The sharing of refinancing gains has been, in general, in accordance with guidance but with some exceptions

In most cases refinancing gains have been shared according to the Code

1.29  The Code required the private sector to generally share 30 per cent of the total refinancing gain with the public sector. Figure 11 shows the amount shared with the public sector of those projects that were refinanced under the Code. Five projects resulted in the public sector receiving less than 30 per cent of the refinancing gains for reasons permitted by the Code but three projects did not share gains which the Code expected to be shared.

The three exceptions were road projects where there was no sharing of the gains

1.30  In three PFI road projects managed by the Highways Agency there was no sharing of the gains on refinancings after the Code came into operation. Two refinancings (A30/A35 (Exeter to Bere Regis) and A50/A564 (Stoke-Derby Link)) were signed on November 7th 2002, a short period, 5 weeks, after the Code had been published. If these had proceeded unchanged but shared in accordance with the Code, the public sector would have received a gain of £1.7 million.17 At the time of the refinancing, the shareholders in both of these roads projects, which had been awarded by the Highways Agency, was Balfour Beatty (68 per cent of the equity) and WS Atkins (32 per cent).

1.31  Balfour Beatty and WS Atkins had begun the process of a refinancing in the previous year prior to the introduction of the Code. They signed commercial terms with their banks in February 2002 and received credit approval from their funders between April and May 2002. During late 2001 and the first half of 2002 it was widely known that the Treasury was negotiating with the private sector a code which would expect the private sector to make 30 per cent of the refinancing gains on early PFI deals available to the public sector. The refinancings of these two projects were planned by Balfour Beatty and WS Atkins on the basis of no gain share with the public sector. Balfour Beatty and WS Atkins were ready to sign the final refinancing agreements with the Highways Agency in September 2002, but due to various delays, the final signing of the refinancing deals took place when the Code had come into practice. The nature of the refinancings did not require any consent or document change involving the Highways Agency and were structured so as not to increase the potential termination liability of the public sector.

1.32  Balfour Beatty and WS Atkins told us that had they been required to share any gain with the public sector then they would probably not have proceeded with the refinancing because the resulting value to shareholders would have been reduced to a level that it would not have been worth pursuing given the additional management time required to re-negotiate the transaction applying to the Code and the uncertainty of outcome that would have been created. However, both Balfour Beatty and WS Atkins confirm that they support the principles of the code and subsequently each has been involved in several refinancing discussions with various public sector bodies where the sharing of refinancing gains was an accepted base assumption even though the concession contracts do not require them to do so.

1.33  On a third roads contract, the A69 Carlisle to Newcastle, which the Highways Agency had let to the Roadlink consortium the project was refinanced in 2004 but with no sharing of the gains. The amount of the refinancing gains has not been disclosed to the National Audit Office but the Highways Agency believes that the gains to Roadlink were less than £1 million.

1.34  The Highways Agency has succeeded in obtaining gains of £4 million on two other road projects where the refinancing gains were shared.

The authorities have taken steps to check refinancing gain calculations but there has been one variation from Treasury guidance in the use of the discount rate

1.35  In projects where a refinancing had occurred, the public sector teams had generally involved advisors in checking that the refinancing gain had been calculated correctly.

1.36  Guidance recommends to departments that refinancing gains should be discounted using the investor's IRR as set out in the PFI contractor's base case submitted when bidding for the contract. This discount rate is used as it is a measure of the private sector's expected cost of using equity capital in the project. In most cases, the higher the discount rate used, the greater the refinancing gains.18 However, in the refinancing at Darent Valley Hospital, the contractor, THC Dartford, successfully argued that using their business case IRR would have given the Trust an unreasonably high amount from the refinancing in relation to the risks that THC Dartford had borne in undertaking such an early PFI deal. After extensive negotiations involving the Department of Health and the Treasury, a compromise discount rate (15 per cent) was agreed between the parties. The 15 per cent used was an approximate equity return prevailing in the market at the time of the refinancing. If the original business case discount rate of 21 per cent had been used, the Trust would have secured an extra £1.4 million. The refinancing gains on other early PFI deals did use higher discount rates equivalent to the base case IRR: Norfolk and Norwich Hospital (19 per cent) and Bromley Hospital (22 per cent).

There are contractual arrangements to share refinancing gains in current deals

1.37  The survey responses to deals signed since October 2002 which are expected to share refinancing gains 50:50 confirmed that these contracts incorporated the prescribed 50:50 sharing mechanism.

1.38  Of the eleven large projects signed after October 2002 which we surveyed, only one had so far undertaken a refinancing (Jubilee, Northern and Piccadilly Tube Lines). The reason why there have not been more is that only one of the remaining ten that have not been refinanced is purely bank financed, where the prospects for refinancing are most likely, and, in any event, the projects are unlikely to have reached the stage when a refinancing would take place. In the Tube Lines project the public sector share of the refinancing gain was a contractually negotiated 60 per cent. This higher sharing arrangement with the Government reflected the fact that the authority was required to give approval to a deal which was predominantly bank financed but was planning to be refinanced using a bond at an early opportunity.

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17  On these deals there is no compensation payable by the Highways Agency to the lenders on contractor default, therefore the termination liabilities of the Highways Agency are unlikely to have increased beyond the original contract.

18  In the case of a refinancing comprising only a reduction in bank debt margin this effect is reversed.