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The process by which such swords can be created is largely unknown. Lizard Kings are known to use such weapons regularly, making it likely that the Lizard Man priests - as the only mortal race known to man - know the secrets and means of manufacturing them. Since Demons (particularly Fire Demons) use Fire Swords, too, it stands to reason that some of the spells and materials used in their manufacture must involve components from the Elemental Plane of Fire.
The flame of a Fire Sword can be treated much like the flame of an ordinary torch for illuminating areas or even setting fires (under the Advanced Fighting Fantasy rules, this might translate into 1 additional point of Damage on a hit, just as much as a torch would inflict).