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

Supplementary memorandum by Mr Paul Davies, PricewaterhouseCoopers

  Thank you for the opportunity to present on project finance and the PFI market. I thought I would write to make a few further points which were raised in the session but we did not have time to cover fully. These points are relatively inter-related and relate to the potential for a UK infrastructure bank, whether risks for a project are the same irrespective of the method by which they are procured, and finally whether Government can benefit from the procurement disciplines of PFI without incurring the cost of finance.

1.   The potential for a UK infrastructure bank

From many of the contributors you will have heard a relatively passionate explanation of the benefits of PFI, emphasising the benefits of the rigour of the PFI procurement process and contractual structure; in particular the upfront due diligence on costs and contracts, transferring PFI risks to competent sub-contractors, a payment regime that enforces continual asset maintenance, and a process that demands clarity from the public sector at the outset about what services it requires and what it can afford.

The key point is that because PFI transfers risk to debt and equity financiers, it institutionalises these project disciplines. If that rigour is not imposed on each project at the outset, that project will not be able to attract finance.

  The biggest innovation of PFI has been to attract those skills used elsewhere by the private sector in project finance into the realm of public sector services and to apply those project disciplines.

  The potential for a UK Infrastructure Bank in the PFI market has to be seen in this context and what its existence might do to those market disciplines.

    — If that bank is designed to address market failure, ie where there is insufficient lending capacity, then its contribution would be valuable. It means that the remaining lenders can retain those skills and stay in the market, in the knowledge that even the larger deals can get financed. This is the role that TIFU has carried out successfully to date.

    — If a UK Infrastructure Bank were designed to be as a relatively economical co-lender alongside private sector banks and does not crowd out those lenders, then it could be a valuable entity as it will improve project economics and affordability. But this is a role already adequately performed by the EIB. So the argument for an Infrastructure Bank would only be for instances where the EIB is capacity constrained.

    — If the Infrastructure Bank were designed to replace or crowd out private sector lenders, then over time the private sector disciplines imposed across PFI deals by a multitude of debt and equity financiers could be eroded; skills which are currently well supplied by the market. It would be optimistic to assume one institution could retain those skills in the long term.

  So any argument for an Infrastructure Bank needs to carefully consider how it might impact the existing market and the application of project finance disciplines in public service delivery.

2.   Are project risks the same irrespective of the method of procurement?

  There is an argument along the lines of "the risk of a project is the same irrespective of the method of procurement. But if the cost of finance is cheaper in the public sector, than it follows the overall project cost will be cheaper if procured by traditional methods". That argument ignores the reality of the procurement process.

Let us assume a Minister is about to approve commercial close for two hospitals for £100 million each; one to be financed by PFI, one by the public sector, using traditional procurement. At that point, the Minister will know that although the PFI's weighted cost of capital is higher, all the rigours of PFI procurement will have been applied as a precondition to obtaining the project's finance; the costs and risks will have been assessed and contractually mitigated at the outset. There is no such similar absolute assurance in the case of the traditionally procured project; its success will depend upon the quality of the procurement team in each instance.

  The key point is that with two apparently identical projects, the PFI project is likely to be inherently less risky because of the imposed discipline of its debt and equity financers before the project commences. This benefit typically outweighs the higher cost of finances.

3.   Can Government benefit from the disciplines of PFI without enduring the cost of finance?

  PFI is still a very small part of Government procurement; less than 10% of annual procurement spend. What is clear is that while many of the non-PFI projects may have no finance requirement, they can all benefit from the skills developed in PFI and that a healthy PFI sector can improve the quality of procurement across Government.

What PFI has created is a small army of individuals in both the public and private sector who have strong project finance disciplines and could use them far wider across Government.

  Given the economic challenges we currently face, to not systematically export that expertise and discipline across Government would seem to me to be a huge wasted opportunity.

Paul A T Davies



21 December 2009

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