Private Finance Projects and off-balance sheet debt - Economic Affairs Committee Contents

Examination of Witnesses (Question Numbers 100-118)

Councillor Richard Kemp and Mr Richard Buxton

Councillor Kemp: We are quite happy to answer questions, my Lord.

20 OCTOBER 2009

  Q100  Baroness Kingsmill: What about the credit crunch, has that impacted?

  Mr Buxton: The evidence at the moment is that the interest rates that we are having to pay on some of the major schemes that have closed recently are slightly higher than the interest rates that we had perhaps a year or two ago. I think long-term I would expect the interest rate gap to diminish, but at the moment schemes are working out slightly more expensive than they were so, yes, there has been an impact. Secondly, for some of the most complex schemes we have to rely on some additional funding sources and the Treasury is now actually making funding available and the European Investment Bank. Schemes that would have relied 100% on finance from the commercial banks for some of the most complex schemes, and I am thinking, for example, of the Manchester Waste Project, has had to rely on Treasury and European Investment Bank funding. Clearly that funding has to be repaid, it is not a grant, it is investment. Actually just securing the level of investment on the very biggest of the projects has in the last year or so been more difficult. On the other hand, the latest evidence suggests that in the course of the last three or four months, compared with this time last year, a significantly higher proportion of schemes are closing and, therefore, the situation does appear to be easing. Yes, there has been an issue and still is a little bit of an issue but I would expect the situation to continue to improve over the course of the next year or two.

  Q101  Lord Griffiths of Fforestfach: My Lord Chairman, before asking a question I would like to declare an interest as the chairman of what at the time I think was the largest PFI project, namely Trillium, which was the outsourcing property services to the DHSS and then to the DWP and its successor, namely Land Securities Trillium, and at present as an advisor to Telereal Trillium. My question is do you see any benefit in developing alternatives to the current private finance models and, if you do, what would they look like?

  Councillor Kemp: The answer is yes and the second answer is we are not sure. We are very clear that in the face of the recession, which is hitting council public sector finances in a variety of ways, we have to form new relationships between the public, private and third sectors. What we are trying to do, and I would be happy to invite one of your Lordships to this, is on 16 November we have some leading members of those three sectors coming together. What we are trying to do is to look again, as I have said before, at partnerships and relationships to make things work. Traditionally the three sectors relate to each other in one way or another purely on a contractual basis. If we can find more flexible ways of creating long term partnerships which will play to the strengths of the three sectors, that will be very strong. At the moment though we tend to create contracts which appeal to the worst aspects of those because we do not trust each other, so we build in certainty instead of originality and flexibility. We are acutely aware of the need to change, but certainly for most of us it is work in progress which we would be happy to report back to you if those relationships developed that we can define better the new ways.

  Mr Buxton: I think it is fair to say that there are already a range of different models that can be used. You have your traditional vanilla-flavoured PFI, clearly the further alternative is conventional local authority procurement. That exists and may well be appropriate under certain circumstances. You then have some of the major government schemes, such as the local education partnerships and LIFT, which are designed at a broader programme level to deliver things. Other ways of doing things might include local authorities entering into some sort of Joint Venture Company and actually directing investing. It may be the local authority giving a session. It may be a local authority doing some form of outsourcing of services. I think there is a range of models and it comes back to the point that Councillor Kemp and I were both making in the beginning that if the playing field is neutral in the sense that if there are subsidies available then potentially any of the existing models might be appropriate depending on the circumstances of the individual project and what you are seeking to achieve. I think increasingly partnerships with third sector organisations and so on are going to be important and how does that fit into some of the programmes that we have at the moment? It is about trying to provide that flexibility.

