Examination of Witnesses (Questions 100
- 119)
WEDNESDAY 1 NOVEMBER 2000
SIR DAVID
OMAND, MR
MARTIN NAREY,
MR DAVID
KENT, MR
ROBIN HERZBERG
AND MR
ANDREW BANKS
100. It is what you reckoned as the cost of
the risk.
(Mr Narey) Yes.
101. What you have actually been paid for, and
it makes it clear in paragraph 1.29, that the extra £1 million
you got back was to cover your costs. So the taxpayer has not
actually made anything. You are simply covering the extra cost.
(Mr Narey) The taxpayer has made something in that
we have had refunded to us monies which we would otherwise have
paid to FPSL for running the prison. We have paid less money than
we would have anticipated paying at the beginning of the contract
because FPSL in recognising the additional risk which we have
accepted have compensated us to the sum of £1 million.
102. They have also given you a greater cost.
The risk cost is an extra £1 million and they have paid you
an extra £1 million to compensate for that. It is a compensatory
payment not an extra profit.
(Mr Narey) That is right but unless the risk is proven
to be sustained and unless the contract is terminated, the profit
to the public sector will be the £1 million.
103. Exactly. If by any chance the contract
is terminated, the public sector might lose £47 million or
something.
(Mr Narey) £13 million at present value. Yes,
that is correct, but the possibility of that is remote.
104. So I come back to the point that yes, you
are quite right, if everything goes right and there is no termination
we may make as taxpayers £1 million.
(Mr Narey) Yes.
105. On the other hand we may lose a lot more.
(Mr Narey) That is correct.
106. The overall evaluation of that which you
have made is that there is an overall cost to the taxpayer of
£1 million. That is your ten per cent calculated on the risk
of extra liabilities over the period.
(Mr Narey) Yes; that is correct.
107. So you have an extra cost of £1 million
and you have an extra payment of £1 million, so you have
been compensated, as it makes clear in paragraph 1.29. This is
a compensation for extra costs, it is not extra money.
(Mr Narey) No, it is compensation for the risk. There
is no cost unless we have to pay it.
108. But the risk is a cost. The risk has a
value and by taking on the extra risk in effect the taxpayer has
had to pay for that extra risk, the £1 million which you
have calculated as the cost of that extra risk.
(Mr Narey) It has no cash value. I accept there is
a value in terms of the risk.
(Sir David Omand) May I also make the point, since
it is quite easy to talk about the £47 million as being a
cost, that in return of course you get a prison.
109. You had a prison before you went in for
the refinancing.
(Sir David Omand) No, the prison belongs to the contractors.
The prison belongs to the Prison Service at the end of the contract.
110. You mean if the liability came about because
there was an early termination you would have a prison.
(Sir David Omand) That is right. We would want to
take the prison early and in return for that it is perfectly reasonable,
as it would be with a mortgage.
111. I understand that but it seems to me that
there is a clear conflict between what you both said in answer
to my first question, which is that the taxpayer benefited financially
to the extent of £1 million and what you are now saying,
which is what is in the report, which is actually that this is
compensation for an extra cost taken on by the taxpayer of £1
million. It does not seem to me that the taxpayer has actually
gained in financial terms anything at all out of that transaction.
You have taken on an extra cost and it has been paid for that
extra cost.
(Sir David Omand) It is a fine line.
112. The next question to you, if I may, is
to say that out of the extra £5.5 million which this refinancing
gained altogether, and there is an extra cost which has also been
gained by this refinancing of £1 million, the cost we just
talked about to compensate for the extra risk which is involved
in this refinancing, so altogether the overall cost of the project
has come down by £4.5 million and all that £4.5 million
has gone to the contractor and none of it has come to the taxpayer.
Why is that?
(Mr Narey) That is for me to answer, it being my decision.
Of the £5.5 million although we disagree on whether we have
benefited in cash terms and I think we have, we have the £1
million in cash against a possibility of paying further money
up front and we shall not know until the end of the next 22 years
whether we have to pay that. I do not believe we will, I think
we have a very good deal in terms of risk, but I accept we may.
113. It is your calculation that it was the
cost of the risk, not mine. You said it was the cost of the risk.
