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


Memorandum by the Institution of Civil Engineers

GENERAL COMMENTS

  1.  In recent years the OECD[43] and HMT[44] have both indicated that UK economic performance has been impaired by a historic under investment in infrastructure, particularly transport infrastructure. The UK also requires major investment to secure energy security, improve the resilience of our infrastructure networks and deliver the transition to a low carbon economy.

2.  ICE believes that to secure maximum value for money, any funding mechanism should contribute to the creation of a stable workflow with reasonably predictable costs. It should also minimise costs for all bidders and allocate risks to where they can most effectively be managed.

  3.  Evidence from our members suggests that PFI does meet some of these goals and has facilitated investment. PFI also has the advantage of making transparent the ongoing maintenance costs associated with infrastructure. In this context, while much of the opposition to PFI has focused on costs imposed on future generations, an alternative view is that PFI protects vital maintenance spending by taking it out of the short term cycle of public expenditure planning.

  4.  However for projects below circa £30 million the high cost of bidding can restrict competition and thus gives cause for concern over value for money, particularly where significant design work is required by bidders.

  5.  We also note that a lack of comparability between projects within and across infrastructure sectors makes it difficult to make a generic assessment of the performance of PFI projects. However this is not necessarily a reason to seek greater standardisation as the structure of elements such as payment mechanisms and specific risk transfers should reflect the needs of individual clients.

  6.  ICE also believes that improvements to the effectiveness of PFI, or any alternative funding source, such as a National Infrastructure Investment Bank will require other changes to the policy and institutional environment for delivering infrastructure projects. We strongly support the provisions in the Planning Act 2008 for the creation of National Policy Statements for infrastructure and for a streamlined planning and licensing approval process via an Infrastructure Planning Commission. This should reduce political risk for all parties and thus reduce the cost of funding projects. The government's recent commitment to create a new body, Infrastructure UK, charged with taking a long term view of the nation's infrastructure needs and identifying how they can best be delivered also has enormous potential in this area.

RESPONSES TO QUESTIONS IN THE CALL FOR EVIDENCE

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?

  1.1  The length and complexity of the procurement process for PFI projects does result in high upfront costs for bidders. ICE believes that this creates high barriers to entry and is a factor driving consolidation in the construction contracting sector. This raises concerns about long term competition and value for money in this market.

  1.2  In the short term, there is evidence for concern regarding value for money from smaller PFI projects. In a 2008 study[45] 88% of respondents considered the bidding costs of small PFI projects (<£30 million) to be more expensive than those of traditionally procured projects. However it should be noted that in the same study only 39% considered the design and construction costs of small PFI projects (<£30 million) to be more expensive than those of traditionally procured projects.

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?

  2.1  The majority of PFI projects span a period of 25-30 years, with the first projects beginning in the mid to late 90's. This means that the evidence base for the full performance of projects will only become clear over the coming decades. However we would make the following observations.

    (i) Traditional procurement models separate some or all of design, construction and maintenance of infrastructure projects. In bringing these together PFI has the potential to deliver a superior product by integrating these elements and aligning the goals and incentives of all parties to the project.

    (ii) The payment mechanism in PFI projects is linked to performance of the asset. In theory this provides an incentive for the timely completion of the construction phase of projects. In the opinion of ICE members who have acted as clients for major projects, this theory is borne out in practice.

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

  3.1  This is an area where it is difficult to give a generic answer due to the diversity of PFI contracts. ICE does however make the following observations.

    (i) Bidding consortia have in theory carried the risk of financing projects. The creation earlier this year of the Treasury Infrastructure Finance Unit (TIFU) to lend to projects struggling to reach financial close does call this aspect of risk transfer into question. It should however be noted that TIFU has only made one loan of £120 million to assist the Greater Manchester Waste Disposal PFI.

    (ii) The level and nature of operational risk transfer varies very much with form of contract. As an example early Highways Agency PFI projects were largely based on shadow tolls, which in practice meant that consortia were taking a risk on whether traffic forecasts were correct. A number of these projects were funded via the bond market, with bonds securing AAA ratings, suggesting a very low level of risk. Latterly the Highways Agency has moved to more rounded measures of performance including levels of congestion, accident rates, lane availability and quality measures linked to relations with Local Authorities and the local community. This has gone some way to better align PFI payment mechanisms and risk transfer arrangements with measures that indicate the wider social benefits of infrastructure projects.

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?

  4.1  Once again this will vary between contracts. In the example given above, it could be argued that in the later Highways Agency projects, the complexity of the performance measures, in particular measures linked to relations with Local Authorities et al does provide a robust means of comparing performance with traditional procurement and public sector service provision. It is also true that Treasury guidance insists that PFI projects have an output or performance based service contract.

  4.2  In this context a key issue is the ability of public sector clients, many with limited procurement expertise to create effective performance management arrangements as part of contractual arrangements. This has been an issue since the early days of PFI and was a factor driving the two reviews by Sir Malcolm Bates, in 1997 and 1999 respectively which led to the establishment of Partnerships UK, whose brief is to "work in the public interest and address the key weaknesses in the current PFI/PPP process in order to make the public sector a more effective client."[46]

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?

