Refinancing guarantees

Because of shortage of long term debt and the extension of the mini-perm concept, a refinancing risk often has to be absorbed by PPP projects.

This refinancing risk is a new, largely un-controllable and significant risk which can only be mitigated:

■  by allowing a sufficient time window for its implementation

■  by testing the project viability in a down-side case where the refinancing does not occur.

This risk is generally passed through to the sponsors, although it often partially translates into an additional cost for the authority when the margin step-up is factored into the base case (see 1.4).

Many argue that, as this risk is of a macro-economic nature, it is best dealt with by the public sector.

However, unlike the two earlier forms of indirect guarantees, this is an untested approach. The first issue is to determine what exactly the public sector is guaranteeing. The procurer may be prepared to assume the risks linked to the variation of a benchmark interest rate (such as the Euribor), it should not accept the consequences of other events which may also influence the feasibility and cost of future refinancing, such as project performance since the contract signature.

In addition, the benchmark rate is only a part of the total interest rate, the other element being the banks' margin. In the current market, this margin does not only cover the risk and return of the bank but contains a sizeable funding cost element. This funding cost element is likely to come down very significantly when the inter-bank markets return to normal, from 150-200 bps today to tens of bps in a "normal" market. Again, if the procurer is to bear the benchmark rate risk, it will also want to benefit from the likely improvements in the funding costs. However, the movements of these funding costs cannot be easily measured as there is no recognised benchmark and rates are likely to vary from bank to bank.