Written evidence submitted by UK Contractors
Group
EXECUTIVE SUMMARY
1. In this evidence UKCG argues that:
— Continued
infrastructure investment is essential to maintain the UK's international
competitiveness and to stimulate growth and employment.
— PFI
has been one way of delivering that investment. It has significant
strengths on which we should build. Even so, it could be delivered
more cost effectively if government was clearer on its long term
investment intentions and there was a more equitable sharing of
risk between the public and private sectors.
INTRODUCTION
2. UKCG represents over 30 leading construction
companies who together produce some £36 billion of construction
turnover—some 30% of the construction industry's total output.
UKCG members have played an active role in PFI as construction
contractors, investors and asset managers. UKCG members have greatest
experience on the construction of PFI assets and especially the
procurement processes used. This evidence therefore largely focuses
on these elements.
INVESTING IN
UK INFRASTRUCTURE
3. The UK needs modern infrastructure to maintain
its international competitiveness. The CBI has suggested that,
to maintain the UK's existing infrastructure assets, the country
needs to spend at least 2.25% of GDP on capital programmes. However,
current fiscal constraints have reduced annual spending to around
1% of GDP and there is little immediate prospect of any increase.
This risks our asset base deteriorating and a decline in international
competitiveness. Use of private finance could help to bridge the
growing shortfall in capital spending provided that it is affordable
in the longer term.
4. Moreover, construction investment stimulates
both growth and employment. An independent report produced for
UKCG by L.E.K. consulting showed that:
— every
£1 invested in construction generates £2.84 in total
economic activity;
— every
£1 spent yields a return of 56p to the Exchequer—net
investment is therefore 44p; and
— 92p
in every £1 spent is retained in the UK.
5. The report also demonstrated that investment
in construction in the UK is the best way of stimulating employment.
A full copy of this report is attached (Appendix 1) to this evidence.
6. With economic growth remaining fragile and
youth unemployment worryingly high, more construction investment
would help to stimulate the economy and employment.
7. PFI has been a means of delivering longer
term investment programmes because it spans changes of government
(nationally and locally) and allows investment to remain fairly
constant throughout the economic cycle.
8. The UK construction industry performs at its
best when it has clear information about the forward line of infrastructure
investment. Given adequate information about the output required
(eg numbers of new houses, hospitals and roads) it can help develop
the most cost effective solutions to deliver them. Such information
provides investor confidence to allow the industry, for example,
to purchase material in bulk, invest in off-site pre-fabrication
and to exploit economies of scale.
9. Currently information about public sector
investment is patchy at best and recent political rhetoric about
PFI has damaged investor confidence. This has been partially recognised
by the government which has made a commitment to publish better
information on forward investment from the Autumn of this year.
It is required now as a matter or some urgency. In addition, the
industry has yet to engage with government in a meaningful discussion
about how we might produce alternative procurement models building
on the strengths of PFI and overcoming its weaknesses.
THE STRENGTHS
AND WEAKNESSES
OF PFI
10. Almost without exception PFI funders and
investors have required the construction to be procured via a
design and build contract which provides certainty that the project
will be delivered to time and to budget. That is one of its main
strengths.
11. A major criticism of PFI is that it is an
expensive way of borrowing money. Without doubt government can
borrow money more cheaply than the private sector because it is
not pricing specific "risk". However, that means the
risks are not always properly analysed leading to project costs
escalating and to programme delays. Over 70% of non-PFI projects
are delivered over budget and in all such instances the public
sector has had to pay more. In contrast, less than 20% of PFI
projects have been over budget and in most of these cases the
cost has been borne by the contractor and not by the public sector.
12. Other strengths of procurement via PFI include:
— It
manages "risk" much more effectively because of the
extensive due diligence necessary to secure private investment
- hence the majority of projects are delivered to time and budget.
— It
provides greater transparency on the "whole life costings"
of projects, because of the obligation to maintain the facilities
to pre-agreed stringent standards and hence clearer information
on value for money.
