29.2.1 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, bidders on larger projects can consider raising money in this market as an alternative to (or in addition to) the banking sector.
29.2.2 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 PF2 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 change according to movements in a selected index, commonly the United Kingdom Retail Price Index (all items).
29.2.3 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.1 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.
29.2.4 Almost all public PFI/PF2 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.
29.2.5 In order to reduce the cost of raising debt, PFI bonds were, formerly, "wrapped" (i.e. they were given a financial guarantee of scheduled payments of principal and interest (in return for a fee) by an appropriately rated financial institution). As a result of the guarantee (or "credit wrap") the bonds themselves could be rated according to the rating of the guarantor. This has historically tended to offer a more affordable financing solution to the Contractor even once the cost of the credit wrap is considered. The cost of the debt may also be lowered through alternative credit enhancements which increase the credit quality of the bond.
29.2.6 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.
29.2.7 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" to reduce the cost of servicing unutilised debt.2 In some circumstances, most likely for private placements, the bondholders may agree to staged drawdown of the bond proceeds (to be more in line with the expenditure profile) and consequently minimise costs.
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1 It is of course important to ensure that a transparent, competitive process is adopted to price the bonds.
2 As regards hedging more generally, see HMT Guidance "Interest rate and inflation risks on PFI transactions" of April 2006. HMTwebsite at www.hm-treasury.gov.uk.