Written evidence submitted by KPMG LLP,
John Laing PLC and Lloyds Banking Group PLC
FOREWORD
1. We are pleased to submit this response to
the House of Commons Treasury Committee on the Private Finance
Initiative ("PFI"), and welcome the opportunity for
further healthy scrutiny of this particular approach to procurement.
2. Our organisations share a belief that the
interests of public value for money, transparency and accountability
are best served by comparing and evaluating across the full portfolio
of procurement approaches available to the public sector. PFI
is one such approach, but only one. A wider scope for this
inquiry, covering all public sector procurement, would allow for
true comparisons to be made, and highlight the relative strengths
and weaknesses of each approach.
3. The Inquiry will no doubt elicit many submissions
outlining the positives and negatives associated with the PFI
approach. With the spotlight on one approach only, the danger
is that supporters of PFI emphasise examples of its success and
detractors emphasise examples of its failure and the true and
fair view is obscured.
4. This joint submission has been prepared with
a view to placing PFI in the wider context of public procurement.
The intention here is not to "defend" PFI by attacking
alternatives. Indeed, each of our organisations are conscious,
and to some extent living the financial consequences, of examples
of both poorly procured PFI deals, and deals which should never
have been PFI in the first place.
(a) As adviser to public and private sector clients
KPMG has frequently advised clients not to pursue PFI within particular
project contexts.
(b) As investors in a wide range of government
contracts, not just PFI, John Laing withdrew from the London Underground
PPP bid process after concluding that the procurement approach
was inappropriate in the context of an unclear specification that
would be likely to favour contractors.
(c) One of the largest investors in and lenders
to PFI projects, Lloyds has real insight and practical experience
of a small number of PFI projects that have run into difficulties:
where risks that are conventionally borne by the public sector
have vested with the private sector, and the private sector has
borne the consequences. To put this into perspective, Lloyds is
involved in around 200+ PFI projects, of which only a few have
run into difficulties.
5. Despite the examples of projects which have
failed under PFI, we believe that PFI has brought tangible benefits
to the UK taxpayer, and that it should continue to be adapted,
amended, and to be considered alongside other procurement approaches.
Best value for the taxpayer will be achieved through continually
evaluating projects and reconsidering procurement approaches.
Indeed, we suggest that the rigour that the National Audit
Office has applied to value-for-money reviews of PFI deals should
be rolled out across all conventional procurement too. There
is much to learn from the failures of conventional public finance
procurements such as Eurofighter, Wembley Stadium, the British
Library, the Cambridgeshire Guided Busway, and currently the Edinburgh
Tram.
What are the strengths and weaknesses of different
public procurement methods?
6. A fundamental challenge for the debate over
public procurement is the lack of good quality data on the historic
costs of the public sector procuring and operating its assets
and services. This affects the ability of Government to properly
compare the value for money of different procurement approaches
and the ability of Parliamentary inquiries such as this to properly
review those decisions.
7. We believe government should invest in systematically
collecting and analysing evidence on the comparative performance
of all procurement approaches. This is not straightforward, as
"brick-by-brick" pricing fails to reflect the different
commercial terms and long-term maintenance costs. To date the
highest quality analysis has been undertaken by the National Audit
Office[25],
[26],
[27],
Partnerships UK[28],
[29],
and University College London[30]
and we recommend the Committee to consider those reports.
8. The single biggest step in this regard would
be the institution of a set of national infrastructure accounts,
which would show both asset investment and asset depreciation.
Such accounts would provide a starting point for inquiries such
as this to get under the skin of the infrastructure challenge
and to compare like with like, and would force the public sector
and its partners to think long-term.
9. Annex One to HM Treasury's National Infrastructure
Plan[31]
contains helpful distinctions between approaches to public procurement.
It is clear here that different approaches are expected in different
arenas, reflecting the respective merits of each. What may in
one circumstance be considered a weakness—eg having to take
considerable time to negotiate contractual terms on how costs
to government for a PFI deal are expected to increase over time
(indexation)—may in other circumstances be considered a
strength—eg confirming the government's own exposure to
various indices.
10. We consider that there are a series of axes
against which procurement approaches should be evaluated: transparency;
urgency; accountability; risk transfer; budgetary flexibility;
specification flexibility; project complexity; depth of market
competition; and cost optimisation. The question of "value-for-money"
is much wider than just getting the lowest bid price, or even
transferring the most risk, but it is about optimally meeting
requirements in the broadest sense. The failure of Jarvis evidences
the danger of judging the quality of bids primarily by reference
to lowest bid price.
