sector authority and the contractor? Is it possible for project performance and credit factors to be separated from market factors when allocating refinancing risk? Question 16: What are the views of respondents on the effectiveness of preferred bidder debt funding competitions? Could a wider application of debt funding competitions enable more effective access to the debt markets and what role should the public sector play in this, at a local or central level? Question 17: What alternative approaches could be considered to inflation risk and interest rate risk management, taking into consideration trade offs between budgetary certainty and operational flexibility? |