Project Financing Initiative

Revision as of 15:16, 21 September 2015

Private finance initiative (PFI) is where the debt incurred by a project is repaid by the income that comes from the completed asset. other names and forms Started by entrepreneurs in America extracting oil in Texas. The project would be financed against the asset in the ground (value of the oil). Set up because projects became too large and companies didn't have the assets to secure a loan against. The financial reward of successful oil extraction was large enough for the lenders to accept the risk of failure. PFI has been commonly used in the UK since it was implemented in 1992 by John Major leader of the Conservative government. one of the largest projects using this method being the channel tunnel between England and France. PFI is used all over the world but primarily in Anglo-Saxon countries such as the U.S., Australia, Canada, South Africa but is also used in pioneering countries such as Chile and the Netherlands.

Financial Management Structure

The procedure involves private companies coming together to form the special purpose vehicle (SPV). This would typically consist of at least one contractor, facilities manager and financiers. These institutions are required to provide some capital to ensure their commitment to the project but this is not enough to fund the whole project. Banks are then approached to provide some financial backing. Following this a thorough risk and feasibility study has to be carried out to ensure that the return on the project is worth the initial investment.

Various formats of PFI BOOT or BOT build-operate-own-transfer or build-operate-transfer is where the private entity constructs the asset and then operates it for a concession period arranged with the public sector entity. This concession period allows the private entity to recover its debts and create a profit before transferring the asset to the public sector. Sometimes it is not appropriate for the private sector entity to own the asset so the public sector will take ownership immediately even though it is operated by a private company.

BOO build-own-operate works the same except the asset is kept privately and not exchanged after the concession period often because the asset no longer has any remaining value.

DBFO Design-Build-Finance-Operate is similar to BOO except with the added responsibility of Design on the private sector entity. This is becoming the preferred method of PFI used in the UK.

DBFO format PFIs are recently becoming more popular because there is no transfer of the asset so a long term contract is made focus is on provision of service rather than facility because only the service is purchased, private sector handles procurement, ownership and operation The project is defined by output (service) rather than input

Key words:

Equity - This is money provided by the sponsors or shareholders. Dividends are returned on the equity only after all other debts and interest is paid off. In the case of project failure dividends may not be returned on the equity so this is where the risk lies. Usually a large dividend is expected as a reward for taking on such a high risk.

Senior debt - this is money borrowed from banks or other financial institutions and is the first money to be payed off on a PFI project. This can be unsecured or secured as explained earlier.

Concession- This is the period where the public sector allows the private sector entity to own, operate the asset by charging users for a service.