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 govt’s 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 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 Source UK National Audit Office

9. 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.

10. 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

11. MoD: Heavy Equipment Transporter Signed December 2001 Term 20 years Full service date July 2004 Capital value c£65.0 million Annual unitary charge c£15.1 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

12. 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 £ £ Advantages and disadvantages

13. 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

14. 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

15. 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

16. 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

17. 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

18. And ‘PFI’ could evolve into a greater range of models More like PFI • 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 Less like PFI

19. 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 government’s commitment to use PFI where this provides best value for money, regardless of accounting treatment.

20. 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

21. Current Margins on UK PPP Lending Source: Ernst &Young