'Refinancing' means taking on new debt to pay off existing loans. The project company and its shareholders may have two main reasons to refinance debt that was initially used to finance the project.
First, the project may have been unable to obtain a financing package with a long enough maturity to match the project's length. This could occur because long-term debt was not available at the time when the project was awarded, or because lenders viewed the project as too risky to extend credit with a long maturity. In this case, the project could proceed with a shorter-term loan, as described in Yescombe's chapter on financial structuring [#295, Chapter 10]. This creates a refinancing risk-that is, the risk that the shorter-term loan cannot be refinanced at the expected terms. The PPP contract should specify who bears refinancing risk, as described in Section 3.3: Structuring PPP Projects.
One option to mitigate refinancing risk is 'take-out financing', in which a second lender promises to take over a loan at some future point-thereby encouraging the original lender to provide longer-term debt than might otherwise be the case. For example, the Indian Infrastructure Finance Company Limited (IIFCL) has established a take-out financing scheme for infrastructure projects [#134].
Refinancing can also provide an opportunity for the project company and its shareholders, if more favorable terms become available. Because infrastructure projects have long durations, capital markets could change during the life of the project and offer better terms on the existing project debt. Lenders also tend to offer better financing terms to projects with demonstrated track records and have already moved past initial risks, such as construction. Yescombe's section on debt refinancing [#295] further describes the potential gains to equity investors from refinancing.
Refinancing with more favorable terms can lower overall costs for users or government, improve returns to investors, or both. The government needs to consider upfront how benefits of refinancing will be treated. Options include:
• Do nothing-allow equity-holders to gain from refinancing through higher dividend payments
• Share gains between project shareholders and customers, by including in the PPP contract or PPP regulation a clause which states that benefits of refinancing must be reflected in the price paid for the asset or service
• Building into the PPP contract the right for the government to require or request refinancing of the project debt, if it believes that more favorable terms are available in the market.
Several governments have introduced rules for how PPP refinancing benefits will be treated, as described by Yescombe [#295]. For example, in 2004 the United Kingdom's Treasury introduced into its standard PFI contracts a 50:50 split of any refinancing gain between the investors and the government [#235]; this was subsequently revised in each version of contract standards [#242]. South Korea has also introduced a similar provision in its legislation governing PPPs. Since 2008, the United Kingdom's government has also reserved the right to request for refinancing of project debt to take advantage of more favorable capital market conditions.