Examination of Witnesses (Question Numbers
77-99)
Councillor Richard Kemp and Mr Richard Buxton
Councillor Kemp: We are quite happy to answer questions,
my Lord.
20 OCTOBER 2009
Q77 Chairman:
Welcome to the Economic Affairs Committee. This is
the second public hearing of our inquiry into private finance
projects. Copies of the Members interests or their entries into
the Register of Interests showing interests which have been declared
are available for the public and witnesses. It is the big tome
there on the table if you wish to take a look at that. Councillor
Kemp and Mr Buxton, thank you very much for coming. We would be
very grateful if you could speak as clearly as you can for the
benefit of the webcast and the shorthand writer. Do either of
you want to make any opening statements or would you prefer it
if we went straight into questions?
Q78 Chairman: On the questions side,
you do not both need to answer.
Councillor Kemp: I think we have decided that
if it is technical the officer will answer.
Q79 Chairman: Perhaps I can make a start
by asking you what are the main areas where local authorities
engage in private finance projects? How important are they compared
to other areas of local authority activity?
Mr Buxton: I think by far and away the largest
area of activity for local authority PFI projects is in relation
to education where there has been a major programme specifically
to build or refurbish schools. Other areas include housing, transport,
social care. An important point is that actually the local authority
PFI expenditure amounts to a relatively small proportion of total
local authority capital investment. Over the course of the last
five years we are looking at figures of in the range of 10-15%
of local authority capital investment. I think it is important
to see PFI very much in the context of an overall approach to
local authority capital investment and not to regard it as, in
a sense, the most burning and critical issue relating to local
authority investment.
Q80 Chairman: You said then that PFIs
are a minority sport, as it were, but how do local authorities
decide whether to use the private finance route or some other
route?
Councillor Kemp: This is one of our concerns,
that there is not necessarily flexibility to enable us to choose
PFI or prudential borrowing or standard routes, we are more or
less guided into a particular project by the government finance
being made available for PFI. One of the things that we do think
we need is more flexibility so that we can choose the appropriate
financing route for the appropriate project.
Q81 Chairman: So you have a budget, as
it were, for PFI?
Mr Buxton: What happens is that the government
makes available PFI credits for certain types of projects. For
example, there are PFI credits specifically set aside for an investment
in building new schools. If a local authority wants to build a
school and to receive a subsidy for building the school, then
in a sense it does not have a choice, it can only use the PFI
route because there is no conventional capital subsidy available
for building a school. The only route is through the PFI credits
and that means that the local authority is forced to use those
credits if it wants to take advantage of the capital subsidy.
I think what we are suggesting is that if there were a level playing
field the capital subsidy element would potentially be available
for a range of alternative funding mechanisms and not just for
a PFI mechanism.
Q82 Lord Eatwell: That is intriguing
because I was about to ask you about the main contribution that
private finance has made to local authority delivery and it sounds
to me as if the main contribution is that it gives you the chance
of capturing a subsidy. Is that fair or is there some other wider
contribution than the fact that you can capture a subsidy in this
particular way?
Mr Buxton: Let us assume that there was capital
subsidy available, or no capital subsidy available equally for
conventional procurement and for a private finance initiative.
If we start with that assumption and then we say given the level
playing ground does PFI offer certain advantages, I think the
answer to that question would be, yes, it offers certain advantages
but it also has certain drawbacks and, therefore, you actually
need to look at each project on a case by case basis. The main
advantage of a PFI project is that it gives you a higher degree
of certainty over build costs and subsequent maintenance costs
on a classic PFI scheme and that is where the concept of risk
transfer comes in. We are not talking about a transfer of the
whole risk. We are not talking, for example, about the contractor
taking on the risk that all the children will or will not all
get five GCSEs. What we are talking about is the construction
cost risk and the subsequent maintenance cost risk because those
are priced in at the beginning of the contract on a relatively
fixed and determined basis.
Q83 Lord Eatwell: That is the biggest
advantage and you said that we have to balance this against the
disadvantages. What is the biggest disadvantage?
