Select Committee on Public Accounts Thirty-Fifth Report


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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