Financing PFI projects in the credit crisis and the Treasury's response - Public Accounts Committee Contents

2  Re-evaluating infrastructure contracts following the credit crisis

11. Some 35 privately financed contracts were let in 2009 during the height of the credit crisis. Higher financing costs increased the cost of a typical contract by 6 to 7 per cent compared to commitments entered into before the credit crisis.[14] When benchmarked against the rates available from the financing markets just before the credit crisis, the higher bank changes on the 35 contracts were around £1 billion.[15] The Treasury and departments saw these substantial cost increases as unavoidable, and the result of market pricing. Figure 1 shows the increased cost of loans for school building projects in 2009, compared to the Government's long term borrowing cost. Figure 1 The increase in PFI school borrowing costs after April 2009

figure 1 here

Source: C&AG's report, extracted from Figure 10

12. Despite the higher project costs from increased bank charges, there was only limited re-evaluation of the value for money of existing PFI projects. A project's value for money was only reassessed if it needed departmental support to meet cost increases of more than 20 per cent or £20 million.[16] Out of the 35 projects that closed in 2008 and 2009, the Treasury-chaired Project Review Group sent back only three projects to make improvements before being approved.[17] No PFI projects were cancelled over that period. Nor did the Treasury alter existing value for money procedures when it eventually issued updated guidance on PFI procurement in August 2009.[18]

13. Although the Treasury told us it was not under political pressure to approve contracts, there were clear drivers which created a need to close contracts despite the high financing costs. The Government's overriding policy priority in 2009 was to boost the economy by letting infrastructure contracts. The Greater Manchester Waste PFI project, delayed by almost a year, was an example of a project that had the potential to help the economy by creating 5,000 jobs.[19] That project, responsible for treating 5 per cent of national waste, was also under legal and regulatory pressure to avoid further delay.[20] It is not unusual for other policy imperatives to take precedence over value for money concerns, as we concluded in our recent report on the multi-role tanker aircraft. In that case, the Ministry of Defence wanted to procure specialist aircraft, and used the favoured procurement route of PFI even though it was not appropriate for such a unique project.[21]

14. The Treasury asked Partnerships UK to evaluate whether the increase in bank financing costs undermined value for money across the board. Partnerships UK analysed the Outline Business Cases for a sample of PFI projects, but did not examine all aspects of financing costs.[22] It concluded that projects were likely to remain value for money if the interest margin which banks add on to the cost of funds for risk was below 3 per cent.[23] Based on this finding, and normal department project review procedures, the Treasury was satisfied that all 35 PFI projects let in 2009 were still value for money.

15. We remain unconvinced that there was sufficient evidence to support this view. This Committee, and our predecessors, have often been concerned about the value for money case for using private finance. We would, therefore, have expected a significant increase in financing costs to have prompted the Treasury and departments to question more closely the value for money of the privately financed contracts let following the credit crisis.

16. The Greater Manchester Waste PFI project was approved as value for money, despite financing costs that included risk margins well above the 3 per cent value for money ceiling identified by Partnerships UK. In the Manchester waste project the risk margin started at 3.25 per cent and after 21 years increased to 4.5 per cent. These higher margins reflected a project that was unique in terms of scale and technology. The Treasury told us that this project was value for money, without the need to make any assumption that high cost financing would be replaced at a lower cost in future.[24]

14   C&AG's report, paragraph 21 Back

15   Q38, Qq129-130 Back

16   Qq13-16 Back

17   Q34 Back

18   C&AG's report, paragraph 1.16 Back

19   Q9 Back

20   Qq5-8  Back

21   Q6, Q141 Back

22   C&AG's report, paragraph 24 Back

23   Qq20-21 Back

24   Qq10-11 Back

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Prepared 9 December 2010