Mr Buxton: The disadvantage is that obviously
you are tied into a commitment over that period of time. For example,
if we take something like school maintenance, historically a local
authority would have been able to take a decision about whether
or not to spend money on school maintenance. At any particular
year it could have decided not to invest in school maintenance
but actually to spend some money on some other form of service
provision. The disadvantage of that is that might lead to under
maintained schools which over a long period of time would require
further investment. So there is a slight loss of flexibility but,
as I say, there are benefits. The other factor is that in the
pricing mechanism for PFI contracts at the moment a private contractor
who is borrowing to finance will probably be paying slightly more
than a typical local authority for borrowing. Therefore, you need
to weigh up the benefits and the disadvantages on an individual
project basis.
Q84 Lord Eatwell: So in capital terms
the project is more expensive?
Mr Buxton: Not necessarily.
Q85 Lord Eatwell: From your point of
view it is less flexible.
Mr Buxton: It may not be more expensive, that
depends on the potential cost overrun issue. Historically public
sector projects have had large cost overruns. The information
collected by the National Audit Office suggests that private finance
projects are actually more disciplined in terms of the financial
angle and, therefore, there is a trade-off.
Q86 Chairman: Would it be possible to
set aside the source of funds issue and have exactly the same
contractual arrangement, possibly with the same company, for the
whole life contract which might have been a PFI or might be an
ordinary public sector one?
Councillor Kemp: I think it is important that
we recognise, particularly as it is only 10% of the funding, that
PFI is a way to create a particular relationship between the public
and private sectors. There has always been that relationship.
For example, we have never built our own schools, we have always
contracted to buy a school. What we need to be more imaginative
about is how to create those relationships and, if I can put it
further, how to create the partnerships within which the public
and private sectors can work to the best advantage. If we can
create effective partnerships in a long-term relationship then
some of those problems with rigidity and lack of flexibility might
disappear. We are very keen on partnerships and have the contract
second. One of the problems is that PFI methodology leads you
straight to the contract before you develop the relationship.
Q87 Lord Levene of Portsoken: I am sorry
to labour this point, but having been involved in one of the early
iterations of this whole programme, which was called Competing
for Quality, which Lord MacGregor may remember, the whole object
of the exercise was to have this element of competition. In other
words, you had the in-house team who could do this and you would
have outside providers, PFI or PPP, to do so. Are you saying that
there are projects now where that choice is lost to you, that
you do not have the ability to choose between the public sector
doing the job itself and the private sector doing it as an alternative
and you are just dictated to as to which way you have to go?
Mr Buxton: I think some of those decisions have
actually been taken at a programme level. For example, if you
take the schools programme that has been subject to a very thorough
value for money review at the whole of the programme level and,
therefore, individual projects are financed within the context
of that programme. Individual projects still have to demonstrate
that they meet the value for money criteria, but at the moment
if you are seeking to build a new school then if you want the
capital subsidy that goes with that effectively that requires
a PFI approach.
Q88 Lord Levene of Portsoken: Can I ask
you a different question, if I may? Is there sufficient understanding
within local authorities and a sufficient level of expertise to
be able to manage the project of that nature when it is not being
carried out in-house but is being carried out by a private sector
contractor or consortium?
Councillor Kemp: In my view there is. In a large
authority like my own—I am a Liverpool City Councillor—we
are regularly procuring big contracts in a variety of ways and
we have in-house knowledge. For smaller councils and very high
specialist projects we have traditionally had 4ps, an agency,
which is partly paid for by the government and partly paid for
by the user and we have now linked up with Partnerships UK to
create a new organisation in the Local Partnerships, so that expertise
is available across the piece. To follow up partly on your last
question, things have moved on in the last 12 to 15 years and
very few councils, for example, now have their own architects'
department in the way that they used to. It is a question of where
we procure the private sector in to help us and in what format
rather than we do it in-house or externally.
Mr Buxton: If I may add to that. I think that
if a local authority is going to be building a new school the
skills that it requires are going to be very similar regardless
of which contractual route it chooses to go down. For example,
if you are planning a new school you need to be able to think
about long-term time horizons and scenario planning. You need
to engage with the service users, the teaching community. You
need to think about the different types of things that you want
the school to do and its links with the rest of community infrastructure.