  Q102  Lord Best: I would like to look ahead a bit because we are still in the early years of all these PFI contracts and to draw you a bit on the inflexibility of being boxed into a contract that lasts 25 or 30 years. Although everything comes in on time or on budget on day one—great and there are the gains—is it not likely that almost every public service we can think of will change very dramatically in a much shorter timescale than 25 or longer years? I am familiar with the world of residential care homes and I cannot believe that the same home, even though there is a wonderful contract to maintain it for 25 years, will be required for the same purpose 25 years from now. We are going to do all kinds of things differently. How wise is it? Even schools—and you were mentioning schools as the shining example—can you be sure that we will teach our children in the same way of going to classes and maintaining as is. Is it not going to be fantastically expensive to buy your way out of those contracts later on as a local authority if you do not like what you have got then?

  Mr Buxton: I think those are very valid points. It is important to recognise that local authorities enter into 20-year contracts outside what we would regard as a PFI framework. I am familiar with a local authority that sold its residential care homes and gave the contractor who purchased the residential care homes a 20-year contract guaranteeing occupancy of the residential care homes. That happened completely outside this traditional PFI and that was an outsourcing transaction. Was the local authority right to do that? No, I think they were completely wrong. At a time when we are seeking to encourage more people to remain in their own homes a 20-year guaranteed occupancy contract for residential care homes would seem to be a major mistake, regardless of whether you do it by an outsourcing deal or a PFI deal. Schools are a very interesting example. Remember, if we did not have PFI and we would be only be going down conventional procurement we would still be building the school. In other words, you would still end up with that building. The very valid question is what we would require in 25 years' time. I have heard the suggestion—and I am not saying whether this is right or wrong, I am not entirely sure—that what we are doing at the moment with schools, regardless of whether it is PFI or not, is that we are simply building new versions of old schools. So we are simply building something that looks modern, it has new technology but essentially it is the basic fundamental concept that we have had for a very long period of time, which is a place to which a large number of young people go where they are detained during the day time and fed knowledge, information, learning and so on. As a parent I am not uncomfortable with that but if we were to say what is education going to be like in 25 years' time, if we judge by what has been happening in offices—in my own organisation most of my staff are home-based, they travel around to where they need to be, they are linked up electronically in various ways—does this mean that in 25 years we will not need the same type of buildings but we will have a much more networked education? I do not know the answer to that. It is the same question whether or not we are going down a conventional procurement route or a PFI procurement route. We still have to make that decision as to whether we are building a set of buildings. Therefore, I do not actually think the critical issue there is around PFI. I think you are absolutely right to raise the issue but that is why I am saying the same skills are needed whether we go down conventional or PFI procurement because they are skills about scenario planning. What is the educational world going to look like over a longer period of time? The difference is, yes, we are committed to the maintenance aspect but actually that is a relatively minor aspect of the overall contract and one on which most of the contractors do not expect to make a significant profit margin, therefore I see the issue as being broader than just PFI.

  Councillor Kemp: If you were to look at it in the long-term, that is one of the reasons I am really in favour of local flexibility. If you can imagine a school which capital asset was controlled by a local organisation which knew the patch it was responsive to, it still ends up with a school, but if you can build the other things in then the ability to move it around and make it more flexible would be much enhanced. As someone who has gone round and tried to convert old schools into other uses, because we have lots of them in Liverpool that are listed buildings, one of the problems is that once you build something with classrooms designed for people to move around every three-quarters of an hour, you have designed a particular type of building and they do not convert very well to anything else, even if they are lovely listed buildings.

  Q103  Lord MacGregor of Pulham Market: It has been suggested that private finance models have not been overly successful in providing innovation and delivery. Would you like to comment on that general view in relation to local authority PFIs?

  Councillor Kemp: First of all, I think we should set this against what I believe is a massive change in local government over the last 12 to 15 years. I have been a councillor a long time and in my view local government is now operating at as high a level as I have ever known it. The importance of that to your question is that that also means that local government is more imaginative, innovative and more pragmatic than it has ever been before. That means that when it goes to providers, whichever route—and we are fairly neutral about this—it is coming up with a more innovative specification where it is able to. Where it is not able to then we will just procure a school, as we have discussed before. So I think that local government is engaging with the private sector in ways that we would not have dreamed of 12 years go, and it is that coming together, that bringing together the best skills of both, which I think is feeding innovation, but not a PFI route per se.

