Written evidence submitted by Colin Raynor[22]
EXECUTIVE SUMMARY
1. The submission goes beyond central and local
government balance sheets by calling for clarity on how PFI partners
should account for their interests. The submission also calls
for open and systematic monitoring of key financial and related
targets for individual projects against independently verifiable
data to better inform taxpayers and assist public expenditure
decisions. The submission uses the Nottingham tram project as
an example of where open and systematic reporting has fallen short
of expectations and raises the question of whether promoters and
their counterparts in government departments can be trusted to
report disappointing project performance and if not what can be
done to remedy this.
2. The examples of the Nottingham tram's Special
Purpose Vehicle Arrow Light Rail Ltd and the publicly owned tram
operator Nottingham City Transport Ltd—a key partner in
the SPV—are used to show how well intentioned politics may
give rise to a lack of transparency in accounting arrangements
that in turn can mask taxpayer risk and give rise to exaggerating
project performance. This can then unduly influences decisions
regarding more of the same.
3. The submission closes by reporting how difficult
it is for members of the public to challenge accounting arrangements
where they believe these may have been wrongly applied. Underpinning
the submission is the folly of not openly monitoring the financial
performance of a project and hastily planning to expand without
first undertaking an independent review to establish whether financial
and associated business plan targets have been met and what lessons
need to be learned before proceeding with more of the same. Responses
to Freedom of Information questions are used as evidence to substantiate
points made.
RECOMMENDATIONS
4. The Select Committee should consider the following
recommendations:
(i) To assist with the understanding of financial
performance by non finance experts including government inspectors,
financial and related targets such as unit costs should be derived
from approved PFI business cases and systematically monitored
and reported by HM Treasury. Targets should be independently verifiable
to ensure credibility (paragraph 10).
(ii) To improve transparency, Government guidelines
for PFI accounting should be reviewed and revised to ensure receipts
from government or local authorities such as the capital grant
and other discretionary payments are separately identified in
the body of SPV accounts. This would also help to identify short
term government subsidies and to form a reasonable view of the
sustainability of projects whose long term survival rely on external
revenue sources (paragraph 17).
(iii) If the government is serious about accounting
for PFI debt and potential risk, it should consult with the relevant
professional accounting bodies to ensure that international accounting
standards are applied within the UK in a manner that requires
appropriate shares of losses and debts incurred as a result of
any involvement with a PFI project to be reported in the body
of private company accounts. This can best be ensured by publishing
reporting expectations immediately following closure of PFI agreements
(paragraph 21).
BACKGROUND AND
ARGUMENT
5. Transparent accounting of PFI is not only
about recording debt on HMG's or even a local authority's balance
sheet—this is "no brainer" as this is clearly
necessary for planning public expenditure at the macro level as
is the need to introduce credit ratings for local authorities.
The government needs also to look at the complex accounting arrangements
for individual PFI projects to see how the public can be assisted
in interpreting results. For example, PFI accounting arrangements
invariably involve a Special Purpose Vehicle (SPV) and in some
instances publicly owned "private sector" companies
as an SPV partner. Each SPV and its constituent partners produce
their own audited accounts and some will show PFI debt and losses.
Yet project promoters can routinely dismiss debt and losses as
merely paper transactions. The public would be greatly assisted
with interpreting project related accounts if clear information
on key financial and related targets were made available so that
a considered view by the non finance expert could be made on whether
a project has delivered value for money in meeting objectives.
6.The example of the Nottingham tram—often
referred to as the Nottingham Express Transist (NET)—is
used to illustrate the need for improved financial and related
information.[23]
For illustrative purposes only, two key players in the Nottingham
Tram project are selected, namely Arrow Light Railway Ltd (Arrow)
and Nottingham City Transport Ltd (NCT). Arrow[24]
is the SPV formed "to design, build, fund, operate and maintain
Line One" of the tram. Previously part of Nottingham City
Council (NCC), NCT is Nottingham's major transport operator and
was set up to operate along commercial lines as a private limited
company in 1986. NCC is NCT's major shareholder and is able to
exert significant influence on its operations.
7. Government approval for the Nottingham tram
was based on a business case founded largely on the economic value
of so called non monetised benefits ie Pound sterling values were
attributed in the business case to assumptions regarding how much
journey time could be saved by non tram users getting in and out
of the city of Nottingham as a result of reduced traffic congestion.
Lesser values were attributed to other assumed economic benefits
such as the creation of new jobs. Attempts to measure and report
on non monetised benefits have not been made although some service
performance data—compiled by the promoter—is reported
in order to justify continuation of the capital grant. However,
this submission puts to one side these and the non monetised benefits
and focuses on the tangible but surprisingly forgotten financial
and related targets hidden in the business plan.