All of those issues I would argue have to be considered whether
you are using a conventional procurement route or a PFI route
and, therefore, actually the issue for me is not so much do local
authorities have the skills to do PFI but do local authorities
have the skills to do large-scale procurement, which is a slightly
broader question. I would entirely endorse what Councillor Kemp
has said. I think the major authorities will have that expertise
in-house and some of the smaller local authorities will need to
rely on some external expertise, which is where an organisation
such as Local Partnerships, which is partly owned by the Local
Government Association, has been deliberately set up to provide
that support to those authorities who do not have that expertise
in-house.
Q89 Lord Paul: In your experience have
the private finance projects delivered value for money?
Mr Buxton: I think in general that the answer
has to be yes. I think the National Audit Office have themselves
done a number of studies of the delivery of private financial
projects. They have, for example, shown that private finance projects
do deliver to time slightly better than conventional procurement.
They have also found that private finance projects deliver on
budget slightly better than conventional procurement. I would,
however, have to stress that the differences between private finance
projects and conventionally procured projects is not enormous,
so we are not saying that this is an absolutely one-sided argument,
that private finance projects always deliver on time and on budget
because there are a percentage that do not, but it is a slightly
higher percentage than we find with conventionally procured projects.
I think on balance, looking at the trends over the last few years,
we can say that private finance projects have delivered what they
were expected to deliver. Clearly the critical issue, and this
again applies as much to conventional procurement as to PFI procurement,
is if the local authority does not really understand and have
a clear vision for what it is seeking to procure, the limitations
are going to be in that initial conceptualisation. Do you want
a school that simply sits there and is used by students during
school hours or do you want a school that is part of the community
infrastructure? That is the critical issue from my perspective.
Again, when you are thinking about a school and we are building
something that has to be there for 25, 30 years or longer, do
we understand what we are going to require out of the school in
25 or 30 years' time? I think those are some of the complex issues,
but I would argue that they are the same issues for conventional
procurement as for PFI procurement.
Q90 Chairman: Can I push that slightly
further back to my earlier question and that is in principle at
any rate the nature of the contract, whether it is a PFI contract
or a conventional public contract, could be precisely the same
and the only difference would be the sources of funds, so wherein
lies the benefit from a different source of funds if both sources
were unconstrained? Obviously if one is constrained and the other
is not—
Councillor Kemp: It is not necessarily a different
source of funds, it is a different route to funds possibly from
the same source. If we went for a prudential borrowing route it
would cut out one element of that process. Not a very large part
of the process because, as Richard says, the importance for the
local authority is to understand what it wants to procure, so
a lot of the checks that go into a PFI route would be done by
a local authority choosing any route. It would make things a little
easier. For example, we can borrow money more cheaply than a private
sector organisation can, but so can other partners. For example,
I chair a housing association and we can also borrow more cheaply
than the standard private sector. We have a £100 million
fund to invest and in one part of the northwest we are building
a health centre. There is no reason why we could not build a school
taking advantage of the lower rates in a community which we understand
because we control the housing there to which we could add on
our housing association head office for the area, to which we
could add on other facilities which we know the local community
wants, but those are very difficult to do because if you go through
the health route you have a LIFT scheme; if you go through the
education route they have bulk bought from a series of providers.
It does take out to some extent that local originality and our
ability to find savings by being small because the assumption
is that you find savings by being big.
Mr Buxton: If I could add, Chairman, typically
with a private finance scheme the local authority is only paying
when the scheme is delivered, so there is that element of risk
transfer. Arguably you could set up forms of slightly different
procurement which would rely more on local authority borrowing
which could actually come up with a mechanism which would transfer,
but essentially the essence of the private finance project is
that it is payment on delivery and it is that extra security that
the local authority is given that is the key advantage of the
private finance contract.
Q91 Lord Paul: Out of the two, if you
had to choose in the first reference, which one would you choose?