— It
maintains the asset to pre-agreed standards. In contrast, buildings
procured by other methods often quickly fall into disrepair due
to the lack of an adequate maintenance budget.
— PFI
has transformed the way in which the public and private sector
work together—relationships have moved from one of adversity
to partnership and trust—also increasing certainty of outcomes.
— Because
the public entity is entering into a long-term commitment it has
been encouraged to consider its long-term requirements, possible
changes to how services are delivered and procure more flexible
and adaptable buildings.
— Generally,
because the buildings are owned by the private sector partner,
the authority avoids having to pay capital charges.[71]
— Generally
the asset is returned free of charge at the end of the concession
(even LIFT[72]
offers an option to acquire at below market prices).
13. As operated in the UK, there are also a number
of weaknesses with the PFI model. These are:
THE PROCUREMENT
PROCESS IS
OVERLY LONG,
EXPENSIVE AND
WASTES RESOURCES
14. There are various reasons for this:
— In
the early days of PFI (especially in the health sector) it was
because the public sector could not decide quickly what it wanted
and what it could afford. A survey carried out by the then Major
Contractors Group in 2005 on 57 PFI projects showed that the average
delay in projects against published schedules was 8 months and
the costs associated with these delays were £1.21 million
per project (some 1.6% of project values).
— More
recently, when not applied appropriately the EU Competitive Dialogue
Procedure has led to delays in the procurement process and consequently
increased costs. This was recognised in the findings of the HM
Treasury Review of Competitive Dialogue published in November
2010.
— In
the recently aborted Building Schools for the Future Programme
the client required too many fully worked up bespoke designs the
majority of which were wasted as contractors were eliminated from
the competition. More upfront attention to design and some elements
of standardisation would reduce procurement costs significantly.
15. Even now the procurement process for a new
hospital project in the UK can take over two years before any
construction work is undertaken. For example, Papworth Hospital
Procurement—OJEU in August 2010 and due to sign a contract
in late 2012. However, in contrast, where PFI has been exported
the procurement process has been shorter and slicker. For example
the equivalent timeline for Bermuda's first PFI project was less
than 18 months.
THERE HAS
BEEN AN
EVER INCREASING
TRANSFER OF
RISK TO
THE PRIVATE
SECTOR
16. PFI seeks to transfer the risks to the party
best able to manage them (including retaining certain risk within
the public sector). As the risks of PFI have become better
understood and better managed the costs of PFI should have consequently
reduced. This has not been the case because, as PFI has evolved,
the private sector has been asked to take on more and more risk—some
of which is unnecessary—which has added to costs.
17. Some examples of risks transferred to the
private provider which may offer better value for money if retained
by the Public Authority include:
— Insurance,
where under more traditional procurement government has a policy
of self insurance.
— ICT.
— "Soft"
services.
— Anomalies
in the Payment Mechanism.
— All
of the Unitary Payment at risk.
— Security
of electricity supply and related switchgear design, which could
be standardised in a common specification.
— Change
of Law.
— Interest
rates.
— Energy
efficiency.
— TUPE.
— Pensions.
18. A more sensible balance of risk between the
public and private sector would reduce the cost of projects significantly.
"GOLD PLATED"
SPECIFICATION ON
BOTH THE
CONSTRUCTION AND
OPERATION OF
BUILDINGS
19. There are numerous examples of over specification
by clients both for the initial building specification and the
on-going operational service requirements. These include:
— Construction.
— Public
art.
— BREAMM
specifications.
— Services.
— In
many contracts there is evidence of inappropriate response times
requiring resources and procedures that are unnecessarily expensive
to achieve over-specified outcomes.
20. In addition, contractors are asked to hand
back buildings at the end of the concession period (normally 25
years) in pristine condition. The adoption of less stringent standards
would also reduce costs significantly.
