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

Examination of Witnesses (Question Numbers 419-439)

Mr Adrian Olsen, Mr Philip Turville and Mr Laughlan Waterston


  Q419  Chairman:

Welcome to the Economic Affairs Committee. This meeting is the eighth public hearing of our inquiry into private finance projects. Copies of the members' entries in the Register of Interests and of interests declared as relevant to this inquiry are available to the public and to the witnesses. Mr Olsen, Mr Turville, Mr Waterston, welcome. Thank you for sparing your time this afternoon. We would be grateful if you could speak reasonably clearly and slowly for the benefit of the webcast and the shorthand writer. When we reach the questions, in order to save time, if one person answers and the others are happy with that answer, then leave it at that, but feel free, if you want to add to the first answer, to do so. Would you like to make an opening statement or should we go straight into questions?

Mr Olsen: Happy to go straight to questions.

  Q420  Chairman: Perhaps I might start with the first question, a general question. What has been the impact of the recent financial crisis on raising funds for private finance projects?

  Mr Olsen: Clearly the shortage of both capital and liquidity in the financial markets over the last 12 to 18 months has had a significant effect and influence upon the ability for projects to find banking finance over the last 12 to 18 months of the process. A number of projects have closed but a number have struggled to find sufficient lending capacity from the markets to permit those to go to full financial close. There has been a significant effect on the availability of bank debt.

  Mr Waterston: May I add that to an extent the withdrawal of all of the mono-line insurers from the markets and the lack of liquidity in the bond market have also resulted in less funding being available for PP projects and any other project finance transactions. I refer to the mono-line insurers because they insured the bond issues which used to fund project finance and gave them a high credit rating so they were able to be bought in the market.

  Mr Olsen: A further by-product of the reduced capital and liquidity has been the disappearance of the syndication in the market. As banks have withdrawn or reduced their capabilities to lend, those banks which historically would have taken an underwriting position prior to syndicating into the market have ceased to do so.

  Q421  Chairman: Do you think this is a temporary phenomenon or have we moved on to a new era?

  Mr Olsen: The severity of the situation we have found ourselves in is temporary. We will, in time, move back to some semblance of normality, let us call it. There has been a paradigm shift, a quantum shift in the way in which banks in this space and indeed banks generally will lend in future. The capacity that was in place two or three years ago will be significantly less when we emerge from current troubles than it was at the peak of the market.

  Mr Waterston: Twenty to 30 banks were lending in PP/PFI before the crisis with long term debt at very cheap margins because of their very cheap cost of funding. That number has now been dramatically cut; at one point it was down to less than five and is probably around 10 at the moment. That is very temporary but whether that will increase to where it was before the crisis is debatable. I doubt the liquidity will return to quite that high level. A few banks may return but it is the issue of providing the long term debt with the level of liquidity there used to be. I think that is very unlikely but the liquidity will increase a bit.

  Q422  Lord MacGregor of Pulham Market: We are very interested in the secondary market for PFI projects. Could you give us an overview of the pros and cons of the existence of the secondary market?

  Mr Olsen: When you say "secondary market" do you mean secondary equity market or secondary debt market?

  Q423  Lord MacGregor of Pulham Market: You could try both but particularly the secondary equity market.

  Mr Olsen: It would be fair to say from my perspective that I have little experience of secondary equity markets. I can speak to the secondary debt markets but other than observing from a distance, not to avoid the question, I really do not have anything very much to say on that particular subject.

  Mr Turville: RBC is more on the advisory side than perhaps my colleagues here. We have been involved in a number of transactions, both buying and selling secondary assets in the PFI market. The secondary market remains open but there is a lot less liquidity within the market now. There has been some change in the players and some of the funds which were very active say two years ago are less active in today's market. You may have seen from the PFI press of last week or so that there have been a few transactions which still occur; Carillion sold a couple of assets in the last couple of days, for example.

  Q424  Lord MacGregor of Pulham Market: Until recently did it encourage the initial flow of funds into the PFI market in the sense that people knew that there was a secondary market to pass on to?

  Mr Turville: It certainly does. It is the same on the bank debt side. The presence of the secondary markets encourages people to provide funding to the transactions in the first place.

  Mr Olsen: It is particularly pertinent to those equity providers which are perhaps construction companies or operating companies which are effectively recycling their capital into the secondary market, freeing up capital to return to the primary market for the next set of deals.

  Q425  Lord MacGregor of Pulham Market: Mr Turville, I see you advised on the Norfolk and Norwich University Hospital NHS refinancing.

  Mr Turville: Yes.