NO SYSTEMATIC
REPORTING AGAINST
FINANCIAL AND
RELATED BUSINESS
PLAN TARGETS
8. In large measure the public has not been well
served by financial performance reports for the Nottingham tram.
Possible targets relating to farebox revenue and patronage were
set out in appendix B to the original business case (copy at Annex
A—[annexes not printed]). Taken together these produce a
crude unit cost (about £0.59 per journey in 2000 prices)
which management accountants would regard as a good efficiency
measure:
Figure One
FINANCIAL AND RELATED TARGETS FOR SUGGESTED
MONITORING TAKEN FROM THE ORIGINAL BUSINESS CASE FOR THE TRAM
| Annual estimated patronage (millions)
| Annual estimated revenue (£millions)
| Unit Cost (£) |
| 2003-04 | 4.4 | 2.32
| 0.53 |
| 2004-05 | 9.94 | 5.86
| 0.59 |
| 2005-06 | 11.12 | 6.55
| 0.59 |
| 2008-09 | 11.34 | 6.69
| 0.59 |
| 2013-14 | 11.86 | 7.0
| 0.59 |
| 2018-19 | 12.37 | 7.3
| 0.59 |
9. Repeated Freedom of Information requests for progress reports
against revenue and patronage targets were made to the promoters
and DfT. Each drew a blank. Two responses received from DfT (copies
at Annex B) will be of particular interest to the Select Committee.
It proves not only that such targets have not been monitored but
that officials apparently don't seem all that bothered that they
have not been monitored. It is also worth noting that prior to
receiving this response I had complained to the Secretary of State
for Transport that an earlier request for a copy of the business
plan could not be met because officials informed me they did not
have a copy. Having then found a copy it seems their copy didn't
have any annexes! Just as worrying is that the same officials
do not consider ANY independent assessment of the tram's financial
performance is necessary before proceeding with more of the same
by way of line extensions (evidence at Annex C).
10. The availability of systematic reports against agreed
financial and related targets would be invaluable. For example,
it was pretty obvious during the Public Inquiry for tram extensions
that the government inspector considering the case had little
financial expertise. Given the difficulty trying to get the information
on financial performance from the project promoters and their
"minders" at DfT there are concerns that left to their
own devices there may be a reluctance to produce such information
should it shed the project in poor light. For this reason it is
recommended that to assist with the understanding of financial
performance by non finance experts including government inspectors,
financial and related targets such as unit costs should be derived
from approved PFI business cases and systematically monitored
and reported by HM Treasury. Targets must be independently verifiable
if they are to be credible
SUSTAINABILITY IN
TERMS OF
OPERATING COSTS
AND REVENUES
IS CRITICAL
11. Given the absence of financial monitoring reports, the
taxpayer is reliant on the accounts of the SPV Arrow for tracking
success. Furthermore, it is not unreasonable when reviewing these
accounts to have in mind the final paragraph of page 10 of the
main body of business case for the tram (Annex D) that states
"a further requirement of the appraisal process is that,
in operating terms, the scheme is financially self supporting,
with operating revenues exceeding operating costs." This
implies—to the lay person at least—that money received
from the fares of passengers might be expected to cover basic
operating costs. This scenario would also support claims by the
project's promoters that the introduction of a tram will significantly
increase the number of fare paying passengers using local public
transport. Indeed such increases were deemed necessary to achieve
the desired operating surplus.
The operating profit reported by the spv could also be reported
as a loss
12. There are guidelines for the production of SPV accounts
but in practice the tram's promoters have a high degree of flexibility
which could intentionally or unintentionally be used as in the
case of the Nottingham tram to give the impression that money
received from the fares of passengers have covered basic operating
costs and to claim, if this is the case, that the tram is a profit
making sustainable enterprise. These concerns are best considered
by comparing the results of Figures two and three below.
13. Figure two shows an extract taken form Arrow's audited
profit and loss account for the year ended 31 December 2009 (full
copy at Annex E). We can see the accounts give an impression that
everything is going according to plan as they show an operating
profit before depreciation for the year: This bottom line is regularly
quoted as the headline result by the promoters to demonstrate
the success of the project. The promoters openly dismiss depreciation
as a paper transaction. More worrying is the fact that financial
analysts may routinely take the reported operating profit as the
basis for comparing performance with private companies which may
have different reporting policies. This potential inconsistency
needs to be addressed.