Mr Buxton: I would not. I see that conventional
procurement and PFI have advantages and disadvantages and it depends
what your priority is as a local authority. If you want slightly
more flexibility then you do not want to tie yourself to a longer
contract. On the other hand, if you want greater price certainty
then you may well wish to enter into a PFI contract. It really
depends on the nature of what you are trying to deliver. It also
depends on the risks that you are trying to avoid. For example,
if you are building a leisure centre then actually the private
sector is very capable of taking on the whole risk of the occupancy
or use of the leisure centre. On the other hand, if you are building
a prison what private sector contractor is going to take an occupancy
risk on a prison? Clearly they are not. Therefore, this issue
of risk transfer, yes there is always an element of risk transfer
but it is not the whole risk associated with the entire life of
the project. I think sometimes the public perception is that PFI
transfers the whole risk. No, most PFI projects concentrate on
transferring the construction cost risk and the operational maintenance
risk. Some projects can transfer more than that but actually the
core risk transfer is around the capital construction cost and
the maintenance cost risk. It is not a case of better or worse
and I think that is why what we would be arguing for is as neutral
and level a playing field as possible so that local authorities
can make their own decisions as to the appropriate nature and
use of PFI projects. For certain types of projects that is absolutely
not the right thing to do.
Q92 Baroness Hamwee: To extend that slightly,
as well as asking us, as I assume you are, to back your call for
the level playing field, presumably you would like us to say that
the greatest flexibility in the type of project would be helpful
when government is issuing credits, putting it in rather straightforward
terms.
Councillor Kemp: Any local authority has a variety
of needs. We deal with things on a themed basis because that is
the way ministries do it. We need, in capital as well as revenue
projects, to be able to assemble what our communities need and
there is often in that context more conflict between local government
and Central government delivering mechanisms than there is about
our particular route for financing any particular set of circumstances.
Q93 Baroness Hamwee: Can I ask about
the longer term impacts using PFI, whether there is any difference
between PFI and conventional projects. We have had some evidence
from I think it was Sheffield where they say that an emerging
issue is that PFI contracts with fixed price or inflation-linked
contracts in the public sector funding environment where standstills
or even cuts are going to be possible, non-PFI arrangements may
be easier to manage down in such an environment.
Mr Buxton: If we take the schools example. Let
us say that you go through conventional procurement and you build
a school, you expect to maintain it. A school has costs that you
have to pay. The issue with conventional procurement is that you
can in a bad year choose not to do the same degree of maintenance
on the school and, therefore, you have a slightly greater degree
of flexibility. Whether it is a good thing not to do the maintenance
on the school I would have to put a question mark there. On one
level you can say that the local authority should have the flexibility
not to maintain its schools; on the other hand, as a parent I
might be saying, "Actually I would prefer a situation where
the local authority was really committed to maintaining the school
during the life of it because arguably a poorly maintained school
is not a conducive environment for learning". We are not
arguing PFI is wonderful or PFI is awful, there is a balanced
approach to be taken to this and there are arguments for and against.
I would accept that one of the challenges, if you have a long
term contract, is that your payments are fixed.
Q94 Lord Tugendhat: You have made some
very interesting points in answer to a lot of questions within
other questions, as it were, but coming back to the point that
you have just made, do you believe that some private finance projects
are more successful in some public services than others? In other
words, are some projects more suitable for PFI than others?
Councillor Kemp: Quite clearly those that are
best are ones that you know are going to be there for a long time.
You build a road; you build a school, things like that. They are
solid, they are going to exist. There might be some questions
around the edges about what a school will be doing precisely in
25 years, but those are good long-term things on which we can
see the effects. It should not be used for things like IT which
change so rapidly. By the time you have actually gone through
the process the specification will have moved on. That is where
you go for a more flexible partnership. For example, a lot of
councils now have set up Joint Venture Companies with their IT
provider and that is another way of bringing in finance, of bringing
in appropriate private sector expertise in a way that is very
readily adaptable to meet continually changing circumstances.
Q95 Lord Tugendhat: I realise that this
is not your direct responsibility, but would you feel, therefore,
that hospitals are perhaps a less appropriate kind of project
because of the very high IT involvement?
