1.27 We found no evidence in the survey returns that the private sector had withheld information about a debt refinancing from an authority. We did find six projects where the authority had not reported a refinancing but there had been some form of financial restructuring of the debt. However, these did not constitute refinancings where the gains should have been shared with the public sector (Figure 9). Treasury guidance permits gains on certain transactions which improve the terms of a project's debt finance to be retained by the private sector (Figure 10 overleaf).
9 | PFI projects within our survey which had experienced some form of financial restructuring of the project debt | |||||||||||||||||||||
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Form of Financial Restructuring | Numbers of Projects | Why the financial restructuring does not require any sharing with the government | ||||||||||||||||||||
Access to a funding allowance which could be drawn upon to meet the demands for variations. [Connect and Power Supply PFI projects] | 2 | There was no refinancing of the original debt and there was no gain realised to be shared with the public sector. | ||||||||||||||||||||
To resolve the distressed financial position of the contractor. [Croydon Tramlink] | 1 | There was no gain to be shared. Rescue refinancings are specifically provided under Treasury guidance as situations where the public sector will not share in refinancing gains. | ||||||||||||||||||||
Additional borrowing to run the project. [MoD's Signal Service project] | 1 | The Authority explained that the debt increased when, after the contract award, the Contractor found an error in the financial model used to support the bid for the project and therefore had to borrow more money, with no deterioration to the Authority's position. | ||||||||||||||||||||
Corporately refinanced (financed using its own resources) [Global Wide Area Network Linking Operation] | 1 | Corporate refinancings are defined by guidance as non-qualifying i.e. the private sector is not obliged to share the gain.1 | ||||||||||||||||||||
New owners sought external financing - original deal was corporately financed (London Fire) | 1 | Consultants to the project team concluded in a review of the restructuring that there was no gain to be shared. | ||||||||||||||||||||
Source: National Audit Office Survey | ||||||||||||||||||||||
NOTE | ||||||||||||||||||||||
1 Treasury guidance on standard PFI contract terms (SoPC3 section 35.4.3) requires the authority and its advisors to conduct due diligence over corporately financed projects in order to satisfy themselves that the financial structure is not simply designed to bypass the refinancing provisions. | ||||||||||||||||||||||
In addition, in the MOD's Skynet satellite communication project, the private sector consortium Paradigm has raised new finance in connection with a revised insurance strategy for the project, the additional costs of which will be borne by the MOD.
10 | Debt transactions where Treasury guidance provides that gains do not have to be shared |
The following is a summary and the full details of exemptions from gain sharing are as stated in the standard contract terms issued by the Treasury. ■ Corporately Financed projects. These projects are financed through the corporate funds of the service provider rather than through finance obtained specially for the project so that the contractor is both service provider and financier. The Treasury view is that in the circumstances which meet the criteria set out in its guidance it is not feasible to identify any financing benefit that the contractor may secure. ■ There is no gain sharing until the internal rate of return (IRR) assumed in the bid has been achieved. Investors whose IRR at the time of the refinancing is below their base case model IRR, are entitled to retain refinancing gains without sharing, until the project's IRR rises above its base case IRR. This concession was mainly intended to help projects in financial difficulties. However, in our opinion, it can also produce outcomes which appear overly generous to investors whose returns in projects out perform initial expectations as a result of large refinancing gains. For example, in the Norfolk and Norwich hospital refinancing, in line with the voluntary code, the contractor Octagon was exempt from sharing £5.8 million of the refinancing gain as its pre-refinancing IRR (16 per cent) was below its base case IRR (19 per cent). Immediately after the refinancing, Octagon's IRR increased to 60 per cent. In our view it would seem more appropriate in such cases where the post refinancing IRR is significantly above the base case IRR for the full amount of the gain to be shared. The Treasury view is that changing the voluntary code would jeopardise the voluntary sharing arrangement which to date has been adhered to. ■ Improvements in general interest rates if the private sector was exposed to interest rate risk. The contractor bears the risk of increased interest rates following financial close. Where the contractor has not hedged this risk and is therefore exposed to both upward and downwards movements in interest rates, the contractor is entitled to keep gains arising from favourable movements in interest rates. Source: Standard contract terms issued by Treasury (SoPC3). Information on the Norfolk and Norwich Hospital Refinancing from the NAO report on that transaction. | |
1.28 It would be risky for a private sector company and associated lender to undertake a refinancing without informing the public sector. Any refinancing that increases termination liabilities or requires covenant changes, requires agreement by the client. Also, guidance on PFI contract terms provides for termination of the PFI contract for a breach of the refinancing provisions. In this event the authority's termination liabilities would include nothing in respect of compensation to the equity shareholders. Furthermore, it would be difficult for the private sector to secure the agreement of all of the equity holders in a project to such action given the reputational damage that would result from subsequent discovery.