11. PFI itself has become something of a UK export
success story. UK firms and UK professionals have been instrumental
in establishing burgeoning PPP markets in the USA, France, Germany,
Australia, Canada, and throughout the Middle East. These states
have been attracted to the transparency and accountability which
comes with the introduction of private finance. Indeed, it is
worth reflecting on the point that even oil-and cash-rich nations
with large sovereign wealth funds are using PFI, even though they
evidently do not need the finance.
12. We believe the PFI programme will continue
to bring much needed innovation to public procurement and that
the case for PFI's continued role can be made. PFI today is quite
different to the PFI of 15 years ago.
13. The future role of private finance is subject
of a legitimate debate around such questions as: the appropriate
discount rate for government to use in evaluating whole-life costing;
how decisions are made between procurement approaches; how public
sector stop/go decisions are made; how "value for money"
can be proven; how barriers to entry can be reduced to encourage
further competition; how procurement processes can be streamlined;
how the cost of private finance can be reduced through milestone
payments or other upfront contributions; when to tender key subcontracts;
and how performance data is best displayed. But the scope for
continual improvement is no reason to abandon the PFI approach
altogether.
In what circumstances are PFI deals suitable for
delivery of services?
14. The challenge for public sector procurement
is in determining which approach is the most suitable within a
specific project context, and this challenge applies whether the
proposed project is infrastructure or services or both.
(a) PFI deals generally take a long time to procure,
down in part to commercial complexity and in part to the need
for clear specification at the outset. We would suggest that PFI
is not suitable for urgent "quick-fixes".
(b) PFI deals offer cost and project transparency
which is substantially ahead of other procurement approaches.
PFI enables the public sector to enter into commitments with its
eyes wide open. Building a new school is a financial commitment,
and a commitment to a community, and whereas under PFI the costs
of the school are defined, conventionally the long term costs
of the commitment to the community are unknown. Such transparency
also enhances accountability: across much of the world PFI is
promoted as a route to tackling corruption.
(c) PFI relies on clear upfront specification
in order to optimise a series of asset management and investment
tradeoffs. This means that PFI tends not to be suitable where
substantial flexibility is required, such as, for example, in
IT procurement.
(d) One common criticism of the PFI concept is
that it is rigid, and prevents governments substantially changing
budgets on a regular basis. In some cases such flexibility may
be helpful, but in many cases it is perverse to suggest that deviations
should be made from an optimally planned maintenance regime. The
rationale behind whole life costing is that lower investment on
an ongoing basis saves substantial costs down the line. To argue
for short term budget flexibility is to saddle future taxpayers
with a disproportionately higher backlog of maintenance work.
(e) Straightforward and commoditised procurements
do not necessarily benefit from the rigours of the private finance
approach, but where projects get too complex and specifications
grow and grow the constraints of private finance can undermine
delivery quality. For PFI it is important that both the specification
and project risks are clear. The London Underground PPPs failed,
in part, because the condition of inherited assets was not well
understood.
(f) The depth of market competition does not
necessarily correlate with project complexity, and is always something
that should be considered before a procurement approach is adopted.
There is no point running a competitive process in which only
one bid is received: different procurement approaches offer different
solutions to non-competitive situations. PFI isn't best able to
manage this kind of situation, and the competitive pressure between
bidders is essential to keeping costs low.
(g) The importance of the discipline that comes
with whole life costing, and asking contractors and their lenders
to put their money behind their forecasts to the PFI concept cannot
be understated. In the right deals the higher cost of capital
required on PFI deals[32]
compared with public finance can be more than justified on the
basis of risk transfer, and enhanced planning, accountability
and risk management.
15. Whilst we do believe that there is potentially
a role for private finance in the delivery of frontline services,
this would likely require a step away from PFI in its traditional
form. Projects risks and opportunities are likely to be different,
especially under payment-by-results style regimen.
How far can risk really be transferred from the
public to the private sector?
16. Successful risk transfer is based on understanding
not just the project risks, but also which counterparty is best
suited to managing those risks. Successful risk transfer is about
finding a balanced risk transfer in which risk is optimally located
with the party best placed to manage it, and who has the best
incentives to do so.
17. In order to ensure contractual clarity and
to properly scope the project, PFI investors undertake rigorous
through-life risk analysis, and this forms a substantial part
of the PFI procurement process. The intensity of such analysis
makes PFI deals stand apart from conventional deals: under conventional
procurements the incentive both for the public sector and the
delivery partner to undertake risk analysis is diminished.
