Chapter 5: CONCLUSIONS AND RECOMMENDATIONS |
159. Against a background of shortage of funds
and doubts about conventional methods of procurement, it was clearly
in the public interest for Governments to look for new, efficient
and cost-effective ways to meet demand for new public infrastructure
160. The rapid growth of private finance projects
over the past decade or so is striking and has played a significant
role in the expansion and renewal of the nation's infrastructure
161. Despite the scarcity of private finance,
there are few advocates of a return to the old system of public
procurement in those sectors where PFPs prevail. But PFP payments
are contractual commitments and, as public spending is constrained,
could have an adverse impact on the budgets available to public
authorities for other, non-PFP, expenditure. They could, for example,
exacerbate any budgetary pressures arising from unforeseen bunching
of commitments and demands in a given financial year. The Government
should monitor and control year by year the impact of PFP commitments
on the budgets of Departments and public authorities with a view
to ensuring that delivery of essential public services in future
years is not unduly constrained or jeopardised by such commitments
162. Even though the cost of debt in private
finance projects will usually be higher than under traditional
procurement, this factor alone does not rule out the use of private
finance. The higher cost of debt reflects risks carried by the
private sector and a margin for profit. And, apart from bearing
risks that would otherwise fall to the public sector, private
finance can offer other advantages over traditional procurement
to offset the higher interest rates (paragraph 30).
163. The NAO is sceptical about optimism bias
uplifts in the context of Public Sector Comparators and about
applying optimism bias solely to estimates of public sector costs.
The projected costs of private finance projects may also be subject
to optimism, although not necessarily at the same level as in
conventional public sector procurement, and in practice any overruns
would normally be met by the private sector (paragraph 36).
164. The addition of optimism bias may in many
cases have had the effect, even at reduced discount rates, of
tilting the comparisons of net present value which public authorities
have to make, in favour of PFP and against conventional procurement.
We recommend that, in order to reach a fairer basis of comparison,
where a percentage uplift for optimism bias is added to the estimated
Net Present Value of Public Sector Comparators, an appropriate
rate of uplift should also be added to estimates of the NPV of
the cost to the client under PFP (paragraph 37).
165. It is difficult to compare whole life costs
because PFP costings include maintenance and other services over
many years while costings of conventional procurement generally
do not. We recommend that, in order to make possible proper comparisons
between privately-financed and traditional procurement, the Government
should collect on a whole-life basis cost data on some comparable
traditionally-procured projects. Better data would help public
authorities achieve good value for money, the main criterion of
successful procurement (paragraph 40).
166. A Value for Money test based on imputed
costs of a Public Sector Comparator (PSC) should be a useful tool
in assessing the relative costs and merits of private finance
and traditional procurement. But its value is limited by shortage
of relevant data and by the selective inclusion of optimism bias.
Even if these deficiencies were addressed, as we recommend above,
public authorities should not rely solely on PSCs when choosing
a procurement route (paragraph 44).
167. There may or may not be enough lenders in
the market already to finance public infrastructure, even in a
period of restricted credit such as we now face. It is too early
to tell whether the Treasury Infrastructure Finance Unit (TIFU)
will bridge the gap. The pros and cons of establishing a National
Infrastructure Bank should be kept under review (paragraph 49).
168. There should be greater clarity about financial
liabilities arising from PFPs. The Treasury's requirement that
departments should run two sets of accounts, though an understandable
response to the use of one accounting system within departments
and another nationally, is far from ideal. Furthermore, national
accounts solely on a UK GAAP basis give a misleading picture of
overall liabilities by excluding most PFPs from figures of Public
Sector Net Debt. We recommend that the Government should publish
figures for total liabilities for privately-financed public sector
procurement as a separate item alongside figures for Public Sector
Net Debt. Brief statistical information should also be supplied
as to the distribution of these liabilities across a series of
separate categories that reflects differences in the extent of
risk transfer away from the public sector (paragraph 59).
169. Inclusion of PFP liabilities in Departmental
balance sheets, as now required, together with publication of
aggregate figures of national PFP liabilities, as we now recommend,
should provide a clearer picture of their economic significance.
The motive widely imputed by witnesses to the Treasury for its
perceived bias in favour of PFPstheir low profile in accountswould
also fall away (paragraph 60).
170. We recommend that, subject to the need to
maintain control of public spending, the Government should take
measures to remove institutional bias in favour of private financing
of public procurement, so that public authorities can select it,
or another procurement method, on a case-by-case basis according
to value for money (paragraph 61).
171. There is strong evidence that PFPs have
a better record of on time and on budget delivery than traditionally
procured projects, although it appears this gap is narrowing.
Nonetheless, too many PFPs are delivered late, albeit contractors
rather than public authorities are liable to the consequent financial
penalties (paragraph 69).
