2 The role of equity investors in
private finance projects
10. Equity investors play an important role in
developing deals by bringing together the private sector team,
designing and overseeing sub-contracts and securing debt finance.
Some investors are contractors who take the initial risks of a
long tendering period, and the construction risks, but often sell
their shares soon after the asset has been delivered to realise
the profits or fund new projects.
Other investors retain their initial shares or buy contractors'
shares to secure stable returns from a project's operational period.
Investors' views on how projects are operating can provide valuable
information to inform changes that can improve the procurement
and development of PFI projects.
11. There has, however, been little transparency
over the returns which investors have made from PFI projects which
has damaged the public perception of this form of procurement.
The Treasury has not gathered information on a systematic basis
to demonstrate that the pricing of equity is optimal.
Open book accounting, where the private sector allows full access
to their financial information, is not a common practice.
12. We are concerned about the extent to which
interests in PFI projects are held overseas and whether Treasury
takes proper account of this when they assess the tax implications
of PFI. The Treasury believes that all PFI project companies are
registered in the UK, but cannot confirm this as it does not hold
information on the identity of each project company. The Treasury
expects issues relating to corporation tax to be taken into account
in assessing the value for money of PFI deals, but does not consider
the extent to which ultimate investors in PFI projects may be
based overseas and thereby not liable to UK capital gains tax.
13. This Committee has previously called for
private sector companies to be subject to the provisions of the
Freedom of Information Act for work they do that is funded by
the taxpayer, to provide proper transparency on the private sector's
handling of government projects.
The investors we questioned accepted that they should be subject
to Freedom of Information but believed this should only happen
if the same conditions applied to all forms of procurement. The
Treasury expressed reservations about extending the Freedom of
Information Act to contractors for reasons of cost and commercial
sensitivity but once contracts have been let we are not convinced
this argument is valid. 
14. The investors we questioned pointed to difficulties
they faced in engaging in PFI projects. These included the significant
lead times and procurement costs including time on bids that never
come to fruition. Investors take these issues into account in
deciding whether to invest in PFI projects in the UK as opposed
to opportunities overseas.
Carillion told us that they had incurred losses on certain projects
although overall they are making a return from PFI projects in
excess of 15%. In
the case of the Queen Alexandra PFI hospital, Portsmouth they
confirmed they were able to sell their investment of £12
million for £31 million within a few years.
15. Nevertheless, the available evidence strongly
suggests that, in the main, the returns which equity investors
receive from PFI projects are too high for the risks they bear.
There are a number of market inefficiencies which contribute to
the government paying more than is necessary for equity. These
inefficiencies have contributed to some investors having made
annual returns as high as 60% on selling their shares in PFI projects.
Such high returns also reflect that the Government, in providing
the private sector with long term stable cash flows, similar to
an annuity, is creating an attractive tradable product once the
early construction risks have been dealt with.
16. Most investors achieved greater returns than
they expected when they entered into PFI projects which suggests
that the risks are not as great as the investors had assumed in
pricing the deals.
Mark Hellowell of the University of Edinburgh considered that
the annual PFI charges paid by the public sector could be 3% to
5% higher than is necessary because of the inefficiencies in the
way that equity is priced in the deals.
The National Audit Office's detailed analysis of three deals found
unexplained profits of around 1.5% to 2.2% of the public authorities'
annual payments, amounts which become significant over 30 years.
17. One area of inefficient pricing results from
the high cost of bank debt and the influence of bank lenders on
profits. We welcome
the Treasury's intention to bring in more diverse sources of finance,
including pension funds, reducing the amount of bank debt and
the banks' influence on investors' profits.
This follows our recommendations in our report on Financing
PFI projects in the credit crisis and the Treasury's response.
18. Doubts remain whether competitions for PFI
contracts secure the best price and eliminate investors' opportunities
for excess profit. Consequently, the public sector needs to be
vigilant in challenging all aspects of pricing in bids. In order
to challenge bidders' prospective returns, departments require
current knowledge of pricing in the market for equity in operational
PFI projects. Where
there is evidence that investors are making high rewards during
the contract period which are out of line with the risks they
bear, public authorities need mechanisms for sharing in these
rewards. Investors in PFI projects are more likely to accept sharing
returns above a predetermined level than to accept a cap on equity
profits or a share of gains on share sales. This is because investors
may need to benefit from projects which are going well to offset
those which may be delivering lower returns than expected
19 C&AG's report, paragraph 7 Back
Ibid, paragraph 2 Back
C&AG's report, paragraph 10 Back
Ev 23 Back
Lessons from PFI and other projects, Forty-fourth Report
of Session 2010-12, Conclusion and recommendation 4 Back
Qq77-79, Qq172-173 Back
Q43, Q70 Back
C&AG's report, paragraph 11 Back
Q2, Q82 Back
C&AG's report paragraph 12 Back
Q174, C&AG's report paragraph 11 Back
Ninth Report of Session 2010-11, Conclusion and recommendation
Q89, C&AG's report paragraphs 12, 13 Back