Equity Investment in privately financed projects - Public Accounts Committee Contents

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.[19] 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.[20] 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.[21]

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.[22] Open book accounting, where the private sector allows full access to their financial information, is not a common practice.[23]

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[24].

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.[25] 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. [26]

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.[27] 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%.[28] 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.[29]

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.[30] 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.[31]

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.[32] 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.[33] 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.[34]

17.  One area of inefficient pricing results from the high cost of bank debt and the influence of bank lenders on profits.[35] 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.[36] This follows our recommendations in our report on Financing PFI projects in the credit crisis and the Treasury's response.[37]

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.[38] 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 [39]

19   C&AG's report, paragraph 7 Back

20   Ibid, paragraph 2 Back

21   Q1 Back

22   C&AG's report, paragraph 10 Back

23   Q89 Back

24   Ev 23 Back

25   Lessons from PFI and other projects, Forty-fourth Report of Session 2010-12, Conclusion and recommendation 4 Back

26   Qq77-79, Qq172-173 Back

27   Q43, Q70 Back

28   Q58 Back

29   Q16 Back

30   C&AG's report, paragraph 11 Back

31   Q144 Back

32   Q105 Back

33   Q2, Q82 Back

34   C&AG's report paragraph 12 Back

35   Q174, C&AG's report paragraph 11 Back

36   Q124 Back

37   Ninth Report of Session 2010-11, Conclusion and recommendation 4 Back

38   Q89, C&AG's report paragraphs 12, 13 Back

39   Qq66-70 Back

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Prepared 2 May 2012