172. Substantial price increases are undesirable
late in the bidding process whatever procurement path is chosen.
Despite the longer bidding process under PFPsand the associated
higher coststhe greater likelihood of projects being completed
on time and on budget after the contracts have been signed can
be a benefit worth some extra expense to the public sector at
the initial stage (paragraph 75).
173. Construction and maintenance risks are usually
seen as suitable for transfer to the private sector; whereas activities
over which the private contractor is seen as having little or
no influence have not been transferred (paragraph 81).
174. We welcome the Government's action to secure
for the public sector a substantial share of refinancing gains
in PFPs. We recommend that the Government should continue to learn
from experience in order to ensure that the public sector enjoys
a fair share of benefits from improvements in financing arrangements
175. The failure of the London Underground Metronet
PFP gave private finance projects in general a bad name. Yet this
project was exceptional because huge debt guarantees together
with a typically narrow equity base limited risk transfer. We
recommend that the state should not guarantee large amounts, and
a high proportion, of debt as a means to make highly geared PFPs
happen. For such exceptionally large and complex projects alternative
procurement approaches should be used (paragraph 101).
176. Private finance has led to a much needed
focus on maintenance of public infrastructure. Public authorities
should however keep a watchful eye on the price paid for what
is on balance a positive development. We also recommend that the
Government should promote the bundling of construction and maintenance,
and whole-life costing, in all public procurement, whether privately
financed or not (paragraph 108).
177. Monitoring and managing private finance
contracts has long been a weakness of the public sector, although
there have been improvements in recent years. We recommend that
public authorities should do more to maintain and improve commercial
skills of staff dealing with private finance projects, with emphasis
on long-term contract management as well as contract negotiation
178. There is some concern that construction
companies which can sell their stakes in PFPs shortly after a
project is operational may build a lower quality asset than if
they remained shareholders with responsibility for maintenance.
Although due diligence and checks by buyers in the secondary market
amongst other parties may meet this concern, we saw no empirical
evidence in this area. We recommend that the NAO should undertake
studies of the effects of secondary markets on standards of quality
in PFPs (paragraph 117).
179. Traditional procurement has also benefited
from the lessons learnt from private finance projects. Risk management
and due diligence appear to be better in the public sector as
a result of PFPs. These benefits need to be included when assessing
the total benefits of private finance (paragraph 122).
180. PFPs have led to some innovation although
few witnesses described this as a key reason for using private
finance. It is for public sector clients to request more innovation
from contractors when negotiating private finance contracts, if
that is what they are seeking (paragraph 126).
181. Public sector employees transferred to the
private sector during the course of a PFP are protected by TUPE
(Transfer of Undertakings (Protection of Employment)) regulations
and employees recruited directly are protected by general employment
law. Pay and conditions of the two categories of employees may
well differ, at least at the outset. Where average labour costs
subsequently fall, in a PFP transferred from the public sector,
such cost savings may simply indicate that the pay and conditions
of the employees previously in the public sector exceeded the
market rate (paragraph 130).
182. Inflexibility has been a feature of private
finance contracts, although it has also been a key factor in forcing
the public sector to plan ahead. But flexibility is negotiable,
at least to some extent. Public authorities should determine how
much flexibility they want, the means of achieving it in the terms
of the contract and what they are prepared to pay for it; then
negotiate accordingly (paragraph 138).
183. We recommend that the Government should
explore the feasibility of importing into PFP contract terms selected
features of regulatory review models for utilities (paragraph 139).
184. High bidding expenses risk reducing competition
for private finance projects which, in turn, could increase costs
to the taxpayer. The Government should examine possible mechanisms
for encouraging competition, such as returning an element of bid
costs (paragraph 145).
185. The projects most suitable for private finance
are those where the requirements can be clearly specified at the
outset and which are of a size that consortia of private sector
companies can take on their balance sheets (paragraph 152).
186. The private sector is clearly not best suited
to bear all the risks in all forms of private finance project.
Experience has shown, however, that bundling certain services
with construction in PFPs has delivered benefits, including the
transfer of risk from the public to the private sector. We believe
there is scope to transfer more demand or output-related risks.
For example, with a prison such risks could be partly transferred
by rewarding contractors for lower re-offending rates. In education,
more risk transfer might be possible in the provision of teaching
services; independent schools already take on all such risks.
There is similar scope for the transfer of demand and output-related
risks in relation to medical services (paragraph 157).
187. We recommend that the Government should
examine what additional risks now borne by the public sector can
sensibly be transferred to the private sector, acknowledge the
lesson of experience that the risks of exceptionally complex,
large projects are not suitable for transfer to the private sector,
and produce comprehensive revised policy guidelines (paragraph 158).