(Mr Narey) Yes, but we have the cash up front; the
cash was given to us. Set against that of the £5.5 million,
£4.5 million remained with FPSL for their risk and £1
million was given back to us for increased liabilities. As I have
indicated, if we were doing this again, if there were a refinancing
of a future project, with the experience gleaned from this, I
should seek a greater share of that. At the time, last April,
based on the advice I received from professional advisers, I believed
we were getting a fair deal, against the belief at that time that
on the contract—and we have now changed the contracts—we
had only marginally any leverage on approving the financing anyway.
It is entirely arguable to suggest that FPSL did not need to obtain
our advice for any of the refinancing.
114. I thought it was clear in here that the
contract could not have been refinanced if any extra liabilities
came to the public sector.
(Mr Banks) There was some doubt as to whether, under
the definition of lender liabilities, there was in fact an increase
in lender liabilities. There certainly was an increase in lender
liabilities at certain points of time, namely from 2013 onwards
but the overall level of liabilities, if that was interpreted
as being the maximum level of lender liabilities, was not actually
increased. It is that point which actually led to the uncertainty.
Initially when we entered the refinancing our advice was that
we did not actually need Prison Service consent. We decided that
it was appropriate on advice and on talking to lenders that they
would like the comfort of that consent within the context of that
ambiguity. There is still some doubt as to whether consent was
required. We decided and we sought consent to take a cautious
view, to put that beyond doubt.
(Sir David Omand) I may say that there would have
been a matter of considerable legal debate over whether, having
established £1 million as a compensation for the increased
risk, if the Prison Service had then withheld consent to the refinancing
on the grounds they wished to extract more of the surplus, the
contract being silent on the question of refinancing, whether
that would have been a reasonable thing to do. I am not sure we
would have won such a case.
115. If the prison had been built by the public
sector under the normal rules then applying for financing public
sector projects outside PFI, and had interest rates later fallen
in the way they did, would the public sector under the old rules
have been able to gain any benefit from the fall in interest rates?
(Mr Narey) If we had built the prison conventionally
we would have built the prison with funds obtained from the Treasury
on a capital basis so there would have been no benefit to the
Prison Service in terms of interest rates.
116. I am asking about the public sector not
the Home Office.
(Sir David Omand) I would defer to Her Majesty's Treasury
on that.
(Mr Hull) I do not really know. It depends on exactly
how it would operate. The funds would already have been voted
to the Prison Service to build the prison and they would have
been voted through the normal supply procedure which does not
necessarily mean raising capital in the financial markets although
it can mean that by issuing government debt. It would be a matter,
when the time came, of whether government debt had to be issued
in order to cover this particular item and that is why I do not
know. It depends on the circumstances.
117. Let me leave that one as we are short of
time and I do not want to go too far down that route. Figure 1,
part 2, shows that the shareholder returns go down under the new
financing system quite sharply after 2012, just at the time when
operating costs are beginning to rise. What happens if the prison
becomes non-profitable at that stage and FPSL pull out? Presumably
the operating costs must have a margin for error in them.
(Mr Kent) On the issue of the contractor pulling out,
there is no facility in the contract for them to terminate. Only
the Government can terminate this contract.
118. If they decide they are not making any
money out of it so they might as well run it rather badly?
(Mr Kent) In that case they could be faced with a
number of potential penalties: financial penalties, reduction
in payments for non-available places, ultimately contract termination
at which time the prison would return to the Prison Service.
119. What worries me is that at the very moment
when it seems to be becoming potentially sensible for FPSL to
pull out that is exactly the moment at which apparently the termination
costs come to a maximum. I am rather concerned that it may well
be that the incentive for FPSL to do something like persuade you
that they might be given the sack on the grounds of non-performance
comes at just the moment it becomes really rather dangerous for
you to be there.
(Mr Banks) If I might answer from a contractor point
of view, there are significant penalties in the contract for non-performance,
not least the penalty to our overall reputation in terms of providing
services of this kind. I would actually say that the performance
of Group 4 as operator of this prison is actually fully backed
by parent company guarantee. Therefore, in terms of recourse from
the Prison Service to Group 4, that is significant.
| 
