3 Cancellation of the loan
Introduction
10. The cancellation of the loan related to both
the absolute availability of government funds and the comparative
affordability of the loan in relation to other projects sponsored
by the Department. In this section we consider that rationale,
alongside the issue of the release of equity in the company as
a condition of any loan agreement.
Affordability: the absence of
available funds
11. In announcing the cancellation of the loan, the
Chief Secretary to the Treasury concluded that the previous administration
had "committed to spend money that they simply did not have".
[14] On 5 July, the Deputy
Prime Minister argued that:
the loan pledged by the last Government [...]
was announced for political purposes, just before the general
election, to allow the then Prime Minister to make a late-night
photo-opportunity visit to Sheffield Forgemasters two days before
the election, and the Government made that announcement in the
full knowledge that they did not have the money to make the promise
in the first place.[15]
12. Later that month, the Deputy Prime Minister continued
that line of argument:
Lord Mandelson was writing out cheques to companies
like Forgemasters, which he knew would bounce.[16]
13. The suggestion that the loan was signed off in
the knowledge that there was no money available at all was fiercely
denied by former Labour Ministers. Pat McFadden MP, who was a
Minister in the Department when the loan was offered, told the
House during a debate on the loan in July 2010, that he had received
a letter from Simon Fraser, the then-Permanent Secretary of the
Department, which set out the Department's handling of such loans:
When a new project or policy is considered the
Department provides thorough advice to Ministers, including on
the following aspects: value for money, legal implications, delivery
of policy objectives, stakeholder and media reaction and available
sources of funding. When funding cannot be identified from within
existing departmental budgets it is agreed with HM Treasury.
[17]
Mr McFadden further told the House that Mr Fraser
confirmed that:
The process above was in place while you were
a Minister here.[18]
14. However, when he gave evidence to us the Secretary
of State appeared to distance himself from this line of argument,
along with a number of other reasons given for the cancellation
of the loan:
Those were not arguments that I and my Department's
Ministers have advanced. We took the decision on affordability
grounds.[19]
Furthermore, it is now clear that the loan was subject
to normal departmental accounting procedures. As the Accounting
Officer of the Department, Mr Simon Fraser had responsibility
for ensuring the financial probity of any spending commitments
made by his Department. If he was in doubt, it would have been
open to him to request a Ministerial Direction; a mechanism by
which senior civil servants can articulate their opposition to
Departmental spending. Records recently released by the Department
under the Freedom of Information Act confirm the fact that Mr
Fraser was content with the financial arrangements and would not
need a Ministerial Direction.[20]
This was confirmed by Janice Munday, Director of Advanced Manufacturing
and Services at Department for Business, Innovation and Skills,
who told us that there was no need for a direction because "all
of the tests were met" under the Industrial Development Assessment
Board assessment.[21]
15. While Treasury consent was required before the
loan was approved, the Secretary of State acknowledged that such
consent was a standard practice for loans out of the Strategic
Investment Fund because the value of the loan was larger than
the Department's delegated authority, set at £25million,
and not because funding could not be identified within the Department.[22]
16. It is clear that the loan was subject to the
normal procedures within the Department, and approved by the then
Permanent Secretary and HM Treasury. Therefore, we are convinced
that former Ministers signed off the loan in the full knowledge
that it could be funded.
Affordability: a comparative choice
17. In his written and oral evidence to us, the Secretary
of State put forward a more detailed explanation of why he decided
to cancel the loan. He said that the central reason for the cancellation
of the loan was that of affordability at a Departmental level.
