2 NEGOTIATING FINANCING ISSUES
10. The financing of a PFI deal can be complex and
raise issues with which public authorities may not be familiar.
Our predecessors underlined the importance of authorities equipping
themselves with suitable skills and drawing on appropriate advice
if they are to deal effectively with financing negotiations to
secure the best outcome for the taxpayer. Our predecessors also
stressed that authorities should ensure that they are aware of,
and use, the full strength of their negotiating position when
dealing with requests to vary the terms of PFI deals. The finalisation
of the financing arrangements before the Trust let its PFI contract
and the subsequent refinancing were situations where negotiations
on complex financing issues were likely to be critical to achieving
value for money.[14]
11. Before letting this PFI contract, the Trust did
not take steps to make Octagon compete its funding arrangements
for the project, despite the fact that there had been a two year
delay in closing the deal. The availability and pricing of alternative
financing options can change over time, so competing the financing
could have produced savings in the financing costs. When the Treasury
subsequently ran a funding competition on its PFI deal the competition
reduced the contract price by 7%. Octagon undertook a funding
competition when refinancing its contract with the Trust. The
Trust argued that, when it was finalising this contract during
1997, the PFI funding market was insufficiently developed to facilitate
a competition. The Trust considered there would have been a greater
risk to value for money from delaying the closure of the deal
at a time when construction costs were increasing. The finance
terms in the PFI deal which the Trust closed in 1998 were in line
with other early bank financed PFI deals. However, as the Trust
had not pressed Octagon to test the financing options, including
the newly emerging PFI bond market, during the two years it took
to finalise this deal, the Trust had not demonstrated that the
best possible financing terms were achieved.[15]
12. In letting its PFI contract, the Trust had not
negotiated to share refinancing gains even though the Department
was aware of the potential for refinancing benefits. During the
subsequent refinancing negotiations the Trust accepted increased
risks which it could have resisted through more robust negotiations
when Octagon was seeking to treble the returns to its investors.
The Trust acknowledged that it could have blocked the increase
to the liabilities it will now have to pay to end this contract
early. Yet it took no steps during the refinancing negotiations
to avoid the possible increase to these termination liabilities
of up to £257 million. The Trust thought that objecting to
the higher termination liabilities would have limited the amount
of the refinancing gain but this belief was untested.[16]
13. Alternatively, the Trust could have sought to
strike a better deal by negotiating a bigger share of the refinancing
gains as compensation for taking on the increase in termination
liabilities, a strategy which the Prison Service had adopted successfully
when it was faced with increased termination liabilities on the
refinancing of the Fazakerley Prison PFI contract. The Department
argued that, rather than be ambitious for an increase to the share
of the refinancing gains, it had been important to show the market
an initial example of a refinancing which complied with the terms
of the new voluntary code for early PFI deals by giving the public
sector a 30% share of the refinancing gains. The Department also
considered that it would have been inappropriate for the Trust
to seek a larger share of the refinancing gains as there were
three PFI building contractors which had each made losses of between
£40 and £100 million on certain PFI projects and the
public sector was not obliged to share in these losses. The Department
acknowledged, however, that the public sector now expected to
share in 50% of the refinancing gains in current deals. The Treasury
considers that it is too early to judge whether the 50% share
needs to be adjusted but it will review this as experience emerges
of using this gain sharing arrangement.[17]
14 13th Report from the Committee of Public
Accounts, The refinancing of the Fazakerley PFI Prison Contract
(HC 372, Session 2000-01) and 22nd Report from the
Committee of Public Accounts, PFI refinancing update (HC
203, Session 2002-03); Q 161 Back
15
C&AG's Report, Figure 23, p21; C&AG's Report, Innovation
in PFI financing: The Treasury Building project (HC 328, Session
2001-02); Qq 26-34, 72, 75-76 Back
16
C&AG's Report, Figure 12, p12; Qq 11, 77, 118, 128 Back
17
C&AG's Report, The refinancing of the Fazakerley PFI prison
contract (HC 584, Session 1999-2000) paras 1.24-1.30; Qq 78-83,
117-119, 121-122, 127, 129-147, 158-160, 173-176 Back
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