36.1.1 A bond is a negotiable debt instrument that pays the bondholder a rate of interest on the face value of the bond. The bond markets offer a source of long-dated debt and, accordingly, it is now commonplace for bidders on larger PFI projects to consider raising money in this market as an alternative to (or in addition to) the banking sector. This is also becoming more commonplace in Northern Ireland, for example, in roads PFI's.
36.1.2 Bonds can be issued on various different terms. The principal amount of the bond can be repaid either in full on final maturity (a "bullet bond") or, more commonly for PFI projects, in instalments according to an agreed amortisation schedule. Interest may be fixed rate (the interest rate is set on issuance and does not vary) or floating rate (the interest rate varies with a money market reference rate, such as LIBOR, and is reset at the beginning of each interest period). In addition, bonds (usually only fixed rate bonds) may be index-linked, so that payments of principal and interest escalate according to movements in a selected index, commonly the United Kingdom Retail Price Index (all items).
36.1.3 Bond issues may be public, meaning they are listed on a stock exchange (and therefore are more widely available). Alternatively, they may be distributed by way of a private placement. This will involve an offer to a very limited number of (occasionally sole) investors.630 Private placements are often unlisted, and if so need not comply with listing authority's disclosure rules, therefore requiring less disclosure than a public offering.
36.1.4 Almost all public PFI bond issues are rated by one or more rating agencies. This provides a transparent assessment of the underlying credit quality of the issuer, and when combined with the relative standardisation of bond terms and conditions it assists in the tradeability of bonds. The underlying credit rating of PFI projects is usually at the lower end of "investment grade", in the range of BBB-/Baa3 to BBB+/Baa1.
36.1.5 In order to reduce the cost of raising debt, most PFI bonds to date have been "wrapped": scheduled payments of principal and interest are guaranteed (in return for a fee) by a monoline insurer.631 As a result of the guarantee (or "credit wrap") the bonds are themselves rated according to the rating of the monoline, typically AAA/Aaa. This has tended to offer a more affordable financing solution to the Contractor even once the cost of the credit wrap is considered.
36.1.6 Bond transactions require specific documentation. The primary selling document is the Prospectus, which sets out all the information that the issuer of the bonds believes is material to any potential bondholders' decision to invest. It contains the terms and conditions of the bond, together with a description of the issuer and the project. If the bond issue is listed, the Prospectus must comply with the relevant listing authority's rules. There will also be a bond trust deed, setting out the rights of the bondholders, and a subscription agreement, obliging the bond managers to subscribe for the bonds at the issue price.
36.1.7 In addition, as bond proceeds are usually received in a lump sum at Financial Close, but the expenditure profile may vary, the proceeds are often deposited with a highly rated bank until required, through a fixed-rate deposit known as a "Guaranteed Investment Contract".632
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630 It is of course important to ensure that a transparent, competitive process is adopted to price the bonds.
631 A monoline insurer is a specialist insurer whose only line of business is financial guarantees.
632 As regards hedging more generally, see HMT Guidance "Interest rate and inflation risks on PFI transactions" of April 2006. HMT website at www.hm-treasury.gov.uk.