In his opening statement he set out the context in which the Department
was operating:
The position that we are now dealing with is
that we have inherited a very difficult financial position. We
had to make some very quick decisions on cuts in my Department.[23]
He highlighted the fact that all Departments were
told by HM Treasury to find significant in-year savings:
We had a list of projects, which the last Government
had advanced to varying degrees. We had an understanding of the
scale of the cuts that we had to make.[24]
18. Mark Prisk MP, Minister of State, Department
for Business, Innovation and Skills, told the House that the loan
would therefore have necessitated the Government having to borrow
further money to finance the loan:
Financing a loan of this nature needed £80
million more debt to be issued. That would have meant £80
million more debt on the Government's books this year. So to claim
that somehow this loan would not be as challenging as all that
or would not really represent debt on the books of the Government
is not correct. The reality is that by taking on that commitment
we would have been adding to the enormous debt, regardless of
the nature of the assets it financed.[25]
19. The Secretary of State reiterated this line of
argument and asserted that the loan would have to have been supported
by an equivalent level of additional Government borrowing. He
also confirmed that the loan would have been "cash straight
out of the door in the financial year". For that reason he
said that Ministers judged that cancelling the loan was "the
best and most sensible decision to make".[26]
The option to delay Government financing of the loan as an alternative
to cancellation was not possible because all money drawn down
through the Strategic Investment Fund had to be done so by March
2011.[27]
20. In total, of the £34 billion of spending
commitments subject to re-evaluation between £1 billion and
£2 billion was cancelled, leaving £32 billion of spending
commitments to go forward. Of the 22 projects sponsored by the
Department, a majority were reapproved on the basis that they
were "contractually committed" and would have involved
"very considerable costs" to the Government had they
been cancelled.[28] In
his supplementary evidence, the Secretary of State set out those
projects under his Department's responsibility which were subject
to the reassessment, and which projects were contractually committed,
and which were not. We set out the list below:BIS
projects which were contractually committed
| Project Name |
£million |
| Airbus: A350XWB | 340
|
| Spectrum clearance costs
| 280 |
| Post Office | 180
|
| Discovery Research Ship
| 75 |
| UK Online | 30
|
| GBI: Nissan | 20.7
|
| NaREC—Offshore wind turbine test site
| 18.5 |
| Student Loans Company |
16.3 |
| Offshore Wind Demonstration and Deployment
| 12.8 |
| International Space Innovation Centre
| 12.5 |
| NaREC—Offshore wind blade test site
| 11.5 |
| Student Loan sales programmes—cost of advisors for feasibility study
| 0.48 |
BIS projects which were not contractually committed
| Project | £ million
|
| Ford Loan Guarantee |
378 |
| GM Loan Guarantee (company withdrew)
| 270 |
| Broadband Universal Service Commitment (USC)
| 200 |
| Diamond Phase III | 97.4
|
| UKCES grant letter |
77.3 |
| Offshore Wind—Support for Developing Manufacturing Facilities
| 60 |
| Growth Capital Fund |
50 |
| Offshore Wind—Mitsubishi
| 30 |
| Digital Participation |
4.0 |
21. We accept the Government's argument that, in
relation to those projects which were contractually committed,
it would have been uneconomic to cancel them. As an example the
Secretary of State highlighted the example of Nissan, which was
given a £20.7 million grant. He explained that the grant
was re-approved because it had already been "legally committed"
and would be "phased over several years".[29]
He also explained that the continued commitment to Ford, a project
which was not contractually committed, was because the assistance
was in the form of a loan guarantee which would not be subject
to any "upfront costs" and therefore did not require
additional government borrowing.[30]
22. The cost to the Department of the non-contractually
committed projects was £518 million.[31]
We appreciate that budget cuts were unavoidable and that difficult
decisions had to be taken, but the level of spending reapproved
indicated that the question of affordability was comparative,
that a choice could be made on the merits of individual projects.
The decision to cancel the loan to Sheffield Forgemasters was
made in that context. As the Secretary of State explained, the
loan was:
A substantial project that we decided not to
proceed with. There were others that we could have cut, but for
contractual and other reasons we decided not to do so.[32]
23. However, it is not clear that any comparative
cost-benefit analysis of those non-contractually committed projects
was undertaken. When we wrote to the Secretary of State in July,
we asked him to set out the criteria under which the Government
reassessed the loan. The Secretary of State's response was: "the
decision to cut the Forgemasters loan was based on affordability".[33]
24. All Governments have to come to decisions on
the merits of public spending and in the current climate, the
present Government was presented with a difficult task. The issue
of affordability becomes even more important. That said there
is a fundamental difference between making choices and affordability
in absolute terms.
25. The Secretary of State was working in the
context of in-year cuts demanded by HM Treasury and therefore
tough decisions had to be made. At short notice the Department
had to deliver significant savings and decide where to allocate
its limited resources. While we disagree with the process, we
recognise that it was the Department's responsibility to deliver
these savings.
26. Some DBIS projects requiring government funds
were reapproved even in the absence of any contractual commitment.
A choice could therefore have been made by Ministers on where
the axe would fall. We do not believe that any substantial comparative
cost-benefit analysis was undertaken on those non-contractually
committed projects under review. Rather it appears to be the
case that the Sheffield Forgemasters loan was identified as an
easy cost saving. While this is a legitimate way to proceed, the
Department should have been more transparent in articulating this
process and not hidden behind the simple defence of affordability.
Furthermore we did not receive any detailed explanation of how
the Sheffield Forgemasters project was chosen ahead of the other
non-contractually committed projects sponsored by the Department.
