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


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 (paragraph 14).

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 (paragraph 21).

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 (paragraph 24).

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 PFPs—their low profile in accounts—would 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 PFPs—and the associated higher costs—the 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 (paragraph 85).

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 (paragraph 112).

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).

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