Generally, refinancing is not considered a downside risk but an upside benefit. When the project performs well, the private partner will have the ability to renegotiate the debt on better terms or refinance the debt, including an increase in the debt level so as to amortize share capital early (“recap”). Even if the project is performing simply as anticipated, there is likely to be an option to refinance since the risk profile will improve by entering into the Operations Phase.
Although not common worldwide, a number of countries, especially developed countries, introduce provisions in their contracts so that the authority has access to a portion of the refinancing gains. When a government wants to reserve for itself access to the refinancing gains (usually by a decrease in the service payments, although sometimes by means of an upfront payment), it is not common practice to request more than 50 percent of the upside. Chapters 7 and 8 provide additional information on this matter.
Refinancing may also be an adverse risk when the financing strategy of the private partner relies entirely on refinancing: instead of financing from the outset on a long-term basis, the project company enters into a short-term debt (typically under a “mini-perm structure”) with the intention of substituting that financing with a long-term financial agreement (maybe in the form of project bonds when the development of the country-market allows for this). In such situations, there is a risk of refinancing being under worse (or much worse) conditions than anticipated in the financial plan.
This risk should be generally borne by the private partner, to the extent that it is free to decide its financial strategy.
Only in exceptional cases should governments also assume the risk (adverse consequences) of a refinancing. This should only be considered when there is a clear prospect of it being Value for Money, and it has been established in advance that there is no direct access to long-term financing for the specific project (which should have been duly appraised during the preparation of the project). This may be the case of some EMDEs, as noted.
At this point, the government may be interested in sharing the risk of a failure in refinancing (for example, by providing guarantees to the lenders in case the refinancing does not succeed).
This practice implies a high risk in the hands of the public sector, and it creates incentives for speculation by the private party. Therefore, it should be carefully considered in developed countries or in countries where the financial market provides for access to long-term finance.