Dilution of Equity
27. The question of the dilution of equity in the
company, in relation to the company board, became the subject
of significant interest both inside and outside of the House.
Statements by the Prime Minister and the Deputy Prime Minister
appeared to indicate that the company's board members were reluctant
to dilute their equity in exchange for any loan. The Deputy Prime
Minister, in response to an oral question from Rt Hon Alun Michael
MP, commented:
Do I think it is the role of Government to help
out owners of companies who do not want to dilute their shareholdings?
No, I do not.[34]
This view was reiterated by the Prime Minister who
argued that:
The question is whether it is an appropriate
use of taxpayers' money to give the loan to a business that could
raise the money by diluting its shareholding.[35]
28. An article in the Financial Times on 19 July
2010 referred to a letter from the Deputy Prime Minister to Graham
Honeyman, Chief Executive of Forgemasters in which the Deputy
Prime Minister reportedly wrote:
[You] made clear to me your own willingness to
dilute your equity share.[36]
29. When he gave evidence before us in July, the
Secretary of State sought to clarify the position:
There is an inherent problem when you have a
fairly small company taking on a very big project that either
they finance it entirely through loans, when it becomes very highly
geared, or they take on equity, in which case they dilute the
shares. That is not a criticism of the company; that is just
defining the problem, and that is the difficulty they have had
with this project.[37]
30. He subsequently expanded on this in a Written
Statement to the House on 27 July. We set out the Statement below
for clarity:
[...] there is an inherent problem with a relatively
small company taking on a very big project. If the company finances
the project with a large amount of debt it is likely to become
so highly geared that its long-term viability is put at risk.
If it funds the project with third-party equity, existing shareholders
have to dilute their shareholding. This is not a criticism of
the company, its shareholders or the project; it is simply a statement
of the problem and it is something that the chief executive of
Sheffield Forgemasters, Graham Honeyman, raised in an interview
with the Yorkshire Post on 17 June 2010 when he made the following
points:
"Private equity would take the whole of
the shareholding away from Forgemasters and put it in the hands
of somebody else. That is, not just my shares (49%) or the other
directors, 65% of the shop floor own the shares in the company.
The amount of money to put in to fund the press would more or
less have to absorb the whole of the shareholding".
"The reason why we went to the Government
is the interest rates were reasonable. Bank interest rates are
very high therefore we would have to make huge profits every year
in order just to pay off interest on the debt. This is why we
needed support from the Government".
It is this dilution that the Prime Minister and
the Deputy Prime Minister were referring to when they spoke in
the House. The chief executive of Sheffield Forgemasters has confirmed
that he is prepared to dilute his shareholding in the company
in order to facilitate the project. However, it has also been
clear that the shareholders would seek a fair price for any equity
sale, and at this time their view is that their returns from growing
the business organically are likely to exceed those from undertaking
the 15,000 tonne press project if the purchase of the press was
financed by substantial equity dilution".[38]
In respect of the loan, the Secretary of State confirmed
that equity dilution was not an issue and that "the company
did indeed make it clear that it was willing to dilute.[39]
31. It is clear that a level of equity in the
company would have been transferred out of the company as a condition
of the Government loan to Sheffield Forgemasters. It is also clear
that board Members were willing to agree to such a transfer. We
conclude that a dilution in equity did not represent an obstacle
to providing the loan.
14 HC Deb, 17 June 2010, col 1040-1 Back
15
HC Deb, 5 July 2010, col 43-4 Back
16
HC Deb, 21 July 2010, col 343 Back
17
HC Deb, 22 July 2010, col 590 Back
18
HC Deb, 22 July 2010, col 590 Back
19
Q 1 Back
20
The full list of documents released by the Department can be found
at www.bis.gov.uk/site/foi/information-released Back
21
Q 18 Back
22
Ev 13 Back
23
Q 1 Back
24
Q 10 Back
25
HC Deb, 21 July 2010, col 531 Back
26
Q 1 Back
27
Ev 15 Back
28
Q 5 Back
29
Ev 12 Back
30
Ev 12 Back
31
This figure excludes the GM loan guarantee and the Ford loan guarantee
as these did not require up-front costs. Back
32
Q 8 Back
33
Ev 12 Back
34
HC Deb, 22 June 2010, col148 Back
35
HC Deb, 7 July 2010, col 369 Back
36
www.ft.com Back
37
Oral evidence taken before the Business, Innovation and Skills
Committee, HC (2010-11) 384, Q 51 Back
38
HC Deb, Tuesday 27 July 2010, col 79WS Back
39
Q 24 Back
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