Private Finance Initiatives Contents

2Decisions about future investments and PF2

14.In 2012, the Treasury replaced the PFI model with PF2 as part of efforts to address some of the previous Committee’s criticisms of PFI, including inflexibility and lack of transparency. PF2 is not fundamentally different to the PFI model. Treasury told us that it considered PF2 to be a valuable means of delivering public assets and services, but only when it is used for the right projects with the right type of risks. It told us that it was being more selective in its use of PF2 to ensure that projects represented value for money.66 So far only six PF2 projects have been commissioned, with another two projects in the pipeline.67

15.The public sector can borrow more cheaply than the private sector.68 According to Treasury rules, any decision to invest using PFI or PF2 needs to be supported by an assessment demonstrating that PFI provides better value for money than conventional public sector procurement.69 Prior to 2012, this assessment comprised of a qualitative and quantitative component, however, following a number of criticisms (such as adjustments favouring PFI that lacked an empirical basis) the Treasury withdrew the quantitative model and guidance.70 The Treasury told us that for PF2 deals it would work with the IPA and relevant departments to assess whether a deal meets the criteria set out in the government’s Green Book, including assessing the reliability of demand forecasts, and the affordability of the proposed deal.71

16.Aside from value for money assessments, there remain budgeting and accounting incentives that encourage the use of PFI in preference to other procurement approaches, and are unaddressed under the new PF2 model. In 2012 the previous Committee found that PFI projects rarely scored against scarce departmental budgets, giving departments an incentive to use PFI to provide public assets and services, particularly in times of public expenditure constraints.72 The UK produces National Accounts, recording and describing economic activity in the UK, which include important statistics such as Gross Domestic Product (GDP) and the UK’s headline debt statistics such as Public Sector Net Debt (PSND). The National Accounts are produced using internationally agreed rules. Under these rules, most PFI debt is not recorded on the government balance sheet and is excluded from calculations of the level of debt within the public sector (often described as “off balance sheet”), which is advantageous to the Treasury.73 Departmental budgets are set using the same principles as the National Accounts. When departments use PFI, the payments are spread over the life of the contract, with no large upfront payment as there would be if government borrowing was used. This is beneficial for departments that have limited capital budgets but, for example, need to build a school or a hospital, and departments have said that they were only able to build certain assets through PFI as there was no other finance available.74 The National Accounts are different to the Whole of Government Accounts (WGA), which consolidate all financial statements across the public sector and are produced using a different set of accounting rules that recognise most PFI projects as on the government balance sheet.75

17.The Treasury told us that PFI and PF2 is only used if it demonstrates value for money compared to conventional public sector procurement, and that the UK’s level of debt and the balance sheet treatment had no bearing on a decision to use PFI and PF2.76 Despite this, Treasury is making changes to PF2 to ensure it remains off balance sheet in the National Accounts. For example, private companies can reduce costs and make gains by refinancing debt if the cost of borrowing has fallen since the PFI deal was originally signed. Previous Committees emphasised the need for the taxpayer to share in these type of gains, saying that a refinancing can greatly increase the returns to the private sector and change the balance of risks and rewards.77 In response, the Treasury established “gain–share arrangements” allowing public bodies to take 50% of any savings made by private companies in refinancing the PFI or PF2 debt.78 Under the National Accounts rules, the higher the percentage the public sector is entitled to, the more likely PF2 will be recorded on the balance sheet and count towards UK debt. In 2016, Eurostat, the statistical office of the European Union, made changes to the rules governing the National Accounts, meaning that the PF2 model would be recorded on balance sheet and count towards UK public debt.79 To avoid this, the Treasury is significantly reducing the percentage that the public sector will receive if savings are made, from 50% to just 33%.80 Ministerial submissions have stated that the Treasury has recognised that this change will have a negative impact on value for money.81

Use of Private Finance 2 (PF2)

18.The public sector has used PFI less and less over time, falling from a peak of over 60 projects in 2007–08 to no new PF2 contracts at all in the last two years.82 IPA told us there are other ways of involving the private sector in infrastructure investment, and over the last five years the government has secured more infrastructure investment using these other methods than through PF2.83

