Private Finance Initiative - Treasury Contents

Written evidence submitted by Skanska


1.  Skanska welcomes the opportunity to submit written evidence to the Treasury Committee and to contribute to the ongoing debate regarding private investment in public infrastructure.

2.  The UK Government recognises that significant infrastructure investment is required to underpin the UK's growth and that a high proportion of this investment must come from the private sector.i The key is to find a model of investment that works for both parties.

3.  Skanska has been involved in the UK PFI/PPP market since its inception and has accumulated a wealth of experience across sectors including health, education and transport infrastructure. Our experience suggests that, whilst PFI is a significant improvement over traditional procurement methods in many respects, such as long-term cost certainty, it also has weaknesses, such as limited flexibility and high procurement costs.

4.  However, we strongly believe that PFI remains an effective procurement route for certain types of projects and that a number of the concerns about the PFI model can be eliminated or mitigated by some relatively simple changes. These include re-assessing risk transfer, re-examining specifications for both construction and operations and streamlining the procurement process. PFI is a tried and tested model that has evolved over time and both public and private sectors now have considerable experience which can be used to improve the process and its application.

5.  Skanska supports the further development and evolution of PFI to provide a procurement model which facilitates much-needed private sector investment into infrastructure in a manner which meets the current and future needs of the public sector.

What are the strengths and weaknesses of different public procurement methods?

6.  There is a proven need for infrastructure in the UK that is currently unfulfilled. The Government's National Infrastructure Plan 2010ii sets out ambitious targets for development of public infrastructure, particularly economic infrastructure, to facilitate growth and development across the country. In the current economic climate, however, there are insufficient public funds to provide all of the investment required and the Government therefore acknowledges that continuing private investment is vital.

7.  Various funding models have been proposed to facilitate investment from non-public sector sources. We consider some of these alternative models further below (see paragraph 11) but think it is helpful to consider first the strengths and weaknesses of PFI.

8.  PFI is a significant improvement over traditional procurement (ie procurement funded entirely by the public sector) and has brought a number of benefits including:

—  Fixed price, time certain construction—historically, traditional procurement had resulted in construction projects that experienced significant delays and cost overruns. The NAO paper to the Lords EACiii identified that 69% of PFI projects were delivered within a month of the due date and the vast majority of price increases resulted from public sector-requested changes during construction. In contrast, a previous NAO report had found that only 30% of major non-PFI construction projects were delivered on time and 27% on budget;iv

—  Whole-life costing—maintenance of public sector assets tended to be inconsistent and, in difficult economic times, sometimes non-existent, leaving a legacy of dilapidated assets. PFI provides cost-certain long-term maintenance, ensuring that the asset is returned to the public sector at the end of the project in the same condition as it has been maintained throughout the project term;

—  Improved service delivery—the performance regime that is built into PFI contracts provides incentives for high quality service delivery, a major benefit in areas that had not previously been subject to such regimes;

—  Improved public sector procurement—as recognised in the Lords EAC reportv and explored by PwC in its 2008 review,vi the increased discipline in risk analysis and allocation that is required in PFI has spilled over into traditional procurement which has consequently benefited from the lessons learned.

9.  We recognise, however, that PFI is not a perfect procurement solution and is not suitable for all projects. In addressing some of the problems of traditional procurement, it has brought with it some new weaknesses, the main criticisms being that it is inflexible and expensive, tying up public resources that could be used elsewhere.