  Q426  Lord MacGregor of Pulham Market: I should declare a very oblique interest in that I am resident in Norfolk and was an MP there for some time. We had some criticism from the previous witness on that. I do not know whether you have had chance to see it. If you did, I would be interested in your comments and if not, perhaps you could look and let us have your comments.

  Mr Turville: I have not seen those particular comments. I did attend the hearing of the Committee of Public Accounts probably two or three years ago on that. I am happy to have a look at those particular comments and revert separately.

  Chairman: If you could let the Clerk have a note, that would be useful.

  Q427  Lord Levene of Portsoken: I wonder whether you could let us know your overview on the effectiveness of PFI projects generally in terms of having projects in the public sector built on cost and on time compared with traditional procurement. When the system was originally introduced this was largely the object of the exercise, to say the public sector is not very good so, if we do a project like this within the private sector, it should improve it. What has been your experience of that?

  Mr Olsen: It is certainly the case and the evidence would suggest, as you have already stated, that the projects which have been completed have to a very large extent been completed on time and on budget. I would put that down to the policing, the rigours of the due diligence process which go in to and up to financial close and then the monitoring and the policing which happens on the project post actual close. Certainly evidence would suggest that PFI definitely delivers on time and on budget. I am sure there are exceptions but in the main that seems to be the case. That surely is one part perhaps of the value for money debate and discussion that ensues from PFI. Certainly my own evidence on the 50 or 60 deals that my bank has done in this space would suggest that PFI does deliver on time and on budget.

  Q428  Lord Levene of Portsoken: When you are talking about those transactions, were they straightforward construction projects or did they include the running and operation of them as part of the deal?

  Mr Olsen: In all cases running an operation post construction and of course a mixture of construction technology. At one end of the spectrum, a standard accommodation type project all the way through to some of the MoD projects, waste projects, with a full spectrum of technologies and difficulties from the very simple to the very complex.

  Q429  Lord Levene of Portsoken: We had a witness here three or four weeks ago who told us that they were virtually only able to use PFI as a method of procurement because it was the only area where there was cash available but that the traditional method of procurement through the public sector doing the procurement itself was much cheaper and more effective. What would you answer to that?

  Mr Olsen: My personal view is that I simply do not have enough reference data to compare it with the traditional procurement method. My answer would be that I have seen PFI in action and the evidence suggests that it does work on time and on budget but unfortunately I have no frame of reference to look at the traditional procurement method.

  Mr Waterston: I agree that it is difficult to comment on the traditional procurement side because there is very little evidence, whereas there is a huge amount of statistics on the PFI side. I would certainly back up what Adrian says that there is no doubt on our side that the PFI structure does help ensure that the PFI projects are more often built on time and on budget than you would see under traditional procurement. You just need to look at projects such as the Scottish Parliament or Thames Barrier to see the evidence of that.

  Q430  Lord Levene of Portsoken: Presumably you are saying that is how not to do it.

  Mr Waterston: Yes, sorry; evidence that the PFI structure is more effective. Furthermore, under the PFI structure, and this is an important point, where there are time delays or cost overruns, in the majority of scenarios they are borne by the private sector, whereas, if it were a traditional project, the cost overruns and the time delays would more often be borne by the public sector. It is a very important distinction to make that if there is a delay in a PFI project, which does not happen that often but it does happen, first of all the costs are borne by the builder, who pays liquidated damages to cover the bank's costs, cover additional costs in the project. If there is an extra cost to them in building it, perhaps steel goes up in price, then they have to cover the cost not the public sector. That is another benefit of the PFI element, referring to some points in the PPP Forum paper which was submitted to the House of Lords and which refers to a 2003 NAO Report on construction and PFI projects which gave some interesting statistics on how they very often did complete on budget and on price.

  Q431  Lord Forsyth of Drumlean: Earlier we have some evidence some weeks ago from the contractors and someone said that they were pretty neutral as to whether they did a project by PFI or by traditional means. When they were asked which resulted in them making most money, they said it was PFI. Why is it that the contractors should make more money out of PFI than traditional methods, do you think?

  Mr Waterston: That is a difficult question to answer from the banking side.

  Q432  Lord Forsyth of Drumlean: That is why I asked it.

  Mr Waterston: We do not see the actual profit level within the building contractor. I suppose it depends case by case between the various contractors. Perhaps that contractor had not had delays on its projects so had not had to pay liquidated damages or perhaps had calculated the costs very carefully so there were no cost overruns. I am sorry I cannot answer that in any more detail.

