Photo by: FMJ

In the 2012 autumn statement, the government announced reforms to the Private Finance Initiative, through a new model called PF2. Eighteen months since its introduction Angela Mackay explores the technical content of PF2 reform, focusing on the substantive changes which have been introduced, why they matter and the impact to date on the FM sector.

September 2014

The Private Finance Initiative (PFI) has had some bad press in the UK. “Cancel these crippling PFI hospital contracts and put the ministers who signed them in the dock” screamed the Daily Mail; “PFI is bleeding hospitals dry: 1 NHS trust on the brink, 6 critical, 16 poorly due to debts” shouted the Mirror, together with (generally true) stories about a Treasury Christmas tree which cost £900, a plug socket which came in at £320 and £149 to install a small noticeboard.

The problem with PFI in the UK is mainly perception, agrees independent FM consultant Bernard Crouch. “In Canada, Australia and other countries, PFI is perceived as a good way to build and run public sector buildings. But in the UK the media has convinced us that it is entirely bad.”

When stories break about a light-bulb costing £120 to change, what is not mentioned is that the PFI contractor is working in accordance to an agreement which all parties evaluated and signed up to, says Crouch. “The agreement will often describe which suppliers and sub-contractors are to be used – and percentage mark ups are added as per the agreement. We have some really good PFI projects in the UK which are never mentioned, with excellent outcomes delivered – however greater transparency on PF2 is unlikely to alter ‘it cost how much!’ horror stories.”

Crouch cites a good example of an unheard story. Sodexo has a key performance indicator around recidivism at a prison they run under a PFI arrangement – they pay a penalty when a former prisoner re-offends. “I suspect they are doing a lot more with prisoners to stop this happening than a typical state-run prison would. This is an example of a well considered PFI agreement.”

TARNISHED

But it is the horror stories, which make the juicy headlines and led, in part, to the government introducing in December 2012, a new PFI model. In the foreword to the PF2 policy document, the chief secretary to the Treasury expressed the view that PFI had become “tarnished by its waste, inflexibility and lack of transparency”. Son of PFI, or PF2, was meant to address these, and other, issues. It made several key changes:

• Speeding up the tendering process so from the project tender to appointment of preferred bidder takes no longer than 18 months. The previous process was considered too slow and costly.
• Increasing public sector investment in PFI projects. The government will invest between 30 and 49 per cent of the overall equity, lowering the debt finance required, reducing market capacity constraints which enables more competitive pricing. Overall this reduces the burden on future generations and ensures that public and private sector motivations are aligned.
• Removing soft services such as cleaning, catering, security and landscaping from the scope of the contracts (other than where exceptional integration benefits exist) which will now be procured separately through short-term contracts. It will make deals more flexible, especially if authorities want to cut costs through reducing the service specification
• Creating a more appropriate allocation of risk; previously PFI contractors took on more risk and therefore had to build up reserves to mitigate against that risk. Now the public sector retains more risk which improves value for money for the taxpayer.
• Creating greater standardisation of contract documents with a draft services output specification template and pro-forma payment mechanism for accommodation projects
• Placing limits on traditional PFI investors, such as banks, and encouraging the entry of institutional investors such as pension funds and insurance firms.
• The aim is to create greater transparency in the private finance initiative deals, and better value for money.

But anyone who was hoping that PF2 would be the tool to revive the fortunes of the UK infrastructure sector will be sorely disappointed says Ian Pumfrey from the projects and Infrastructure practice at law firm Stephenson Harwood. Pumfrey cites the lack of pipeline projects as a key issue. The scale of the first PF2 project – the Priority Schools Building Programme (PSBP) – was dramatically reduced even before it had got going. Just 46 schools will be procured. And beyond PSBP, there are just a handful of other projects in the pipeline. “Despite the successful delivery of the vast majority of PFI projects over the years, it has been difficult to shake off the negativity that has surrounded the industry in light of political criticism and public perceptions. It was hoped that the launch of PF2 would bring an end to such criticism but without a pipeline of projects that demonstrate how PF2 fixed PFI, that bad press may hang round for a while longer.”

HEALTHCARE

In healthcare, only one hospital, Sandwell in the Midlands, is to use the new model; and the government decided not to use PF2 for military housing.

Part of the reason behind the current small pipeline is the uncertainty over the future of PFI for two years before the announcement of the new model. These types of projects take some time to come to fruition so it may be many years before the industry can judge whether or not PF2 has been a success.

Such programmes tend to start slowly and then gather pace as policy-makers and market practitioners become familiar with the model agrees Gary Watkins, managing director of PPP operational performance management software provider Service Works Global. “Private Finance 2 is at an early stage in this journey, with a small number of health and education transactions currently in the pipeline. But the political will behind the programme is strong and is supported by a growing need for new infrastructure in a context of limited public sector finances.” PF2 will continue to provide a key component of government capital planning, being ‘the only game in town’ for new investments in areas such as healthcare, education, custodial services, defence, and roads, in which public funds are the dominant source of revenue, he says.

DUE DILIGENCE

But Watkins warns that bringing new institutional investors to the party is not as straightforward as it seems. “Often, institutional investors lack the dedicated specialist human resources required to undertake due diligence of project business plans to ensure that risks have been properly identified, allocated and mitigated. And they are unlikely to be comfortable bearing the costs that banks, for example, have borne when undertaking or commissioning independent forecasts, due diligence, and risk assessments. Thus, PF2 projects may not be a straightforward proposition for all investors.” Those that do enter the market will be unlikely to accept at face value the cost/benefit forecasts of project managers and promoters. For project cost to attract institutional investment (and also for government agencies to sign off on new equity investments), there will be an enhanced need for clarity about the true magnitude and severity of project risks – alongside much better assurance that risks have been allocated to the parties best placed to manage them, he says.

INFORMATION

Watkins recommends that to ensure support from institutional investors, the quality of information available pre- and post-contractually must be improved. Part of the solution to this is to use a payment mechanism during the preferred bidder stage, that is capable of delivering consistent, auditable and transparent management of data that can be monitored on a real-time basis. “I recommend that, as the PF2 market matures, investors should require project cost and their subcontractors to have an integrated payment mechanism in place as a basic minimum condition for their involvement in a project.”

Perhaps the UK needs to look further afield – to Canada and Australia where PFI is popular – and look at the ways in which the government can more effectively ‘sell’ PFI to both the industry, the taxpayer and the media. PF2 is a sound model but it needs to win the hearts and minds of UK Plc if it’s to be successful.

What is PFI?

PFI was invented by John Major’s Conservative government in 1992, but only became widespread during the Labour government after 1997. It became a popular method for building large-scale public sector projects such as schools, hospitals, bridges and motorways without having to pay the money upfront. Private sector firms bid to build and maintain the facilities and then lease them back to the Government. Repayment is over a long period – at least 25 years – but at a high rate of interest. The result is that large debts are stored up for future taxpayers.

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