10.  We acknowledge that there are good reasons for these criticisms, but believe that whilst some of the concerns result from the model itself, others arise from the way in which the model has been used or interpreted. More importantly, the model has been improved significantly over the last 10 years and we believe this development can continue. Areas that we would suggest for improvement include:

—  Risk transfer—it is crucial that risks are transferred appropriately in order to maximise value for money for the public sector (see further paragraph 22 onwards);

—  Projects selected—PFI is more suitable for projects where the public sector requirement over the long term is relatively straightforward and predictable (see further paragraph 32 onwards);

—  Funding—shorter term funding should be considered to reduce costs and increase flexibility;

—  Procurement process—as recognised by the recent HMT review,vii the introduction of competitive dialogue has not been entirely successful. We welcome the recognition that it can be burdensome and expensive and look forward to further Government progress on this issue;

—  Public sector skill base—as recognised in both HMT's review of competitive dialogue viii and their draft guidance on operational PFI savings, ix the lack of public sector skills can have a significant detrimental effect, not just on procurement efficiency but also on management of existing contracts. There needs to be focus on development of public sector in-house skills, encouraging the public sector to take ownership of projects rather than relying on external advisers;

—  Specifications—the public sector need to consider more carefully the specification of the project they are procuring in order to ensure that it represents the best value for money (see further paragraph 25 onwards).

11.  We also recognise that PFI will not be suitable for all procurements and that there are alternatives that have been proposed to channel private investment into public infrastructure. These include:

—  Local asset backed vehicles or LABVs—these are dependent upon the public sector having appropriate land or other assets to transfer into the joint venture vehicle and upon the market value of the land/asset that is available;

—  Tax incremental finance or TIF—used appropriately, this model should result in income generation for the public sector but the model does not of itself provide any infrastructure investment;

—  Regulated asset backed or RAB model—this approach has worked well in the utilities sector but, by passing costs onto consumers, it raises issues around affordability and impact on consumers. Equally, it may be more difficult to apply to social infrastructure where users do not generally pay for the services delivered;

—  User funding—this model requires users to pay directly for the relevant infrastructure so is best suited to areas where there is a clear demand from users eg transport. However, it is not yet clear whether there is sufficient public or political appetite for such schemes to be used more widely.

12.  A detailed analysis of these alternatives is beyond the scope of this evidence, but the committee should note that few have a significant track record in the UK and there is little clarity around their potential strengths or weaknesses. Strategic partnering does not of itself introduce private finance and not all funding models result in development of infrastructure.

13.  In contrast, PFI delivers both funding and infrastructure, bundling together a range of activities that the public sector would otherwise have to manage separately, and also ensures that the public sector retains ownership of infrastructure assets. To date, PFI has played a significant role in the expansion and renewal of UK infrastructure, x ensuring that key Government priorities have been met. xi Equally, PFI is now well understood, with a wealth of expertise and experience across the market and what the IMF described as the best developed PPP programme in the world, xii all of which will facilitate the further refinement of the model to ensure it remains an effective tool for the public sector.

14.  The UK has also successfully exported the concept and there are lessons to be learned in return, eg from Canada (which now has a thriving P3 programme) and from other European countries eg France, Spain which appear to have a more efficient implementation of European procurement rules. Equally, other countries have implemented variants of PFI that could offer insights into potential areas for development eg the co-lending arrangement being used on our New Karolinska Hospital project in Sweden and the Non-Profit Distributing model used in Scotland.

15.  In summary, Skanska believes that PFI offers a solid foundation for future infrastructure investment and that, with the right refinements and used for the right projects, it can remain a useful part of the public sector procurement toolbox alongside other funding and procurement models.

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?

16.  Skanska believes that this is primarily a question for the public sector. From our perspective, the balance sheet treatment of a PFI project should be a by-product of the process rather than a key driver of it. The public sector should select a procurement model on the basis of whether it genuinely represents value for money and should not be influenced by matters such as accounting treatment.

How far can risk really be transferred from the public to the private sector?

17.  Skanska supports the NAO's view xiii that PFI can, when properly implemented, deliver genuine risk transfer. There is a tendency for PFI's detractors to focus on the consequences to the public sector of project failure but risk transfer is a much more complex issue.

18.  We recognise that, ultimately, the public sector are responsible for ensuring that services are delivered - if a project fails, they will need to re-procure those services elsewhere. They are also responsible for ensuring that they have selected the right procurement method for the project and for assessing the absolute need for the asset and services over time (see further paragraph 32 onwards), although it is worth noting that this is no different for PFI than for any other type of procurement - all capital spending decisions pre-suppose that the public sector has made a clear assessment of the evolution of demand over the lifetime of the asset.