Councillor Kemp: It comes back to your view
on whether we have hospitals in their current form. In my own
city the Health Service is dispensing with its big hospital that
was going to last 100 years and creating community facilities
around. It is a question of how you would evaluate the risk because
you could well have a contract for building and then a different
set of contracts in relation to what goes in it. So you have to
make a decision on what you think the Health Service is going
to be doing in 25 years and say, "Do I want to procure a
hospital through that route?"
Q96 Lord Tugendhat: The distinction you
have just made is one that could also be made for schools.
Councillor Kemp: Absolutely.
Mr Buxton: That is absolutely the critical point,
that PFI for a hospital could be everything from simply doing
the building and maintaining the building, all the way ultimately
through to actually running all the medical staff. The issue is
where do you draw the line if you are going down that route? Do
you include all the medical equipment; do you include ancillary
staff; do you include medical staff? What is the limit? There
is scope. This is an area where it is possible to make different
decisions and it is not a case of there has to be one answer.
Clearly there will be some government programmes where they will
choose a particular strategic direction, but PFI does not force
you to choose, within that spectrum you can actually make choices.
Q97 Lord Tugendhat: One final question.
Within your association is it your experience that different local
authorities have made a range of very different choices on the
same issue or is there, broadly speaking, a mainstream view?
Councillor Kemp: I would rather turn that slightly
on its head. I would find it difficult to discern whether Lib-Dem,
Labour or Tory authorities went one way, or urban or rural authorities.
By and large most local authorities are extremely pragmatic and
that is why we are looking for the level playing field. We have
to have a relationship with the private sector for a lot of these
activities. As I said before, we have never built a school. Although
we have said it is a council property we have never built it.
So the question is how do we enter that relationship. I think
we would find it very difficult to come up with an authoritative
answer to your question because I have never seen such differences
as I go around the country.
Q98 Baroness Kingsmill: I am stuck with
the boring question, actually! That is, could you elaborate on
the accounting treatment of private finance projects?
Mr Buxton: I think from a local authority perspective
the critical issue for a local authority is the impact on the
council tax. That is the real issue. The reality is that it does
not make a great deal of difference whether you go down a PFI
route or a conventional procurement route. If you have built a
school the school is going to need to be paid for. You are either
going to be borrowing money to build the school and be paying
that money back, or you are going to be paying a private contractor
a unitary charge for the use of that school. The impact on the
council tax is broadly neutral, and I think that is the issue
from the local authority perspective: is there going to be a significance
difference in impact on the council tax and the answer is broadly
speaking it does not make a great deal of difference which route
you go down in terms of the impact on the council tax because
the council tax is about what you are actually spending rather
than a set of relatively arcane accounting rules about whether
something is or is not on balance sheet. The question for local
authorities is what is the impact on the council tax and not what
does the balance sheet look like.
Q99 Baroness Kingsmill: I am delighted
to hear that! So how prepared do you think local authorities are
for IFRS?
Mr Buxton: I think the National Audit Office
is actually doing a piece of work on this at the moment and it
is proposing to come out in the New Year with a statement. My
understanding talking to colleagues in local government is that
no major problems at this stage are anticipated. That is my broad
indication, although I have to say that that is based on a relatively
limited sample of discussions with colleagues at the Local Government
Association. As I say, I think the National Audit Office will
be coming out with more definitive guidance on this topic either
at the end of this year or early next year.
Councillor Kemp: It is interesting for me to
compare what I do as a Housing Association Chair, which is in
my view a public sector body, where I am acutely aware of the
balance sheet because I use the balance sheet as a tool to borrow
more money and do more things, and the concept of a balance sheet
in local government. I do not have a clue what the net assets
of Liverpool City Council are because I only look at the revenue
consequences. If we moved further into the field of prudential
borrowing then that would have to change. Perhaps that is one
of the things that the changes will make us more aware of. If
I have got assets how can I best use them to use more money in
the way that the private sector does? So I think those changes
are useful. How or where councillors are aware of these issues
I am not sure, but we have always had officers to guide us.
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