  Mr Buxton: Again, I think it comes back in part to the more general issue around procurement and in part the creativity and skills of the team that is leading the procurement process. PFI can produce innovation, as can conventional procurement, but it actually needs a leadership that wants to challenge and develop. To give you a specific example, I think in the waste sector at the moment some of the waste PFI projects are actually very innovative. Specifically, the recent example is Manchester Waste, which is a £640 million project and they are actually using waste to produce solid fuel and the solid fuel is then used to actually produce energy. This is something that has been developed through the PFI process. In waste we have got contractors who are looking at biofuels coming out of waste and so on. So I think that there is real innovation going on there. We can point to a number of community type projects where you actually have health facilities and libraries and CABs and youth clubs in the same centre. Yes, you could probably have produced the same innovation with conventional procurement but the skill is in the team that sits behind that and says, "Yes, we want to make this a community project. Yes, we understand the needs of our community. Yes, our elected members are fully engaged. Yes, we have teams of people who are working with the community to get their input." I think if you do that then you can actually generate innovation both with PFI and conventional procurement.

  Q104  Lord MacGregor of Pulham Market: Yes, because the example you have given on biofuels, biomass and bioenergy and so on could happen within the conventional field as well because the innovation and inventiveness is in relation to the project rather than the financing.

  Mr Buxton: I think that is right.

  Q105  Lord MacGregor of Pulham Market: Just listening to you in the whole of this session it seems to me to some extent that the whole PFI issue is different for local authorities compared with Central Government. There have been criticisms that PFI has been used in Central Government to get projects moving faster than the old conventional arrangements—off balance sheet financing, if you like, and so on. That does not seem to apply in the local authority area, not least because of the constraint and impact on council tax. You are really saying that it is just one model among a number that should be used but it does not have an effect on big capital projects going ahead faster than they would otherwise.

  Mr Buxton: Except to the extent that Central Government determines that certain types of projects may only proceed through the PFI credit mechanism. I am sure that was understood in your question.

  Q106  Lord MacGregor of Pulham Market: Yes, it was.

  Mr Buxton: I just wanted to make that clear for the record.

  Q107  Lord MacGregor of Pulham Market: If that was not there, all the school projects were PFI, then you would want the level playing field.

  Mr Buxton: Absolutely.

  Q108  Lord MacGregor of Pulham Market: That is really the message you are trying to convey.

  Mr Buxton: Yes, indeed.

  Q109  Chairman: Let me ask it in a slightly different way to be absolutely clear. If the hidden hand of the Treasury said that rather than having 10 or 15% of the local authority expenditure in this area being PFI you could double it if you wanted to, would that make any difference?

  Councillor Kemp: It would depend on the types of projects, as we said before, that any council was dealing with at any one time because there are some types of projects that we do not think that would apply to. In general terms it could increase or go down but as long as we could relate it to what was particularly needed in our own individual circumstances.

  Q110  Chairman: I was not suggesting that they mandated you should, but if you had the freedom to double it would that make any difference to your investment programme?

  Councillor Kemp: No, I do not think it would.

  Q111  Lord MacGregor of Pulham Market: Why then do you think that you have this constraint in terms of school building? Why is that linked entirely to PFI?

  Mr Buxton: How are you going to build a school without the capital subsidy? That is the issue for a local authority. A local authority cannot afford to go around building schools without some form of subsidy.

  Q112  Lord MacGregor of Pulham Market: I understand that but why do you think that the Central Government is insisting on that?

  Mr Buxton: Central Government has done a programme level value for money study and concluded that at a programme level PFI is value for money for the delivery of schools.

  Councillor Kemp: Because it is looking at the savings of bigness, whereas as we said before we can also make savings through smallness. We are not getting the benefits of local knowledge, the full application of local services and opportunities into what is effectively a national programme delivered locally.

