House of Commons - Public Accounts

Select Committee on Public Accounts Forty-Third Report

FORTY-THIRD REPORT

The Committee of Public Accounts has agreed to the following Report:

THE USE OF FUNDING COMPETITIONS IN PFI PROJECTS: THE TREASURY BUILDING

INTRODUCTION AND LIST OF CONCLUSIONS AND RECOMMENDATIONS

1. In May 2000 the Treasury signed a Private Finance Initiative (PFI) deal with Exchequer Partnership, a consortium comprising Bovis Lend Lease Ltd, Stanhope Plc and Chestertons International, for the refurbishment of its headquarters building in Whitehall. The 37 year contract, consisting of a two year refurbishment period followed by a 35 year concession to maintain the building and provide facilities management services, will cost the Treasury some £170 million.

2. The history of the deal was complex, including a 15-month period during which negotiations with Exchequer Partnership as the preferred bidder were terminated. When negotiations were re-opened it was on the condition that funding for the project would be obtained through a separate competitive process. The competition, run by Exchequer Partnership with the close involvement of the Treasury, was an innovation which reduced the cost of the financing, saving the taxpayer £13 million.

3. On the basis of a Report by the Comptroller and Auditor General[1] the Committee took evidence from the Treasury, the Office of Government Commerce, Exchequer Partnership and Partnerships UK. We examined whether funding competitions have a role to play in future PFI projects, the role of project management skills in the public sector and the additional costs to the public sector of using private finance. The merits of the underlying PFI deal itself will fall to be considered by the Committee in the light of a further report which the Comptroller and Auditor General has in hand.

4. Our key conclusions are:

Funding competitions should always be considered in future PFI procurements

The competition achieved the Treasury's two objectives: to obtain funding at the best available price; and to help get standardised PFI contract terms accepted by potential funders. The success of the competition raises the question whether such a method should be used to obtain funding in all future PFI deals. Some cases lend themselves to it: projects in mature sectors of the PFI, or those that are relatively simple in terms of the risks borne by the contracting parties. Novel or complex projects will be less suitable. In all cases, therefore, a funding competition should be considered—though it will not always be appropriate to use one.

Departments should place greater emphasis on developing the skills needed to deliver major capital projects

The main justification for the PFI is that it enables private sector project management expertise to be harnessed to ensure that projects are delivered to time and budget. But, however public projects are financed, project management expertise is needed in the public sector too. Departments should recognise the importance both of developing staff with project management skills, and of husbanding those skills.

The additional costs of using private finance need to be clearly identified

The private sector cannot borrow as cheaply as can the Government, and Treasury publications on PFI matters adduce that fact as a potential drawback to the use of private finance. Yet the Treasury surprisingly suggested that no additional net costs in PFI deals might result, provided differences in risk between PFI and conventional projects were taken into account. Funding competitions clearly help to ensure that the external financing costs are minimised but it cannot simply be assumed that the resulting costs of private finance will be no more than that of public finance after allowing for risk. If PFI deals are to be justified on the basis that the benefits of private finance outweigh the costs, then we would expect the Treasury to have a clear idea of what the extra costs of private finance are.

5. Our detailed conclusions and recommendations are:

On the use of funding competitions

(ii) Whenever a department decides that a funding competition is unlikely to improve value for money, the department should nonetheless take a close interest in bidders' funding arrangements to ensure that the proposed funding arrangements do indeed represent good value.

On project management skills within the public sector

(iii) The skills traditionally required for the most senior ranks of the Civil Service have had more to do with policy advice than delivering public services, leading to familiar weaknesses in implementation. Project delivery skills should be better recognised, and it should be clear that there are career paths to the very highest Civil Service positions based on outstanding project management skills.

On the additional costs of using private finance

lower

no difference

(v) If it were indeed true that the risk-adjusted cost of finance for a conventional public project did not differ from that of the corresponding PFI deal, then decisions on whether or not to go for a PFI deal could in principle ignore apparent differences in financing costs and turn instead on differences in the other factors. Several conditions would however need to be satisfied first:

that the market is always given enough information to provide a basis for a thorough assessment of the risk;
that the PFI procurement, including financing, is fully competitive, so that the price fairly reflects the risk;

that the financing instruments used in PFI do not inherently involve extra costs, as the C&AG's Report, Channel Tunnel Rail Link (HC 302, Session 2001-02) suggested that they might (paragraph 2.19 and Appendix 5).

These conditions will not necessarily be satisfied in every case.

THE ROLE OF FUNDING COMPETITIONS IN FUTURE PFI PROJECTS

6. In requiring Exchequer Partnership to hold a funding competition, the Treasury aimed to obtain funding at the best available price, and to persuade project funders to accept standard contract terms for future PFI deals. Both of these objectives were achieved.[2] Previous guidance from the Treasury had suggested that it was sufficient to have a single competition to optimise the separate elements of a PFI deal, so we asked whether the use of a funding competition was a departure from this guidance.

