The following guidance outlines the key issues that should be considered when consent of the Procuring Authority is required for a Project Company refinancing, or the Procuring Authority is otherwise involved.
When a request for approval to refinance is received by the Procuring Authority, or if the Procuring Authority is considering directing the Project Company to instigate a refinancing, the main aim of the Procuring Authority should be to ensure any refinancing does not affect the financial integrity of the Project Company or the project and to ensure the Procuring Authority will not otherwise be adversely affected.
Refinancing can involve any or a combination of the following: a change to the debt pricing; a change of the debt maturity (its tenor); a change in the amount of debt; a change in the amount of debt relative to equity (i.e. the gearing ratio); changed reserve account requirements (e.g. debt service reserve account); the release of guarantees provided by the equity investors or third parties of the Project Company; a change in the security arrangements (e.g. share charges, project asset security, etc.); a change to the repayment terms (including when capital is required to be repaid); a change in the lenders or debt providers; or a change in other finance terms (e.g. loan covenants).
There are several issues that the Procuring Authority should take into account when assessing a refinancing and how it will affect the project, including those detailed below. The review of the proposed refinancing should be undertaken to ensure that value for money is not adversely affected and taking into account the benefits of the refinancing as well as the potential detriment to the Procuring Authority and the project.
Although the above list describes some aspects of what issues should be considered by the Procuring Authority, the project financing arrangements of a Project Company can be very complicated. When considering a refinancing, the Procuring Authority should make sure it fully assesses refinancing and engages adequate legal and financial expertise.
Example – Use of advisors
On the Brabo I Light Rail project in Belgium, the Project Company was not able to raise long-term debt financing at financial close due to the Global Financial Crisis. Refinancing was completed in 2016, with one of the Procuring Authorities taking the lead in arranging it. A working group was set up and external financial advisors were hired and the refinancing was completed in eight months.
For more information, see the Brabo I Light Rail Case Study.
The Procuring Authority will need to do a full assessment of the implications of a given refinancing proposal. This will include ensuring it has the necessary expertise to assess the risks of the refinancing and any potential benefits. This applies to a refinancing requested by the Project Company, as well as the potential for the Procuring Authority to request a refinancing itself.
External advisors will often be needed by the Procuring Authority to assess a refinancing, as it may not have the skills available in-house. The use of external advisors is detailed in Section 2.1 (Contact management team set-up). This will also depend on the Procuring Authority. For example, a large government department may have the expertise available from another part of the organisation or there may be a team available that sits across several projects which has experience with refinancing.
The research indicated that public sector authorities often lack refinancing expertise in-house, and external financial advisors specialised in refinancing are typically required. Issues have arisen due to the time the Procuring Authority has taken to approve refinancing initiated by the Project Company. Where the Project Company is looking to benefit from favourable market conditions, any delays in approvals from the Procuring Authority may lead to the refinancing opportunity being lost.
Where relevant, the Procuring Authority should also consider the potential benefits it can receive as a result of a refinancing through a relevant refinancing gain regime, if this has been provided for in the PPP contract. It is common in developed markets for the Procuring Authority to require any such financial gain be shared between the parties.
Although a refinancing has the potential to be detrimental to the Procuring Authority, it can also provide a benefit when managed correctly. For example, where additional finance is required to complete works not contemplated at financial close.
Example - Refinancing opportunity
On the Queen Alia International Airport project in Jordan, the refinancing for an accelerated expansion of the airport due to higher than forecast traffic volumes was arranged through both additional debt raising by the Project Company and voluntary contribution from the Procuring Authority. Parliament approved such contribution as it was considered to be value for money to bring forward the planned expansion by three to four years and make a voluntary contribution from the scheduled investment payments.
For more information, see the Queen Alia Airport Case Study.
A financial gain can also be generated through a refinancing due to a change in the risk profile of the project or due to a change in market conditions.
How gains are shared between the Procuring Authority and the Project Company needs to be calculated and agreed upon, ideally agreed upon in the PPP contract. Where the PPP contract clearly states how gains are to be shared, this process will be more straightforward. However if the PPP contract does not clearly outline this calculation method then the two parties may have to reach a negotiated outcome.
The financial gain can be distributed to the Procuring Authority in a number of ways including as a lump sum payment, as a reduced unitary charge, as a combination of the two, or by some other mechanism. In a few rare cases, the financial gain is taken ‘in kind’ as a pre-funded scope change financed with the government’s refinancing gain share. This may be difficult to do due to the difficulty in estimating the value of the scope change.
Where a refinancing gain is agreed in a PPP contract, it is also common for some refinancing gains to be excluded. For example, this can occur where a refinancing is contemplated at financial close because the Project Company knows it can get better financing terms after financial close. In these situations the Project Company will argue that these refinancing gains are being taken into account as part of its bid for the project and so should not be shared. In this context, it is important to specifically establish in the PPP contract which circumstances will entitle the Procuring Authority to share in a refinancing gain and when it will not be entitled. Contract managers should be aware of when refinancing gains can be shared to ensure they are making the most of the Procuring Authority’s entitlements.
View our list of previous questions and answers or submit a question to our PPP Contract Management team.