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

Letter and memorandum by Mr David Belton, Sheffield City Council

1.   How should the cost and benefits of Private Finance projects be assessed? What discount rate should be used in comparing Private Finance with conventional public procurement? Are current procurement procedures satisfactory? Is enough information disclosed on Private Finance projects fully to assess whether the taxpayer is getting value-for-money?

  We would expect any project to be assessed by options appraisal in the first instance to establish whether the scheme would deliver any benefits.

  Having established a need, we would expect any further appraisal to be based on a whole-life comparison to take account of residual values of any assets involved.

  Typically projects with the characteristics of delivering and/or maintaining new infrastructure eg buildings or services will be capable of alternative ways of provision, one of which would be PFI. We would look to compare:

    — PFI;

    — Local authority funding-prudential borrowing eg PWLB;

    — others eg bond issue;

    — Central government loan funds.

  The focus of existing value for money (VfM) tests is on VfM for the authority. If using central government loan funds this test needs to relate also to VfM for the public sector more generally.

  It follows that the discount rate for use in "conventional public procurement" should be that at which the funds are procured eg if central funds then the long term treasury borrowing rate or if locally funded via prudential borrowing then PWLB.

  We believe that current procurement procedures are generally good but often lock in (or out) funders at too early a stage so recent Treasury guidance will allow more bidder competition on funding and for options to be kept open until much closer to financial close.

  VfM is both an absolute and relative term. Current tests against an alternative option, along with scenario testing, provide an indicator of relative VfM.

  How can we be sure however that the proposal is absolutely the best VfM?

2.   How does the performance (eg, cost, delivery dates and service quality) of schools, hospitals, prisons, roads and other projects operated under private finance compare to those which were traditionally procured?

  The best contemporary comparison of assets provide by either method is that of schools provided under the BSF programme. Here it would be true to say that the standards and performance are similar. That however is heavily influenced by the LEP structure where the procurement process and negotiation is being handled by a single agency on the authority's behalf.

  Away from that structure PFI brings contractual standards of asset construction and services delivery that when provided "conventionally" requires joined up and consistent thinking by the authority's financial officers, schools' management and indeed schools' heads. This introduces scope for flexibility which can be a good thing but can also to a degree lead to local changes eg school heads having their own priorities.

3.   Is there significant risk transfer to the private sector or is it more apparent than real?

  All the risks associated with the construction delivery of the asset to time, of variation of funding costs over time, and of operating expenses can be effectively transferred to the private sector under PFI (at a cost).


  An issue with certain types of PFI eg schools is that the client has to accept and manage the demand side risk. Therefore risk not fully transferred.

  An emerging issue is that of PFI contracts with fixed price or inflation linked contracts in a public sector funding environment where standstills or even cuts are going to be possible. Non PFI arrangements may be easier to manage down in such an environment.

4.   How effective and costly has it been to monitor the private sector providers' performance and quality of service in Private Finance projects in comparison with traditional procurement?

  Traditionally procured assets require an in house management structure and capability to ensure provision of a satisfactory service. Under PFI much of this responsibility is carried by the provider and governed under the performance requirements of the contract.

  This authority has recognised that contracts do not manage themselves and has made financial and organisational provision for effective contract management to be in place.

  We are in the process then of developing this to ensure that we secure "benefits realisation".

5.   When the basis of a Private Finance contract needs to be altered post procurement because of changing client needs—for example, a bigger jail is required due to a larger than expected prison population—has this proved problematic compared to projects under traditional procurement? What has been the experience of PFI projects that have reverted to the public sector?

  PFI contracts are inherently inflexible for major changes, despite contract procedures for contract variation.

  The challenge eg of adding a major school extension mid way through a 25 year concession is considerable eg costs of a legal variation, funding environment, term of the new contract, private sector opportunity for profit generation.

  (We have no PFI projects that have reverted to the public sector).

6.   How should future payments by the Government under existing Private Finance contracts be recorded in public sector accounts? Is risk transfer an appropriate test? Should all such liabilities be included in the national debt? Should they be accounted for separately from government debt? How much does the public sector accounting treatment of capital and revenue aspects of projects matter?

  Where assets are involved then under private sector accounting the key determinant of whether a lease should be capitalised is whether ownership passes to the client at the end of the term. (Finance Lease) It seems to me that irregardless of the debate about "risk transfer" and "control" this should be the key decider on whether a contract or the asset provision element thereof should be capitalised along with the associated debt stream.

  After all, the authority does have the long term debt liability in respect of an asset which it is enjoying and will in the long run retain.

  To the extent that assets are not involved (and therefore) cannot be capitalised (operating lease), the long term liability should remain off balance sheet.

7.   Would public sector investment in the last decade have been lower without Private Finance? If so, by how much?

  In this authority we have been able through PFI to invest £190 million in Capital schemes (schools and an office building) that would not otherwise have been possible.

8.   How much impact has the financial crisis had on launching new Private Finance projects? Is the crisis likely to have a permanent effect on the Private Finance market?

  This is having no impact on our programmes, although it is requiring close monitoring under our Highways PFI project which is in procurement.

  The "crisis" itself won't have a permanent effect but changes in funders' appetite for business and terms of funding may have a longer term effect.

9.   Are there realistic alternative roles for private finance than the current PFI-type private finance models? Should the UK be aiming for more diversity in private finance models? Would a national infrastructure bank (such as the proposed Dodd-Hagel NIB in the US) add any value in the UK? Should the public sector have a more hands-on role in financing and/or delivery?

  Yes a national infrastructure bank would help provide affordable finance of a suitable scale for PFI projects.

  We recognise however that this will de facto mean the debt will go on national accounts.

  Under turnkey PFI frameworks for certain types of infrastructure the private sector remains the best option operationally and we would not envisage an argument for the public sector to "get more hands-on".

10.   Is there an optimal mix between conventional public procurement and Private Finance for public sector investment? What is the long run role of private finance in the delivery of infrastructure both in the UK and globally?

  Over the long run private finance should provide a competitive market for funds, using structured products, capable of delivery in an administratively commercial and efficient way. Public finances may be cheaper( to reflect AAA rating and longevity of the lender) but will not benefit from the same commercial tension, or be product-geared to the types of funding structure needed, and will be heavy on governance and administration.

  Direct government funding will also appear on Government accounts.

  Where PFI also scores is in the integration of the funding arrangement with a long term operating concession.

  The large players/providers will continue to provide a VfM solution to these turnkey requirements.

25 September 2009

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