19.Since its launch in 2012, only 6 projects have used PF2: the Priority School Building Programme (PSBP), which will build 46 schools in five batches, and the Midland Metropolitan Hospital.84 The projects have capital costs of £623 million and £297 million respectively.85 The Treasury and IPA were unclear in evidence to us about the scale of the pipeline of PF2 projects, or the money involved. In subsequent written evidence, the Treasury told us that there are only two projects that are expected to be financed by PF2: an upgrade of the A303 Stonehenge tunnel and the approach roads to the Lower Thames Crossing.86 The Treasury expects investment in the two projects will amount to between £6 billion and £7.8 billion.87 When questioned on the future use of PF2, the Treasury said that PF2 will only be used in a “handful” of cases over the next three years, but were unclear on the number and cost of future projects.88 The Treasury told us that it now views PF2 as a “useful tool” in a range of options for financing public infrastructure, but that it will use it in a more focused way. It confirmed that it would not return to the levels of investment seen at the height of PFI, which saw investment peak at £8.6 billion in 2007–08.89 Some departments have said that their reduced use of PFI and PF2 results from concerns about cost efficiency and value for money.90 The Treasury and IPA told us that PF2 is being used less because the public sector is now better at managing project risk, thereby reducing the probability that publicly funded projects with be delayed and run over budget.91

20.The Treasury told us that the outlook for investment in infrastructure is very ambitious.92 In 2016, the IPA identified a need to invest in £300 billion of infrastructure by 2020–21, and expects the private sector to finance half.93 On current projections PF2 looks likely to provide a relatively small role in achieving these aims, and it appears unclear how far PF2, and similarly other private financing, will help the UK meet these financing needs.94

21.We asked the Treasury when PF2 investment would be suitable, if the public sector is now much better at managing risk and can borrow more cheaply. The Treasury told us that the transfer of a project’s risk from the public sector to the private sector was one of the main benefits of the PFI model. But it accepted that risks should only be transferred to those who are able to manage them better than in the public sector.95 Some assets are more complex, and therefore risky, to build than others. Around two-thirds of all current PFI contracts involve “accommodation”, (for example schools) which is considered to involve relatively low construction risk.96 The Treasury told us that it considers PF2 to be a specialist tool, appropriate in a relatively narrow set of circumstances, and if the risk transfer is not suitable, then PF2 is not the right structure for investment. As such, large, complex projects such as HS2 and Crossrail are now being funded publicly.97 The IPA told us that only projects where the private sector is best placed to identify and manage risks should be considered for PF2, and that projects that are large, with too much complexity and technology risk (such as IT projects) are unsuitable for PF2.98 If PF2 is more targeted than PFI, and the public sector is better at managing projects as well as being able to borrow more cheaply, it becomes more difficult to justify using PF2 because there is a smaller range of projects where the private sector is better placed to manage risk, and the future scope for PF2 to contribute to the UK’s infrastructure investment needs looks limited.99

66 Q 123

67 Qq 39, 127

68 Q 121

69 Q 30; C&AG’s Report, para 1.27

70 Q 23; C&AG’s Report, para 1.32

71 Qq 95, 123

72 Committee of Public Accounts, Equity Investment in privately financed projects, 81st report of Session 2010–12, HC 1846, 2 May 2012

73 Qq 56, 131–132

74 C&AG’s Report, para 1.14

75 C&AG’s Report, para 1.16

76 Qq 57, 58

77 Committee of Public Accounts, The Refinancing of the Fazakerley PFI Prison Contract, 13th Report of Session 2000–01, HC 955, 4 July 2001, para 5; Committee of Public Accounts, Lessons from PFI and other projects, 44th Report of Session 2010–12, HC 1201, 1 September 2011, para 3

78 C&AG’s Report, para 3.18

79 C&AG’s Report, para 3.18

80 C&AG’s Report, para 3.18

81 C&AG’s Report, para 3.18

82 Q 32; C&AG’s Report, Figure 6

83 Q 134, C&AG’s Report, para 3.22

84 C&AG’s report, para 3.19

85 C&AG’s Report, para 3.19

86 Qq 34, 39

88 Qq 31–41

89 Qq 23, 30–31

90 C&AG’s Report, para 2.3

91 Q41

92 Q 132

93 C&AG’s report, para 1.2

94 Qq 41, 123, 130, 132

95 Qq 22, 31, 80

96 C&AG’s Report, para 1.7

97 Q 121

98 Q120

99 Qq 41, 121

Published: 20 June 2018