18. From the public sector perspective it is
about incentivising best delivery. Risk analysis feeds into contractual
incentive mechanisms, making the risks less likely to occur. Where
risks are transferred to the private sector, and risks do in fact
occur, the private sector bears the impact.
19. Lloyds has practical experience of projects
(eg Dudley Hospital and Whittington Hospital) where costs which,
were it not for PFI, would sit with the public sector, such as
the cost of delayed completion, have been borne by the private
sector (contractor, equity provider, investor, banks).
20. In the early years of PFI when John Laing
fulfilled the combined role of investor and contractor, it experienced
losses in excess of £130 million across a number of PFI projects
on which technical problems gave rise to cost overruns. The most
notable being the National Physics Laboratory which has been the
subject of an NAO review and Public Accounts Committee review.
21. True comparison across procurement approaches
requires us to understand the parallel risks under conventional
procurement. How many conventionally procured projects have faced
delayed completion, and what has the cost of this been to the
taxpayer (and future taxpayers) when the public sector has had
to foot the bill?
22. In aggregate, across a portfolio of deals,
the question has to be whether the premium that the public sector
pays for risk transfer is too high. Good public sector procurement
should ensure that comparator modelling is undertaken to explore
what the cost to government of retaining such risks is. Indeed,
the understanding of whole life project risks and their potential
impacts is one of the key disciplines which the PFI approach imposes.
Are there particular kinds of risks which are
particularly appropriate for transfer through PFI deals or particular
projects which are suited for PFI?
23. Projects must be treated on a case-by-case
basis, but as our analysis above suggests, PFI is likely to prove
most attractive where transparency, accountability and cost optimisation
are required, where a detailed specification can be achieved and
extensive flexibility is not required, where there is no immediate
urgency, where risks can be evaluated and risk transfer optimised,
and where there is a competitive delivery market.
What state guarantees are explicit or implicit
in PFI deals?
24. Under PFI government guarantees to pay if
the project requirement is met, and in this regard is no different
to any other contract. If the provider fails to deliver the requirement,
the government's liability is reduced or eliminated.
25. If the public sector opts to terminate a
deal it is equally costly under PFI or conventional procurement.
Whilst under PFI the full return to equity providers and lenders
has to be paid out at the time of termination, under conventional
procurement the equivalent investment will have already been made
through gilt issuance and would be a sunk cost.
26. Any further guarantees in PFI deals are explicitly
written into contracts (such as the SOPC4 standard). As commercial
arrangements entered into following rigorous analysis both the
private sector and the public sector are expected to face the
consequences of the deal—and in some cases this has means
that the private sector has lost money.
27. From the public sector perspective a key
difference between PFI and conventional procurement is that whilst
under PFI, state guarantees are transparent and can be managed;
under conventional procurement such risks tend to be implicit
only.
If PFI debt had been on-balance sheet rather than
off-balance sheet would PFI projects have been used as much? How
should PFI deals be accounted for?
28. The decision as to whether to proceed with
a PFI deal should be based on rigorous qualitative and quantitative
value for money evaluation of all the procurement options available.
Balance sheet treatment should not be a part of this evaluation,
and neither should the availability of "credits".
29. There may have been some cases in the past
where too much risk was transferred out of government in an attempt
to secure "off-balance sheet" treatment.
CONCLUSION
30. We firmly believe there is a continuing role
for PFI, but as one of a range of possible means of procurement.
In the past, PFI has been the default method and its very existence
may have resulted in projects being shaped to fit the PFI model.
Any decision to proceed with a capital intensive project should
be driven by need and affordability, regardless of balance sheet
treatment. The selection of procurement method is a secondary
consideration but for the reasons set out above we believe PFI
will continue to present the most appropriate method in many instances
and will present the best value for money on a risk adjusted basis.
April 2011
25 Improving the PFI tendering process, National
Audit Office, 2007. Back
26
Construction performance, National Audit Office, 2003. Back
27
Managing the relationship to secure a successful partnership
in PFI projects, National Audit Office, 2001. Back
28
Report on Operational PFI Projects, Partnerships UK, 2006. Back
29
Investigating the performance of operational PFI contracts,
Partnerships UK, 2008. Back
30
PFI in school building-does it influence educational outcomes?
KPMG, 2009. This report draws on research conducted under the
supervision of Graham Ive of the Bartlett School of Graduate Studies. Back
31
National Infrastructure Plan, HM Treasury, 2010. Back
32
Again, there is helpful analysis of this in Annex 1 of the National
Infrastructure Plan. Back
| 
