2.8 The OGC took prompt steps to start to develop a new approach which would address NAO and PAC concerns about refinancing. The OGC realised that extensive work would be required to bring about the desired change to dealing with refinancing in new contracts. The key stages would be:
■ To define a proposed policy approach: this would need to consider, inter alia, whether and in what circumstances refinancing should be encouraged, the basis of sharing gains and how the public sector's share of the gains would be received;
■ To research the complex subject of refinancing to confirm whether the proposed policy approach was appropriate and achievable and to consider the practical issues involved in implementing the policy;
■ To devise effective contractual mechanisms that would achieve the desired policy approach; and
■ To secure departments' and the private sector's agreement to the new arrangements.
2.9 The OGC was able to utilise the expertise on financing issues which resides within PUK. Its staff have commercial experience of how refinancing will be dealt with in new contracts. Following discussions with PUK, the OGC took an early decision in summer 2000 on what the basic policy for sharing refinancing gains should be, subject to confirming from further research in the market that the policy would be acceptable and practicable. In developing these policy proposals, the OGC considered whether it would be better to have a fixed arrangement that would apply to all projects or a more flexible arrangement that would require project- by-project negotiations between authorities and contractors. The issues considered included whether it would be possible to identify windfall refinancing benefits that had not been anticipated by the private sector and to use these as the basis for negotiations about sharing refinancing gains.
2.10 The OGC and PUK decided that it would be very complex for departments to attempt to analyse all the underlying factors that had produced a refinancing gain and to attempt to identify which were genuine windfalls. Furthermore, an arrangement that required such issues to be defined contract-by-contract was likely to be time-consuming for authorities and contractors. It would also leave contractors uncertain when bidding for the contract what share of any refinancing gains they might have to forgo. The OGC therefore decided that, subject to further research, it seemed more practicable to develop new guidance that expected a fixed arrangement for sharing refinancing gains, with all such gains (apart from some defined exceptions) to be shared 50/50. This would have the advantage of being easier to operate and would give the private sector certainty about arrangements for sharing refinancing gains when bidding for contracts.
2.11 With PUK's assistance, the OGC carried out initial research into the subject of refinancing and the private sector's approach to refinancing. In late 2000, PUK commissioned Deutsche Bank to advise on this topic. This initial research identified that there would be many complex issues to consider in developing new guidance. For example, a consortium can make many different types of change to its financing structure. These would need to be understood and consideration given to whether the new arrangements for sharing refinancing benefits should encompass all these types of changes.
2.12 The initial research also identified that there was a range of views in the private sector about the idea of sharing refinancing benefits. These would need to be reconciled and managed if the private sector was to be persuaded that 50/50 sharing of refinancing benefits should be the norm in future PFI contracts. There was considerable initial resistance from many in the private sector to the concept of sharing refinancing benefits 50/50. One view expressed to us by the private sector was that applying 50/50 sharing to all new contracts may deter some contractors from bidding for relatively risky projects (for example, services that have not previously been contracted for under the PFI). Contractors consider that the prospect of retaining all refinancing gains if a project is successful is an incentive for taking on risky projects at a price that will be acceptable to the public sector.11
2.13 The OGC could not afford to ignore the private sector's views, as there was a risk that contractors would stop bidding for PFI contracts if they felt that their opportunities to make a reasonable return from them had been severely impaired by new arrangements on refinancing. Most contractors recognised, however, that in the light of the publicity surrounding the outcome of the Fazakerley prison refinancing some sharing of refinancing gains would be appropriate in future deals. If these new arrangements can be adopted without significantly increasing the pricing of PFI deals then they will contribute to improved value for money from PFI deals.
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11 The OGC notes that its July 2002 guidance, although generally expecting 50/50 sharing of refinancing benefits, specifically allows variant bids without 50/50 sharing for projects where there are substantial market risks.