  Mr Buxton: We should also recognise that most school refurbishment is not taking place through PFI. It is much more effective for new build than for refurbishment and the Government fully understands and recognises it, which is why if you look at capital spend on education it is not a case of saying all capital spend on education is PFI, that simply is not the case.

  Q113  Lord Eatwell: It seems to me that the crucial difference with respect to your financing is the constraints that you are placing on the future, and where the future is unknown, such as how technology might change with respect to teaching, or population structures might change, you are stuck. That seems to me to be a major issue, that by having a PFI contract you have committed a set of funds contractually over the future to the delivery of a particular building or services of that building or other services which you may, in 10 years' time, not need, but you have it, you are stuck.

  Mr Buxton: If you are building a road you are putting in street lighting and the chances are that level of certainty—

  Q114  Lord Eatwell: No, let us stick with the school. You have a school building and you get a big population shift. As a local authority you might want to say, "Okay, we will take half those buildings and we will use them for something completely different."

  Mr Buxton: Absolutely.

  Q115  Lord Eatwell: You have a contract to have those things maintained in a particular way, services provided in a particular way, which may be completely irrelevant for the purpose that you want in 10 years' time, but you are stuck.

  Councillor Kemp: Basically you are right, but we would end up with that constraint if we build a traditional school now and we would still be saying in 10 years' time, "What are we going to do with that school?" That comes to the relationship that you have with your contractor because at the end of the day it is in no one's interests to be paying out for a building that is empty, so what will local authority come up with in private sector circumstances about using the half of the building that you no longer need. I am not trying to underrate what you say because clearly if you are in a contract it is more difficult to get out of than if it is your own building which you entirely own or whatever. There are some constraints but I would not overplay that because it is in everyone's interests to make these buildings work, including the private sector.

  Q116  Lord Levene of Portsoken: When PFIs and PPPs were first introduced the rationale was that both Central Government and local government had a pretty poor record of managing large-scale projects, particularly construction projects, so it was felt that by giving these to the private sector they would have a better chance of delivering them on cost and on time and their own overheads would still make the whole project cheaper. This has been going on for the best part of 20 years now. I do not want to ask you about Central Government, but has local government now learnt enough from this, from overseeing these projects, that they can now do it themselves efficiently as one would hope they would have been able to do in the first place?

  Councillor Kemp: A lot of the pre-work, of course, is done within the local authority now. In any big project the local authority, being an excellent client, knowing what it wants, being able to deliver its part of it—for example, you can have a PFI project which needs the local authority to deliver the road system differently to meet it—is up for the major challenges that it faces. Local government has moved on tremendously both managerially and politically in the last 10 to 12 years so I think they are capable of managing it using all the routes.

  Q117  Lord Levene of Portsoken: So if a decision was to made to say, "Here is a pilot project, let us give it back to local authority X and see if they can do the whole thing themselves", they might make quite a good fist of it?

  Councillor Kemp: We are doing it already because, as we said, PFI is only 10% anyway, so for the other 90% we are already doing it. There is no evidence that we have on which of the procurement routes you use for the money, if I can put it that way, changes your ability to deliver things quickly or slowly, efficiently or inefficiently. I think that we are good enough clients to be able to cope with any of the financial routes which would enable us to use capital.

  Q118  Lord Levene of Portsoken: If that is true, and I have no reason to doubt what you say, then it would infer that Central Government ought to look very carefully at this because if the local authorities are now so good at it that they can do it themselves, so why not leave it with them? Somebody presumably ought to have a look at that.

  Councillor Kemp: We would be happy to look for the evidence. Our general feeling is—and this is a Treasury quote not mine—that local government is the most efficient part of the public sector. I would not necessarily let the PCTs run the same way!

Chairman: On that note, Councillor Kemp, we can draw a close! Thank you very much to you, Councillor, and to Mr Buxton for your time and for answering our questions.

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