2.25 Primary investors play a key role in structuring and bidding for projects and are vital to a competitive procurement process. Most primary investors in PF2 projects will need to have the ability to sell their equity post project construction due to balance sheet constraints and a requirement to recycle invested capital into new projects.
2.26 Secondary market investors are often willing to pay a premium for projects when a project is in operation because some major risks, including construction and commissioning, have passed. This can give rise to higher than forecast profits for the primary investor, often referred to as 'windfall gains' or 'excessive profits', which has led to criticism that, in some projects, the private sector investors have made an unreasonable level of profits relative to the level of risk they have borne.
2.27 PF2 contains a number of measures which curb the ability of the primary investors to generate excessive profits and consequently the potential for windfall gains on secondary market sales, including:
• a mechanism to share any unutilised funds in the lifecycle reserve (Chapter 4);
• the public sector receives a share of any gains achieved if project borrowing is refinanced during the contract term. The improved refinancing gain-sharing mechanism, introduced in April 2012, is retained in PF2;
• removal of soft services (Chapter 4). In the past contractors have typically included a risk premium in the pricing of soft service provision. However, the actual costs may have been lower than forecast, thereby reducing the scope and the degree of risk-pricing in the sub-contracts;
• de-leveraging of the capital structure (Chapter 8), which has the impact of sharing efficiency savings across an increased equity investment and, therefore, the return on the equity investment will be lower; and
• equity funding competitions to encourage long-term investment into projects. By encouraging long-term investors at pre-financial close stage, this will reduce the instances and/or quantity of equity traded in the secondary market.