1 Introduction |
Overview of PFI
1. In November 1992 the then Chancellor of the Exchequer
Norman Lamont made an announcement in the Autumn Statement about
"ways to increase the scope for private financing of capital
was the beginning of what was to become known as the Private Finance
Initiative (PFI), under which groups of private investors manage
the design, build, finance and operation (DBFO) of public infrastructure.
PFI was expanded under the Labour government, which came to power
in 1997. The current coalition government, formed in May 2010,
has confirmed that it remains committed to the Private Finance
Initiative as a way of delivering investment in infrastructure.
In total, 61 new PFI projects were being procured as of March
2011, with a total estimated investment value of £7 billion.
This is additional to over £60 billion of capital investment
(at 2010 prices) already committed by private investors under
signed PFI contracts.
2. In a typical PFI project, the private sector party
is constituted as a Special Purpose Vehicle (SPV), which manages
and finances the design, build and operation of a new facility.
The financing of the initial capital investment (i.e. the capital
required to pay transaction costs, buy land and build the infrastructure)
is provided by a combination of share capital and loan stock from
the owners of the SPV, together with senior debt from banks or
bond-holders. The return on both equity and debt capital is sourced
from the periodic "unitary charge", which is paid by
the public authority from the point at which the contracted facility
is available for use. The unitary charge may be reduced (to a
limited degree) in certain circumstances: e.g. if there is a delay
in construction, if the contracted facility is not fully operational,
or if services fail to meet contracted standards. Thus, the PFI
structure is designed to transfer project risks from the public
to the private sector.
3. The PFI is one form of procurement for the public
sector. There are examples of public sector procurement projects
which have performed both poorly and well. For the most part we
have not focussed on specific cases as we believe that it can
be misleading to focus on high profile and often complex procurements
when trying to assess the costs and benefits of different approaches.
A large body of reports and research has been completed on PFI
and public sector procurement by the National Audit Office and
others. As well as drawing on the evidence submitted to the Committee,
where appropriate we have drawn on this research. In particular
we have considered reports which include samples of projects rather
than reports which examine just one high profile project. Where
possible we have also looked to work which has compared procurement
approaches. We hope that this Report can build on what has already
been done by others. The Report is not an exhaustive examination
of all the details of PFI and public procurementwe have
instead aimed to produce a report in a timely fashion which can
inform work already being done by the Treasury in examining the
use of PFI.
4. In April 2011 the National Audit Office produced
a report which drew
on the significant body of work they had done in the past on PFI.
This report detailed some of the potential benefits and disadvantages
that PFI could bring. A slightly adapted version of a table from
the report is reproduced below:
Table 1: Theoretical benefits and disadvantages
|Potential benefits include...
||Potential disadvantages include...
|Encouraging the allocation of risks to those most able to manage them, achieving overall cost efficiencies and greater certainty of success.
The delivery of an asset which might be difficult to finance conventionally.
Potential to do things that would be difficult using conventional routes. For example, encouraging the development of a new private sector industry.
Delivery to time and price. The private sector is not paid until the asset has been delivered which encourages timely delivery. PFI construction contracts are fixed price contracts with financial consequences for contractors if delivered late.
The banks providing finance conduct checking procedures, known as due diligence, before the contract is signed. This reduces the risk of problems post-contract.
Encouraging ongoing maintenance by constructing assets with more efficient and transparent whole-life costs. Many conventionally funded projects fail to consider whole-life costs.
Encouraging innovation and good design through the use of output specifications in design and construction, and increased productivity and quality in delivery.
Incentivising performance by specifying service levels and applying penalties to contractors if they fail to deliver.
Fewer contractual errors through use of standardised contracts.
|Higher cost of finance which has increased since the credit crisis.|
The prospect of delivering the asset using private finance may discourage a challenging approach to evaluating whether this route is value for money.
Reduced contract flexibility - the bank loans used to finance construction require a long payback period. This results in long service contracts which may be difficult to change.