  5.1  In responding to this question we draw a distinction between two aspects of "post procurement", (i) post financial close and (ii) post service coming into operation.

  5.2  In relation to (i) there has been a debate as to whether PFI contracts should allow the Authority to introduce changes during the course of construction. Frequently such changes are not permitted except by agreement of all parties because changes impact on the project company, the design and build contractor, the facilities management contractors and, unless the change is fully funded by the authority, the financial model and the investors.

  5.3  In addition the structure of PFI contracts is such that it is time consuming to obtain a fixed price for any such changes. A right to instruct changes unilaterally frequently introduces too much uncertainty of cost for an Authority. A more traditional design and build contract could have more flexibility.

  5.4  In relation to (ii), it is often the case that such changes have to be procured via the Service provider and this can be expensive. Authorities that have sought to introduce changes are in the best position to answer this question. As a general rule, in order to reduce the potential for alterations in post service availability, it is important that clients improve the definition of their needs at the start of the process. However it is acknowledged that this can be difficult. As an example, we are aware that in the waste management sector uncertainty over the volume and composition of household waste over a 25 year period has created challenges for clients and contractors alike.[47]

  5.5  ICE is concerned that this lack of flexibility is a factor leading to a lack of resilience and flexibility in our infrastructure networks. In our recent report, State of the Nation: Defending Critical Infrastructure we argued that government should provide incentives for private asset owners to build in resilience and redundancy.[48] This can reduce the later need for alteration due to issues such as lack of capacity or the need to adapt to cope with the impacts of climate change.

6.  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?

  6.1  As of August 2009 there were 136 live PFI projects either endorsed by the relevant government department or signed off worth £17,645 million.[49] They include £3.419 billion PFI projects in DFT and over £2.5 billion PFI projects in DEFRA.

  6.2  ICE members active in the PFI market report that in late 2008 and early 2009 securing funding was extremely difficult. However in recent months the situation is perceived to be easing, although the market has clearly not reverted to its pre economic crisis conditions. Anecdotally, lenders are still seeking relatively high rates of return and are loath to lend for longer than five to seven years. The twin issues of availability and cost of capital are a key part of the case for a National Infrastructure Investment Bank (see below).

  6.2  Commentators have suggested that the risk of a further slow down in the market has been reduced by the recent HM Treasury guidance that while government departments and Local Authorities will have to include PFI projects on their balance sheets, the cost of projects will not contribute towards net public sector debt.[50]

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?

  ICE has long argued that a historic under investment in infrastructure has hampered UK economic performance.[51] In addition in the coming decades the UK will require major infrastructure investment to boost economic performance and support the transition to a low carbon economy. We believe that a National Infrastructure Investment Bank (NIIB) providing a stable source of long term, low cost funding should be created as part of an institutional framework that can create the conditions for infrastructure investment and delivery on this scale. Other elements of this framework would include National Policy Statements for infrastructure, as provided for in the Planning Act 2008 and Infrastructure UK, the body currently being created by government to assess long term infrastructure needs and facilitate their delivery. To this end we have recently published a briefing paper Financing the UK's Infrastructure a copy of which is enclosed with this submission.

  We are also working with the University of Loughborough on a research project that will provide an appraisal of the funding options, including a NIIB, that could support the medium-term and long-term infrastructure development. This project is due to be completed in mid October and we would be very happy to share the findings with the Committee.

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?

  ICE believes that within the UK there will be a role for private finance for as long as there is a demand for improvements to infrastructure and for the private sector to take an element of risk to incentivise efficient performance. Private Finance is appropriate for some types of investment in some sectors where there is a proposition that can be packaged for a private sector partner to deliver and that is well understood by both client and a reasonable number of potential bidders. There will remain many other areas where a proposition cannot be put together, or where PFI is either inappropriate or not affordable. These projects will need to be procured in different ways, including payment of cash backed with close supervision or management of delivery.





























43   OECD (2007) Economic Survey of the UK Back

44   HM Treasury (2007), Productivity in the UK 7. Back

45   Carrillo, Robinson, Foale, Anumba & Bouchlaghem, Participation, Barriers, and Opportunities in PFI: The United Kingdom Experience, Journal of Management in Engineering (July 2008). Back

46   http://www.ogc.gov.uk/documents/modern_government.doc p 1. Back

47   Mattravers, N, (2006), Improving the operation of PFI in the Waste Management Sector, Proceedings of the Institution of Civil Engineers-Waste and Resources Management, Volume 159, Issue 1, pp 3-6. Back

48   ICE (2009) The State of the Nation: Defending Critical InfrastructureBack

49   http://www.communities.gov.uk/documents/localgovernment/xls/1241650.xls Back

50   http://www.publicfinance.co.uk/news/2009/06/stalled-pfi-projects-should-get-go-ahead/ Back

51   ICE (2009), Submission for the 2009 Budget http://www.ice.org.uk/downloads//Budget%20submission.pdf Back


 
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