3. The majority of PFI projects use project finance in the form of bank borrowing in order to fund up-front capital investment. The borrowing is secured against the payment stream of the project, with the interest rate based on the degree of risk that the financial institution sees in the project. Banks generally view the risk as being at its highest during the construction phase. However, once service delivery has successfully commenced, the risk is lower. It is at this stage that the service provider may be able to achieve a substantial refinancing gain by replacing the original bank debt with new bank debt on terms that are more favourable.
4. A key issue in refinancing is the degree to which this increased return should be shared with the public sector. This issue first arose on the Fazakerley PFI prison contract. This was an early PFI contract and the first to be subject to a major refinancing and did not contain any contractual right for the Prison Service to share in the benefit of the refinancing. However, the Prison Service's advisors were able to demonstrate that the refinancing increased the Prison Service's termination liabilities and they should be compensated for the additional risk. The NAO subsequently reported on the refinancing in June 2000 and concluded that the Prison Service had negotiated a reasonable deal. More importantly, the NAO produced a list of general principles that Departments should apply to refinancing. These principles were subsequently included in a refinancing 'Code of Conduct' issued by the Office of Government Commerce (OGC) in October 2002.