PPP and PFI Delivery Through Partnerships

1
PPP and PFI Delivery Through Partnerships

• Peter Livesey
• Senior Policy Analyst
• Corporate and Private Finance

2
Drivers of PFI procurement

• PFI as off-balance sheet investment
• 1992 facilitating investment unaffordable in
  the public sector
• 1997 financing investment within previous
  govts spending plans
• Focus shifted to value for money, but legacy of
  balance sheet treatment remains
• PFI allocates risks to those that are in the
  best position to manage them
• Cost time overruns associated with conventional
  procurement.
• Key is whether cost of private finance over
  gilts outweighs benefits in terms of bank
  discipline, risk transfer and efficient
  management.

3
Project Delivery
Conventional Procurement
Projects over budget 73
Projects late 70
Source UK National Audit Office
4
UK Procurement Policy
HM Treasury Corporate and Private Finance
Team Private Finance Unit
Future PPP approaches
Mandatory PFI Contract
PPP/PFI procurement policy
5
PFI / PPP legislation in UK

• Not a lot has been needed there is no single
  PFI Act
• Specific modest steps have been needed to
  facilitate PFI / PPP at the local level in the
  NHS
• E.g. Local Government (Contracts) Act 1997
• Beyond this existing UK law has been sufficient
  for PFI / PPP contracts to go ahead.
• To think about
• Does the Government have the power to enter
  long-term agreements with the private sector
• Are the underlying elements of PPP / PFI
  contracts legal? E.g. exotic hedging instruments.

6
PFI has been effective procurement tool

• 2006 was biggest year so far for the value of
  deals signed
• closure of a small number of big deals
• progress of projects initiated 2/3 years ago
• Key sectors of PFI investment
• Health - 8.3bn has delivered 64 operational
  PFI hospitals
• Education - 4.4bn covering 836 schools
• Defence - 5.6bn in 47 projects
• Transport - 4.9bn in 46 projects (not
  including tube deals)

7
PFI is a small part of total investment

• PFI has played a small role providing 10 15
  of total investment
• HMT ring-fences local authority PFI through
  credit regime (incl schools), no separate control
  for central govt (incl hospitals)
• HMT sets qualitative and quantitative VFM tests,
  standardised contract terms, provides scrutiny/
  approvals, and sets policy/guidance on, for
  example, workforce issues
• Partnerships UK (45 HMT owned) provides project
  specific support

8
Project Delivery
PPP/PFI delivers benefits on time and on budget
Conventional Procurement PFI
Projects over budget 73 20
Projects late 70 24
Source UK National Audit Office
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Major Rail Project Channel Tunnel Rail Link

• A high speed rail link connecting the Channel
  Tunnel to London, the CTRL was initially procured
  in 1996 as a privately financed concession.
• It has been restructured twice. HMG now
  guarantees the entire 6bn financing and, as part
  of the first restructuring, the project was split
  into two.
• CTRL Section 1 opened on time in Sept 2003 and
  within budget.
• CTRL Section 2 opened in 2007.
• Total cost about 6bn.

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MoD FSTA
Provides a modern, highly capable air-to-air
refuelling and passenger air transport capability
based on a fleet of new Airbus A330-200
aircraft. Cost effective, integrated, 27-year
service, covering provision of aircraft to
training and maintenance services, as well as new
infrastructure. Enters service in 2011. Key
parts of the aircraft will be manufactured in
the UK. Capital value c. 2.2bn Off balance
sheet.
Source MoD
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MoD Heavy Equipment Transporter
Signed December 2001 Term 20 years Full service
date July 2004 Capital value c65.0
million Annual unitary charge c15.1 million
(07/08) On balance sheet Objective Service to
move battle tanks and other heavy equipment
during peacetime and on operations. Sponsored
reserves make up one third of the manpower
required to deliver the service.
Source National Audit Office
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Advantages and disadvantages