The public sector pays for the risk transfer inherent in private finance contracts but ultimate risk lies with the public sector.
Private finance is inherently complicated which can add to timescales and reliance on advisers.
High termination costs reflecting long service contracts.
Increased commercial risks due to long contract period and the high monetary values of contracts.
Source: Adapted from NAO, Lessons from PFI and
other projects, Figure 1
Other issues with respect to PFI of which the Committee
was made aware include: reliance on often poor-quality procurement
methods by public sector clients, over-complexity, over-specification,
transfer of risk inappropriate to private sector and raised construction
Assessing the Value for Money
5. The benefits and disadvantages listed in Table
1 will each have differing impacts on the overall value for money
of a project and some of them may not materialise. Some of the
points listed in Table 1 (both positive and negative) may also
apply to other forms of procurement. The key question to consider
is whether or not the actual benefits unique to PFI outweigh the
disadvantages unique to it.
6. The use of
PFI has the effect of increasing the cost of finance for public
investments relative to what would be available to the government
if it borrowed on its own account. This
disadvantage, unique to PFI, is the most easily identifiable and
measurable. The additional cost has two main components: a higher
transaction cost and a higher return to investors. A principle
behind the PFI contractual model is that it allocates risk to
the party that is best able to understand, control and minimise
the cost of the risk. The cost saving potential of PFI can be
seen to be directly linked to benefits derived from improved risk
allocation. Where a firm bears a risk, it has an incentive to
manage it and take steps to avoid any adverse impact from it.
Better management of a risk may result in greater cost efficiency
and in certain circumstances this may lead to a lower cost for
the public sector. The case for PFI therefore rests on the model's
- allocate risks more effectively than conventional
- ensure the public sector gains from the resulting
savings (relating, for example, to tasks such as construction,
maintenance and service provision).
7. Where such savings offset the model's higher financing
costs, PFI may offer greater cost efficiency than conventional
procurement (i.e. it will produce the required outputs at a lower
cost to the public sector) or as the Office for Budget Responsibility
explain in its recent Fiscal sustainability report: "As
long as the higher cost of capital is offset by greater efficiencies
elsewhere, such projects still offer value for money for the public
as cost efficiency is the key policy objective, the future role
of PFI should be determined by its proven capacity to deliver
such savings and efficiencies. In gathering evidence we wanted
to understand whether the PFI theory, or "theology"
as one witness put it, stood up to scrutiny. In particular was
PFI being used because it provided better value for money, or
were there other incentives at play which led to it being used?
8. We are grateful to Richard Abadie, Steve Allen,
James Barlow, Andy Friend, Dieter Helm, Anthony Rabin, James Wardlaw
and Joanna Webber who gave evidence to the Committee. We are also
grateful to all those who submitted written evidence.
9. We would like to thank Mark Hellowell, Lecturer
at the University of Edinburgh, and John Willman, Editorial Consultant,
for their expert advice with the Report.
1 HC Deb, 12 November 1992, col 998 Back
HM Treasury, Public Private Partnerships - Technical Update, 2010 Back
HM Treasury, PFI projects in procurement, March 2011 Back
Committee analysis of HM Treasury, PFI signed projects list, March
C&AG's report, Lessons from PFI and other projects,
HC 920, 2010-11 Back
Office for Budget Responsibility, Fiscal sustainability report,
July 2011, p41, para 2.46 Back
Q 4 Back
Relevant Interests of the Specialist Advisers are as follows:
Mark Hellowell - no interests declared (recorded in Committee's
formal minutes on 27 April 2011). John Willman has done editorial
consultancy work for a number of clients including PwC, HM Treasury
& CBI (recorded in Committee's formal minutes on 24 March
2011). The Committee's formal minutes and full details of all
declared interests can be found on the Committee's website. http://www.parliament.uk/business/committees/committees-a-z/commons-select/treasury-committee/formal-minutes/