The preferred bidder for a PFI project raises long term bank or bond finance to meet the project senior debt requirement. Debt finance typically covers the whole life of the contract (typically 20-30 years), with increasing amounts being drawn down as the asset is constructed and then being paid off over the operational period.
Private finance is raised at a higher cost than Government can borrow, and so a value for money judgement is required for all privately financed projects, to confirm that the additional costs of private finance are more than offset by the benefits of risk transfer and private sector delivery.
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.
The cost of long term project borrowing can be fixed - either through fixed rate bank loans, or floating rate bank loans with long term interest rate swaps, or through fixed rate bonds - or can be floating. This has enabled a proportion of PFI costs to be fixed, providing a degree of long term budgetary certainty for the contracting authority. In other cases project borrowing has been raised through index linked bonds.
After the construction phase, project companies may choose to refinance project senior debt to the extent that there would be a benefit from accessing lower funding rates. Refinancing gains are shared with the public sector.
A contracting authority may contribute some of the capital funding requirement to the project, reducing the amount of capital funding raised from the private sector, and reducing ongoing project funding costs. The value of capital contributions to a project are limited under current guidance at up to 30 per cent of the project capital value, subject to maintaining appropriate risk transfer and private sector performance incentives.