• Conceptual advantages
• Integrated whole life management
• Risk transfer to private sector
• Design Risk
• Construction Risk
• Financing Risk
• Technology Obsolescence
• Operating and FM Risk
• Focus on output specification
• Opportunities for innovation in service delivery
• Long term certainty
• Private sector capital
• Can be off Government Balance Sheet

• Conceptual disadvantages
• Cost associated with risk transfer
• Price must include profit margin
• Inflexibility

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HMT assessment PFI benefits

• Captures private sector management expertise
• Incentivises whole life costing in provision of
  serviced assets
• Real risk transfer 90 projects completed on
  time
• Operational satisfaction levels are high 80 or
  higher
• HMT policy control increases contract discipline
  and ensures projects are well scrutinised
• PFI now a reasonably well understood procurement
  model with a mature market

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Reducing congestion - M6 Toll Road
Only example in the UK All risks
transferred Power to set tolls with private
sector no restrictions 56 year
concession Refinanced 2006
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HMT assessment issues

• Perceived lack of flexibility
• Operational issues capacity to facilitate minor
  service changes
• Adaptability to meet high level policy changes
• Locks in public sector revenue spending on
  servicing assets (but gives certainty)
• PFI less suited to some areas lack of specified
  outputs (e.g. IT), smaller projects
• Private sector returns debt refinancing (action
  taken to put in place gain share arrangements),
  significant equity returns
• Public sector skills PFI is complex making it a
  challenge for public sector bodies to act as a
  client. Procurement times too long average of
  25 months in education, 38 months in health.
• Additionality Risk that PFI is used for
  additional / non-essential infrastructure
  investment

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Where does value for money arise

• Whole life integrated service - design, build,
  finance, maintenance, service
• Innovative design
• cheaper construction cost
• cheaper whole - life maintenance
• Output specification
• services provided in different ways
• Possible third party income
• catering, nursery facilities, tolls
• Risk transfer
• More efficient utilisation of assets

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If on balance sheet, what happens to PFI?

• Projects in procurement continue to extent
  departments have capital cover
• Future pipeline likely to shrink, although where
  programmes have momentum PFI may continue
• Education programme Building Schools for the
  Future given momentum, may continue
• Waste programme gaining momentum and may
  continue
• Local authorities complexity means could cease
  to use PFI for sectors such as housing and street
  lighting
• Health limited future pipeline.
• Defence limited to few very large projects
• Transport limited

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And PFI could evolve into a greater range of
models

• Debt underpinning (Woolwich extension, M25)
• Could reduce cost of borrowing by c. 50-70 basis
  points
• Risks undermining contractor discipline
• Flexible contract lengths e.g. contract
  termination / asset transfer triggered at
  threshold level of profit (Croydon Tram, Second
  Severn)
• May enhance refinancing gains
• Risk of undermining whole life costing /
  innovation
• Service concessions (M6 toll, Thames Gateway)
• Maintains / enhances discipline on partner (risk
  transfer)
• May undermine whole life costing
• Asset sales (BAA)
• High level of discipline on owner / total risk
  transfer / whole life costing
• Lose public sector control subject to regulation
• Will remain off balance sheet

More like PFI
Less like PFI
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Infrastructure Procurement Delivering long-term
value

• Sets out the next steps the Government is taking
  to secure value for money in its procurement of
  assets, infrastructure and long term service
  provision
• Sets out a range of alternative procurement
  approaches, many of which stem from experience
  with the Private Finance Initiative (PFI).
• Outlines the key drivers in assessing value for
  money when making decisions and encourages the
  use of alternative procurement approaches where
  they provide best value for money.
• Provides assistance on where alternative
  procurement approaches might be value for money
  and encourages dialogue around these alternative
  approaches.
• Reaffirms the governments commitment to use PFI
  where this provides best value for money,
  regardless of accounting treatment.

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M25 Possible New Approaches

• Long construction period 8 years
• Large capital value 2bn
• Innovative financing could create savings
• Debt Underpin
• Up-front capital
• Milestone capital payments
• Debt Funding Competition
• Equity Funding Competition

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Current Margins on UK PPP Lending

Source Ernst Young