Figure Two
EXTRACT FROM ARROW'S P&L ACCOUNT, YEAR ENDED 30 DECEMBER
2009
| 2009 (£000) |
2008 (£000) |
| Turnover | 29,074 | 29,157
|
| Other external charges | (9,849)
| (9,731) |
| Operating profit before depreciation | 19,225
| 19,426 |
| | |
| Depreciation | (7606) | (7,483)
|
| Operating profit | 11,619
| 11,943 |
| | |
| Net interest payable | (16,187)
| (16,399) |
| Loss on ordinary activities before taxation
| (4,568) | (4,456) |
Lobbying for improvements to arrow's accounts
14. Pre 2009, turnover as presented in the 2009 p&l account
was described in Arrow's accounts as "farebox revenue"
because Arrow's accounting policy was to lump together money received
from fare paying passengers with money received from the local
authority for concessionary fares and the capital grant received
from government. Members of the local community felt this lacked
transparency and that the presented accounts could mask losses
and unreported subsidies. These concerns were dismissed as irrelevant
by the project's promoters and the government inspector considering
the case for extensions.
15. After a full two years of lobbying the Financial Reporting
Council, DfT and the local press to have the constituent elements
separately identified, Arrow produced for the first time a partial
breakdown in note one to the 2009 accounts. This was very much
welcomed although it doesn't go far enough because the amount
received by way of concessionary fares has still not been separately
identified. This is important because payments made for concessionary
fares are understood to be discretionary and therefore subject
to possible change eg some local authorities have recently stopped
making payments for concessionary travel during peak travel time.
If such a change were to be applied to the tram it could have
a detrimental and material impact on revenue. There is also no
way of knowing whether the unit cost applied to such journeys
for payments by the local authority is "reasonable"
or comparable to that used in the business case.
Reorganising Arrow's p&l account to give a fairer view?
16. The partial breakdown of receipts in note one to Arrow's
2009 accounts has enabled Figure three to be produced. This comprises
a p&l account for Arrow in which farebox revenue is directly
compared with operating costs and matches the capital grant/availability
payment with the interest payable on the PFI loan. This seems
more consistent with public expectations vis-à-vis reporting
progress towards meeting the business case requirement that "the
scheme is financially self supporting, with operating revenues
exceeding operating costs." Furthermore it is seen that after
6 years of operation the tram does not appear to have met this
objective and that the availability fee may include an element
of subsidy ie the availability fee certainly exceeds interest
payable on the PFI loan. Figures two and three also illustrate
how accounting policy can influence public perceptions ie the
promoters have chosen to show a profit as opposed to what others
may regard as a loss. This may have influenced decisions on extensions.
Figure Three
AN ALTERNATIVE VIEW OF ARROW'S P&L ACCOUNT, YEAR ENDED
30 DECEMBER 2009
| 2009 (£000) |
2008 (£000) |
| Farebox revenue | 7,845 |
8,186 |
| Other (expense)/income | (38)
| 47 |
| Other external charges | (9,849)
| (9,731) |
| Operating loss before depreciation and availability fee/capital grant
| (2,042) | (1,498)
|
| Availability fee income/capital grant | 21,267
| 20,924 |
| Net interest payable | (16,187)
| (16,399) |
| Operating profit before depreciation and after payment of availability fee/capital grant
| 3,038 | 3,027
|
| | |
| Depreciation | (7,606) |
(7,483) |
| | |
| Loss on ordinary activities before taxation
| (4,568) | (4,456)
|
17. There are at least three reasons why the alternative view
or something very similar would be more transparent and useful
than the present view:
— The
accounts would show clearly on the face of the accounts how the
government's capital grants are being dispensed.
— The
accounts would better facilitate a comparison with financial projections
set out in the original business case for the tram.
— Reconciliation
between claimed passenger numbers and fare box revenue would be
facilitated. This is currently not done in spite of apparent anomalies.
It is therefore recommended that to improve transparency,
Government guidelines for PFI SPV accounting should be reviewed
and revised to ensure receipts from government or local authorities
such as the capital grant and other discretionary payments are
separately identified in the body of SPV accounts. This would
also help to identify subsidies and for those reviewing accounts
- possibly with a view for bidding for future PFI contracts -
to form a reasonable view of the sustainability of projects whose
long term survival relies on external revenue.
Different interpretations of international accounting
standards give very different presentations of results and can
be misleading
18. NCT adopted international accounting standards
for the first time when reporting its financial performance for
the 2005-06 financial year. According to the Chairman of NCT,
the reason was "to ensure that the Group is using the same
reporting framework as their corporate shareholder and other Arrow
investors which improves the comparability of the Group results".