7. The Treasury said that this deal had been the first to use such a competition and represented an innovation in PFI procurement which could be extended elsewhere. Funding competitions should always be considered for future projects and departments should retain the right to ask bidders to conduct one. The method was particularly suitable for projects that had been developed to a stage where they were commercially viable, as funders would be unlikely to refuse to fund them. Indeed, for large projects that were not too complicated, funding competitions could become common practice.[3]

8. Asked whether funding competitions should be used in all PFI deals, the Office of Government Commerce considered that they should not. Such competitions were a sophisticated technique which should be used carefully, and as set out in the Comptroller and Auditor General's Report there were many criteria to consider before deciding whether a particular project would be suitable. Nevertheless, the right to request a competition should always remain a credible option for departments to take.[4]

9. The Office was in the process of getting agreement within the public sector on detailed criteria for the use of funding competitions. There would be guidance to departments that they should reserve the right to require a preferred bidder to run a funding competition. The existence of such a right would introduce additional tension into the procurement process to secure competitive financing arrangements.[5]

10. The Office of Government Commerce also believed, however, that there were other ways in which departments could take a close interest in the funding of a PFI project which need not necessarily mean holding a financing competition. Departments should always consult their professional advisers on whether any proposals put forward by bidders were competitive and to what extent bidders had explored the various ways in which a particular project could be financed.[6]

THE ROLE OF PROJECT MANAGEMENT IN THE PUBLIC SECTOR

11. A key factor in the management of the funding competition was the appointment of experienced advisers by the Treasury and Exchequer Partnership.[7] As the cost of professional advice had amounted to about £2.6 million, we asked if it was necessary to rely so heavily on advisers. The Treasury said that as it was a complicated process they had equipped themselves with a good advisory team. However, the existence at that time of the Treasury Taskforce meant that the Treasury had not been over-dependent on external advisers. Asked whether there was a case for other departments to build up more internal expertise, thereby reducing the reliance on costly external advisers, the Treasury said that this was the reason for the formation of Partnerships UK. As a repository of PFI expertise available for use throughout the public sector, the existence of such a central body would avoid the risk of the public sector re-inventing the wheel every time a PFI project was undertaken.[8]

12. We asked the Treasury if such a large investment in professional advice would have been made if the project had been a conventional, public sector procurement. They thought that too little would probably have been spent on advice if the project had been procured conventionally, although they did not have a specific figure in mind. Work by the Office of Government Commerce had demonstrated that many public sector projects tended to go wrong from an early stage. The message to departments was that they should invest in getting projects right from the start, whether they were procured conventionally or through the PFI.[9]

13. Poor public sector project delivery may suggest that project management skills have in the past been undervalued within Whitehall, so we asked whether a successful project manager had ever become a permanent secretary. We were told that permanent secretaries needed particular skills that reflected their heavy involvement in policy advice, working very closely with Ministers. The emphasis in the past had been on the policy aspects of the job rather than delivery, and project management skills may not have been as highly rated as other skills. However, there was now a shift in emphasis to successful delivery, which would give project management skills much greater significance and importance in the future.[10]

THE ADDITIONAL COSTS OF USING PRIVATE FINANCE

14. The cost of private finance for the project was just over one and a half percentage points above the rate at which the Government could borrow through the gilts market.[11] The cost of finance therefore appeared much higher than that at which the public sector could have funded the project, so we asked whether it would have been better value to finance the project with gilts. The Treasury told us that the premium over gilts reflected the inherent risks in the project. If funds had been provided at the gilt rate, this would have meant lending to a risky project, while making no charge for the risk.[12] It would not have been sensible to lend money to a specific PFI project at a privileged rate. If public funds were lent at a properly risk-adjusted interest rate, the cost of finance would be the same for both the public and private sectors. If public funds were lent at a rate below the risk-adjusted rate, then the public sector would be taking an unpriced risk.[13]

15. The Treasury said that the key risks in this project included such items as cost overruns and construction delays, all of which had been transferred to the private sector. Although such risks could be transferred without the need to get the private sector to finance the initial capital costs, experience did not support the argument that risk transfer was successful where the finance was supplied by the public sector. By leaving contractors to back their own judgements on project risk, the use of private finance made for better project management.[14]

16. In assessing the value for money of PFI deals, Treasury guidance requires that the cost of a deal should be compared against a public sector comparator. The Treasury had estimated that the £170 million cost of the project might be £20 million less than a comparable public sector project, using a discount rate of 6 per cent. Recognising that these cost estimates would be subject to examination by the C&AG in due course, we asked the Treasury whether the percentage discount rate was reasonable, given that real interest rates were at a much lower level. We were told that the discount rate was important in such calculations and that the 6 per cent figure was being examined, although a decision on whether or not to change the number had not been taken. Real interest rates were indeed lower than 6 per cent, but the discount rate was not wholly dependent on market interest rates as it incorporated a number of adjustments to reflect items such as inherent risk and the effects of taxation.[15]

1 C&AG's Report Innovation in PFI Financing: The Treasury Building Project (HC 328, Session 2001-02) Back

2 C&AG's Report, paras 4-8 Back

3 Qs 1-2, 75, 102, 160 Back

4 Qs 10, 180 Back

5 Q11 Back

6 Q12 Back

7 C&AG's Report, paras 1.12-1.14 Back

8 Qs 3-4, 26, 158 Back

9 Qs 161-167 Back

10 Qs 14-16 Back

11 C&AG's Report, para 1.42 Back

12 Q27 Back