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

3  Opportunities to improve value for money in the financing of infrastructure projects

17. The public sector has been heavily reliant on the use of private finance to procure infrastructure projects. In 2010-11, the total annual charges payable in that year were £8.6 billion. The future commitment over the next 25 years amounts to £210 billion in cash terms (Figure 2).[25] New infrastructure is forecast to cost £40 billion a year over the next five years, to be funded through a mix of public and private investment.[26]

Figure 2: Next 25 years' estimated payments under PFI contracts

figure 2 here

Source: Budget 2010: the economy and public finances - supplementary material

18. To the extent that private finance is used to fund future infrastructure investment, it is imperative that the Treasury develops other financing solutions to reduce reliance on expensive bank financing. In addition, steps need to be taken where possible to reduce the high bank financing costs of the contracts which have been entered into since the credit crisis.

19. The Treasury is considering a wider mix of financing sources for future projects. The proposed new Green Investment Bank is an example.[27] On future contracts there is also a case for engaging with financial institutions, such as pension funds or life insurance companies, at an early stage to finance a PFI project for its whole life. The Newham school project, after a short period of temporary grant finance, was financed by a life insurance company at an attractive margin.[28] Direct grant funding can help to relieve a project from the banks' high financing charges, even where it is used for only a limited period of time. A financing competition, like that used on the Treasury Building project, can also help achieve better financing rates, if the project is not restricted to a limited choice of financing sources.[29]

20. In terms of attracting finance from pension funds and life insurance companies, the regulatory requirements for the assets that can be held by these financial institutions differ from those applicable to banks. Some of these regulations, relating to the classification of financial interests in private finance projects, act as a barrier to pension funds and life insurance companies' greater participation in the private finance market.[30]

21. Another concern is the persistence of high finance costs throughout the entire life of a PFI project. A high cost of finance applies throughout the operating period, even though this phase represents a lower risk for lenders than the construction phase.[31] This means that the impact of the bank crisis will continue to be felt by PFI projects over the next 30 years as the high bank financing costs are locked in for the life of each project. There is a strong case for unbundling the construction and operating phases, enabling risk to be priced separately on each of the two key stages of any deal.[32]

22. As an immediate response to higher finance costs, the Treasury increased the public sector share of refinancing savings. This means the public sector would capture more of the gains if, at a future date, expensive finance can be replaced by lower cost finance. Banks are willing to refinance their project loans so that they can recycle their capital.[33] New contracts previously provided for 50 per cent of such savings to be shared with the public sector authority. For new contracts since October 2008, the authority share will be 50 per cent of gains up to £1 million, 60 per cent between £1 million and £3 million and 70 per cent of any gain above that.[34] The Treasury believes that there will still be an incentive for the private sector investors to refinance despite now being entitled to a reduced proportion of the refinancing gains.

23. Eventually, the Government may be able to realise up to £400 million in savings from refinancing projects that closed in 2009. However, these gains, which depend on market conditions, are not certain and departments need to be ready to act when conditions are favourable. The Treasury has introduced new arrangements since October 2008 whereby the public authority has the contractual right to request a refinancing, a right which is exercisable once in any two year period.[35]

24. The Treasury is considering the possibility of implementing the National Audit Office recommendation of grouping different PFI projects together to refinance them as a portfolio.[36] Financial institutions with long-term interests like pension funds and insurance companies are likely to be attracted to purchasing debt in a group of similar projects. This would also enhance the public sector bargaining position, reduce transaction costs for all parties and increase the potential gains for sharing between the private and public sectors. The Treasury cannot mandate the private sector investors of different projects to participate in a portfolio refinancing. It can, however, increase the likelihood of these transactions taking place by explaining the benefits that such transactions can secure for both the investors and the public sector.[37]

25. In many projects, investors are realising gains on equity sales of shares in PFI projects as well as through refinancing debt. These gains sometimes arise on complex portfolio transactions. Unlike refinancing gains, there is no requirement for gains from equity sales to be shared with the public sector. If investors are systematically making gains on share sales as well as from refinancing, that would suggest they are regularly earning higher profits than were expected when contracts were signed.[38] This would in turn indicate the taxpayer is not getting a good deal from the original contract. The Treasury does not have a full picture of the situation because it does not monitor the extent of these gains.

25   Qq179-182 Back

26   Q157 Back

27   Q30, Q100, Q152 Back

28   C&AG's report, Appendix Four, Case B, p4 Back

29   Q84 Back

30   Qq191-192 Back

31   Q109 Back

32   Qq70-72 Back

33   Q76 Back

34   Q73 Back

35   C&AG's report, paragraph 2.12, p25  Back

36   Q175 Back

37   Qq176-178 Back

38   Qq130-134 Back

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Prepared 9 December 2010