  Q433  Lord Forsyth of Drumlean: Surely as bankers you will be looking at the margins which are going to be obtained in forming a deal. I am surprised you do not have that.

  Mr Olsen: We do indeed. The due diligence and the risk process that we go through on that is to look at the price and establish that it is neither too much more nor too little. We need the contractor not to pare the price down to the bone and perhaps get into difficulty over the thing but equally not to overprice because they will not win the competition that ensues around the bidding process. It is a question of finding a balance between "too expensive" and "too cheap". Neither is good from our perspective: one does not win the bid and the other one leaves a contractor potentially in difficulty. There have been some examples over the life of PFI where contractors have actually ceased to exist because of the mis-pricing of their contract.

  Q434  Lord Forsyth of Drumlean: So they make more money because you, the banks, insist on a bigger cushion.

  Mr Olsen: What I am saying is that there is a happy medium between the two. The price they charge is the price they charge; they do their due diligence, they do their costings. We ask our technical advisers to look at those costings and the detail. We would bring expert help to bear on that. The question we ask of our technical advisers is whether it is a fair price, a sensible price for the work the contractor is going to do. There will be some element in that price for the risks they perceive they are taking on but, most importantly, we will make sure that the price is not too little so that we have a contractor with the potential to bleed very badly in actually undertaking that contract.

  Q435  Lord Griffiths of Fforestfach: You have made the case from your experience that for PFI, in terms of construction, it is on time and on budget. You then said that in 60 or so transactions in which you had been involved there were also subsequent running costs. I just wonder whether you have any observations on the role of the private sector as opposed to the public sector in delivering services, on the quality of services delivered when the project is completed and the cost of that as you go forward.

  Mr Olsen: Clearly most PFI projects require the private sector both to construct and operate certain elements. Clearly in schools the private sector does not deliver education, they deliver janitorial services, if I may use that term. I come back. In a way it is the same answer as I made to Lord Forsyth of Drumlean's question. We will look at the operator, the company which is providing the operational services through the life of the project and we will ask similar questions of the contract price that they are proposing to put forward to them, that is whether it is an appropriate price for the services that they are going to deliver over the next 20 or 30 years in a lot of cases. Is it the case that the public sector could provide those services? I am sure the answer to that is yes. Could they provide it more cheaply, more efficiently? Again, I am afraid to say, I do not have enough data to be able to compare the two. Evidence to date on the projects that I am aware of which have reached construction completion is that the operational services appear to be going very, very well. A very clear delivery is required and for those contractors who are not delivering there are sanctions, usually in the form of reduced payments, which again is the policing that PFI brings to the process.

  Q436  Lord Tugendhat: I realise that we are deviating somewhat from the line of march but nonetheless might I deviate still further, in particular to ask Mr Olsen a question. The Bank of Ireland must of course have a great deal of experience of the Republic of Ireland and also Northern Ireland.

  Mr Olsen: Yes.

  Q437  Lord Tugendhat: Coming back to the question Lord Levene of Portsoken asked about the efficiency of PFI versus traditional public sector procurement in the United Kingdom, on the basis of the Northern Irish and the Republic of Ireland experience, is there any light you can cast on this. How do they do it in the Republic?

  Mr Olsen: If I may cover Northern Ireland first, clearly the processes in Northern Ireland are identical to the processes in Great Britain. You could argue that there are certain local issues, let us call them, which need to be dealt with.

  Q438  Lord Tugendhat: I imagine.

  Mr Olsen: The general underlying process in Northern Ireland is identical to the procedure in England, Wales and Scotland. In the Republic the process was a little later in starting. We only started to see a programme around about 2000-01, maybe six or seven years after the UK launched. Again, the process is very similar. Obviously the law is very similar and the processes are, in fact I would be hard pressed to name any particular part of the process that deviates from the UK, with the possible exception of the method by which the bid is submitted. In some cases, but not all cases, when a bid is submitted it has to be submitted with full bank financing in place as the bid is submitted into the authority, which is not the case here.

  Q439  Lord Tugendhat: Did the Republic follow the United Kingdom in this particular case because the benefits of PFI over the traditional form of public procurement had been sufficiently demonstrated on this side of the water?

  Mr Olsen: I clearly cannot speak for the politicians and civil servants of the Republic. I sense and imagine that is the case and indeed in other jurisdictions as well. We are seeing this concept elsewhere, variously named but fundamentally what we know as PFI rolling out in Canada, in mainland Europe, Australia, New Zealand, Far East and Middle East. It is rolling out right across the world as a concept. Whilst every jurisdiction has a slightly different hybrid, the fundamentals are basically the same as the UK.

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