Box 5 • Sharing the gains from a refinancing

Guidance 98

Sharing the gains arising from a refinancing operation is an important issue for the design and implementation of the PPP contract that has become increasingly relevant over the past decade. Refinancing is understood as the replacement or renegotiation of the original capital structure, debt and/or equity of the PPP Company on more favourable terms. Refinancings are attractive to the PPP Company when interest rates fall (if the PPP Company can benefit from such a fall under its hedging policy) or when the risk profile of the PPP Company has improved. Refinancings can take different forms, such as:

• a reduction in the debt pricing;

• extension of the debt maturity;

• an increase in the gearing (i.e. the amount of debt relative to equity). This is possible when lenders are prepared to relinquish some of their contractual protection as the perceived project risks are reduced;

• lighter reserve account requirements; or

• the release of guarantees provided by the shareholders of the PPP Company or sponsors or by third parties.

Refinancings will often result in financial gains for the shareholders of the PPP Company. Some of the gains may be justified by the good performance of the PPP Company, but some may also arise from macroeconomic factors or lenders' greater confidence in a specific PPP market (i.e. factors not attributable to the PPP Company). In this case, financial gains for the shareholders may appear undeserved and give rise to political difficulties. As a result, sharing the financial gains from a refinancing operation between the PPP Company shareholders and the Authority is often considered appropriate.

Current practice is to include detailed provisions in the PPP contract setting out a method for determining and sharing the gains from future refinancing - rather than to rely on broad principles and full-blown renegotiation of the contract when refinancing takes place. The UK started the trend in 2002 with its standardised contract provisions for refinancing. Other countries have followed a similar approach.

Refinancing mechanisms are complex and their assessment requires the support of financial and legal advisers. The PPP contract provisions require specific drafting that needs to address several steps that involve: Guidance 99, 100

• calculating the expected refinancing gain to the PPP Company shareholders (e.g. using net present value techniques);

• determining the portion of the gain that should be allocated to each party (e.g. 50:50 split, the Authority's share increasing if specified tests are met, as in the UK, where the marginal rate attains 70%); and

• deciding how the gains should be shared (e.g. lump sum payment to the Authority, reduction in the service fee payable to the PPP Company).

Many details (e.g. the discount and interest rates to be used in the calculations, treatment of the possible impact of a refinancing operation on the termination payment that the Authority might have to make in the future) need to be addressed in the PPP contract to avoid subsequent discussion and disagreements. As with many other aspects of PPPs, it is important to anticipate the issues as much as possible and set out detailed provisions in the PPP contract.