19.  However, when projects get into difficulties, the private sector often suffers significant losses. On project failure, investors will usually lose their entire investment (as was the case on the National Physical Laboratory project), often after also spending significant sums trying to rescue the project. For example, when Jarvis and Ballast got into difficulties, investors in some of their projects provided their own cash to ensure that the projects remained viable. xiv It is also worth remembering that, on termination for contractor failure, the public sector will usually receive the project assets at nil cost, which further mitigates any losses they may suffer.

20.  More importantly, project failures are rare and PFI has a very strong delivery record, ensuring long term risk transfer. Delivery is incentivised by the model's structure—construction is for a fixed price and there are significant financial penalties for the private sector for both late construction delivery and service performance failures. Equally, investors have a long-term exposure to the success of the project and tend to be proactive in managing performance and developing good working relationships with the public sector client.xv Skanska, for example, has an asset management team, provided at its own cost, to monitor and manage the projects in which it invests.

21.  The considerable time and financial input from contractors and investors alike tends to ensure that projects continue to run smoothly and is often vital to the project's success, shielding the public sector from risks and costs that they would otherwise have borne.

Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals, or particular projects which are suited for PFI?

22.  Risk allocation should follow the fundamental principles that risks should be allocated to the party best able to manage them. Over time, standardisation of contracts and the impact of the competitive process have led to an increasing level of risk being passed to the private sector xvi and a tendency for the public sector to take the view that greater risk transfer is better.

23.  However, as with any business, a PFI company will need to price and allocate resources to manage the risks that it takes. Where there is a risk that cannot be managed or is difficult to predict, the company may price that risk at a premium. In these circumstances, the public sector needs to consider whether the benefits of this risk transfer outweigh the cost and therefore represent value for money. Standard form contracts have created a generic approach to risk allocation which does not always represent optimum value for money. xvii

24.  We would support the approach of the recent HMT guidance on savings xviii which has identified that there are some risks that unnecessarily add cost to a project. Potential areas to reconsider on existing projects include risk sharing around insurance premiums and capital expenditure resulting from changes in law. In future projects, the scope for varying risk transfer is significantly greater and we would suggest that matters such as title due diligence, title risk and responsibility for project insurance could also offer potential cost reductions.

25.  We also believe that there is scope for better value for money from reconsidering the specification and performance regimes that are being procured. Our experience has been that PFI projects often have premium levels of design (providing landmark, as opposed to purely functional, buildings) and service delivery requirements far in excess of those provided elsewhere in the public sector.

26.  Whilst this step-change in quality of infrastructure and services has been valuable, in a time of austerity, it is necessary to consider whether this approach genuinely represents value for money. In our experience, there has been a tendency for the public sector to seek ever-higher standards without considering whether this is the best use of their funds. For example, rapid responses times for minor issues may seem appealing but the private sector will require additional staff to ensure capacity is always available and this will increase costs.

27.  Equally, PFI currently requires all assets to be handed back to the public sector at the end of the project term, usually a minimum of twenty five years after construction, in the same condition as they are required to be at the outset and throughout the contract. This can be close to the end of the useful life of the asset, thereby creating a significant lifecycle cost. A review of the handback requirements could offer potential savings to the public sector.

28.  We believe that considerations around value for money and appropriate risk transfer also affect the type of projects that are suitable for PFI (see further paragraph 32 onwards).

What state guarantees are explicit or implicit in PFI deals?

29.  At the heart of every PFI deal is the implicit guarantee that the public sector will always pay what it owes. This public sector covenant strength is the cornerstone of the lower lending rates offered by banks and the capital markets enjoyed by PFI projects.

30.  Skanska believe that covenant strength is a key element of any contract with the public sector, but is particularly crucial where it underpins repayment of significant long-term borrowing, as in PFI. We also believe that whilst this guarantee can remain implicit for central and local government (since no local authority has yet gone insolvent), it needs to be explicit for entities such as NHS Trusts, particularly Foundation Trusts, where there is a real risk of insolvency.

