Written evidence submitted by Skanska
EXECUTIVE SUMMARY
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.
REFERENCES
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
http://www.hm-treasury.gov.uk/press_56_10.htm
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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