Sheffield Forgemasters - Business, Innovation and Skills Committee Contents


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: A350XWB340
Spectrum clearance costs 280
Post Office180
Discovery Research Ship 75
UK Online30
GBI: Nissan20.7
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 III97.4
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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Prepared 14 December 2010