But has this really been the case? The Select Committee can take
a view on this by comparing how NCT and its corporate shareholder
Transdev PLC - both with similar shareholdings and representation
on Arrow's board - apply international accounting standards in
reporting their interests in Arrow. The approaches are radically
different.
NCT uses international accounting standards in
a way that keeps its share of arrow's losses off the p&l and
aalance sheet whereas transdev does not
19. The difference between the way in which NCT
and Trandev interpret international accounting standards in reporting
their interest in Arrow can be best summarised in Figure four
below. Figures are indicative and have been taken from NCT's audited
accounts for the period ending March 2010 (copy at Annex F). It
should be noted that NCT's statements are produced for a period
commencing three months later than the financial statements of
Transdev thus allowing ample time for consultation between the
parties on a consistent application of accounting standards -
consultation that is necessary in order to meet NCT's stated objective
of improving "the comparability of the Group results".
It is also worth noting that Trandev has chosen to "take
a hit" in respect of Arrow's losses on its p&l account
and balance sheet whereas NCT has decided on an alternative interpretation
on the basis that Arrow should be deemed an associate of NCT because
of its input to strategic decision making.
Figure Four
TO SHOW HOW DIFFERENT INTERPRETATIONS OF
INTERNATIONAL ACCOUNTING STANDARDS CAN PRODUCE RADICALLY DIFFERENCE
RESULTS FOR NCT
| £000 |
| Reported profit before taxation year ended March 2010
| 3,329 |
| Share of Arrow's losses as reported in note 14 to accounts
| (4,568) |
| The loss that would have been reported if NCT had applied the same interpretation of international accounting standards as Transdev.
| (1,239) |
20. Alarmed by the radical difference in approaches, complaints
were made to the international accounting Steering Board, HMT
and DfT. DfT advised that I refer my concerns to the Financial
reporting Council (FRC) as presumably DfT experts could see nothing
wrong with the different interpretations (evidence of DfT's advice
is at Annex B). The pursuit of transparency has been a long slog.
Following correspondence with FRC over a period of two years it
seems that both interpretations may be acceptable depending on
the terms of the PFI agreement as this may not treat each party
equally. Nevertheless, on 6 March 2011 FRC advised that it would
write to NCT to "help it determine the status of its investment
in Arrow". Disappointingly, FRC has not yet advised whether
it will also contact Transdev to ask the question whether it believes
its input to Arrow's strategic decision making is equal to NCT's.
21. Part of the delay has been caused by my failure to properly
articulate concerns although FRC also failed to appreciate Arrow
was an SPV. The deliberation by FRC is thus eagerly awaited. In
the meantime, if the government is serious about PFI debt and
potential risk it should seek greater clarity with regards to
PFI accounting within the ambit of international accounting standards
as soon as possible. It is therefore recommended that HMT should
consult with the relevant professional bodies to ensure that international
accounting standards are applied in the UK in a manner that requires
appropriate shares of losses and debts incurred as a result of
any involvement with a PFI project to be reported in the body
of private company accounts (p&l account and balance sheet)
especially those "owned" on behalf of the taxpayer by
local authorities. This can best be ensured by publishing reporting
expectations immediately following closure of PFI agreements thus
reducing any chance of confusion and opportunity for a "pick
and mix" approach.
April 2011
22
Colin graduated from Sussex University with a degree in economic
and social geography. He is an associate member of the Chartered
Institute of Management Accountants and a member of the Institute
of Risk Management. He holds qualifications in anti-corruption
(awarded by the Chancellor Michelson Institute, Bergen) and in
international compliance (awarded by the International Compliance
Association). During a long career in the UK and international
civil services he held a number of positions including HM Treasury
Accountancy Adviser, Head of Resource Management and Finance in
the Department for International Development, Senior Adviser in
the United Nations Industrial Development Organisation, Anti-corruption
analyst, Head of DFID's Private Sector Infrastructure Team and
audit management posts in the Department for Health and the FCO/ODA.
He currently does voluntary charity work on behalf of the Environmental
Law Foundation. As a concerned citizen, Colin takes an active
interest in local development issues and promotes transparency
on behalf of his local community at every opportunity. Back
23
Some service performance data-apparently compiled by the promoter
and the operators-is reported presumably in order to justify continuation
of the capital grant/availability fee. Back
24
Latest shareholdings in Arrow comprise the tram's operating partners
NCT (14.3%) and Trandev PLC (12.5%) plus Innisfree (36.4%), Galaxy
SARL (24.3%) and Bombardier Transportation (12.5%). Back
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