AFFORDABILITY OF
PFI UNITARY CHARGES
21. As pressures increase on the public purse,
there is growing public concern about the affordability of interest
payments on the loans which, as in the case of mortgages on houses,
will always be much more costly than buying the asset up front.
There are opportunities to reduce these costs significantly by
looking at other funding mechanisms. Two possibilities are:
— a more
vigorous approach to identifying and selling surplus public land
to help offset costs; and
— offsetting
costs by charging users for the use of the asset (for example
through toll charging on roads).
INFLEXIBILITY OF
SOME PFI CONTRACTS
22. All PFI contracts include provisions for
the client to vary his requirements, including the right to terminate
voluntarily. The process to define, price, finance and implement
changes can be overly cumbersome due to the need to consider the
immediate capital cost and the ongoing impact on maintenance,
lifecycle, soft services, insurances etc, compounded by the necessary
involvement of the funders and their due diligence process. It
is worth noting that should there be a significant shift on how
services are delivered or stopped being delivered this may result
in redundant facilities however they were procured initially.
23. Experience over the past decade has shown
that it is not always sensible to lock all FM services into long
term contracts spanning the life of the PFI projects. In some
cases—especially recognising that the use of buildings will
change over time—it would be more sensible to have much
shorter time horizons which would deliver greater flexibility.
This is likely to create better value for money in areas such
as ICT and soft services.
24. Turning to the other specific questions posed
by the Select Committee, not answered above:
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?
25. Most PFI assets are now on the Government's
books under IFRS accounting. Even under the old accounting economists
factored PFI obligations (and pension obligations) into the UK's
total indebtedness. Some of the early deals are believed to have
been driven by the off balance sheet factor, however the success
of their risk transfer meant that PFI/PPP came to be recognised
as an efficient model for some procurements.
26. All new PFI contracts now appear on balance
sheet. There is no doubt, however, that some of the early decisions
to keep PFI off balance sheet have contributed to much of the
bad press that it does not provide value for money. Increased
transparency is therefore vital to maintain the long term credibility
of the market. More transparent accounting also provides an evidence
base to demonstrate the advantages of using PFI. Even so, to provide
a clear comparison between PFI and other methods of procurement,
the amount shown on the balance sheet should be confined to capital
costs and not the ongoing service provision.
Are there particular kinds of risk which are particularly
appropriate for transfer through PFI deals, or particular projects,
which are suited for PFI?
27. PFI has delivered numerous successful projects
in both the economic and social infrastructure category, on time
and within budget.
What state guarantees are explicit or implicit
in PFI deals?
28. Implicit in dealing with Government is the
application of the highest standards of probity and governance.
Explicit in the PFI contact is that if services are delivered
to the contract requirements then payment is guaranteed. Failure
to deliver to contract requirements will trigger deductions according
to the terms of the contract, which can vary in detail considerably
from one contract to another. The extent to which deductions can
amount is typically capped. The willingness of the banks to lend
is predicated on the basis of an implied Sovereign guarantee underwritten
by the British Government. Deeds of Safeguard are issued when
a public sector partner changes status, as in the NHS when Foundation
status—giving a high degree of financial independence—is
achieved. This protects the interests of the private sector partner.
In what circumstances are PFI deals suitable for
delivery of services?
29. PFI requires relative certainty, therefore
is not appropriate in rapidly changing technological environments
(IT) or where the scope of work required is impossible to determine
until after the contracts have been signed (London Underground).In
all circumstances when there is a sufficiency of money. The difficulty
arises when there is insufficient to pay the PFI Unitary Charge
and provide an acceptable level of services delivered by
State Departments. When the public sector purse dries up the PFI
contract demands that the PFI payments are paid irrespective of
consequences, for example to staffing levels.
April 2011
71 Capital charges are the capital costs of a project
together with depreciation. Back
72
LIFT is an NHS vehicle for improving primary and community care
facilities. Back
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