31.  Historically, this explicit guarantee has been provided in the form of deeds of safeguard from the Department of Health and, in our experience, has been fundamental to the cost-efficient private sector funding of our acute hospital projects. We therefore believe that removing such deeds from the process has no economic benefit for the public sector.

In what circumstances are PFI deals suitable for the delivery of services?

32.  We believe that PFI is most suitable for the delivery of services that contribute to whole-life costing benefits and which are stable and predictable over the long term. PFI is less suitable for services that need to flex significantly over time to reflect changes in public service delivery, demographics or technology.

33.  The concerns around flexibility logically lead to the conclusion that PFI should be used where the public sector can predict, with a reasonable degree of certainty, that there will be sufficient demand for the services procured, in the same configuration, for the duration of the project term or, alternatively, where it is possible to build flexibility into the design of the asset and/or the services specification from the outset within appropriate value for money parameters.

34.  In contrast, we do not believe that PFI is generally suitable for services that are technology-based such as IT or equipment, because of the pace of change of those areas and the resulting obsolescence risk. For example, our experience of ICT in the Building Schools for the Future programme has been that it over-complicated the process, introducing risks that were unnecessarily complex and which it was therefore difficult to incorporate into the model whilst retaining value for money for the authorities. A number of local authorities, including Bristol Council, Skanska's partner in the Bristol BSF scheme, have now taken the decision to remove ICT from their BSF procurement and procure it separately.

35.  Equally, we believe thought should be given to whether "soft" facilities management services, such as cleaning and catering, should be included. These interface much more closely with frontline services and are proportionately more affected by changes in public sector service delivery. They are also much more exposed to changing employment costs and commodity prices.

36.  This issue has been recognised by HM Treasury in the use of value testing arrangements for these types of services, which allow services to be re-priced periodically. However, whilst our experience has shown that this is a useful tool, its primary benefit is to ensure that the initial costing of services represents the best value for money for the public sector. It is more difficult to use these mechanisms to flex the services themselves, which returns to our point that PFI is best suited for services that can continue in their original form for the duration of the project term.


i  National Infrastructure Plan 2010, HM Treasury and Infrastructure UK, October 2010.

ii  National Infrastructure Plan 2010, HM Treasury and Infrastructure UK, October 2010. See also Lord Sassoon's comments at the plan's launch

iii  A Paper for the Lords Economic Affairs Committee, National Audit Office, October 2009.

iv  PFI: Construction Performance, National Audit Office, 2003.

v  Private Finance Projects and off-balance sheet debt, House of Lords Select Committee on Economic Affairs, 17 March 2010.

vi  The value of PFI - hanging in the balance (sheet), PwC, March 2008.

vii  HM Treasury Review of Competitive Dialogue, HM Treasury, November 2010.

viii  HM Treasury Review of Competitive Dialogue, HM Treasury, November 2010.

ix  Making Savings in operational PFI contracts—DRAFT, HM Treasury, January 2011.

x  Private Finance Projects and off-balance sheet debt, House of Lords Select Committee on Economic Affairs, 17 March 2010.

xi  Government Response to the First Report of the House of Lords Economic Affairs Committee, Session 2009-10, April 2010.

xii  IMF (2004), Public-Private Partnerships, Fiscal Affairs Department, World Bank.

xiii  A Paper for the Lords Economic Affairs Committee, National Audit Office, October 2009.

xiv  The value of PFI—hanging in the balance (sheet), PwC, March 2008.

xv  The value of PFI—hanging in the balance (sheet), PwC, March 2008.

xvi  Public private partnership financiers' perception of risks, Demirag, Khadaroo, Stapleton and Stevenson, 2010.

xvii  Public private partnership financiers' perception of risks, Demirag, Khadaroo, Stapleton and Stevenson, 2010.

xviii  Making Savings in operational PFI contracts—DRAFT, HM Treasury, January 2011.

April 2011

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Prepared 10 August 2011