Cutting through the hysteria

In public-private partnerships (PPPs) and Private Finance Initiatives (PFIs) in particular have never been media darlings, but since the start of this year much of the coverage has been bordering on hysterical.

And, as is so often the case with hysteria, the picture that emerges is difficult to understand and incomplete, fuelling the feeling of outrage and failing to help people understand what is really going on.

It’s no wonder PPP and PFI come in for so much flak when the public only sees over-simplified arguments that omit crucial information, facts and figures – and present a picture of scandalous returns for the private sector partners running the projects and poor value for money for the taxpayer. In the vast majority of cases, that is simply not what has been happening.

Perhaps the biggest and most frequent misrepresentation and misunderstanding is that PFI is about building an asset and making the state pay for it over 25 or 30 years at 10, 20 or even 70 times the original capital value. What in fact happens is the private sector contractor takes on a longterm commitment to build an asset and provide a service to maintain and operate it to a pre-agreed standard over the lifetime of the concession, taking over heavy lifecycle costs and routine maintenance risk.

Nonsense

That PFI is a golden opportunity to fleece the public sector and/or the public is nonsense. The contracts are awarded after a competitive tender process – meaning to win the deal firms must bid each other down on price and up on service provision.

These contracts are carefully drafted to try to maximise value for money for the taxpayer. for example including penalties for failing to meet availability and performance criteria. So if a school is late being finished or a hospital operating theatre is unavailable because of a maintenance problem the provider will be financially penalised.

In terms of benefits, PFI delivers many.

PFI projects help the Treasury with long-term spending plans and have a good track record of coming in on budget and on time – in stark contrast to projects run by local authorities and government departments.

PFI has also delivered an otherwise unaffordable upgrade to the UK’s Victorian infrastructure that was desperately needed and has benefitted millions of Britons in terms of health, education, transport, the environment and security – both national and international. Economically, the country has derived billions of pounds worth of benefit without shouldering the risk, which is taken on by the private sector provider, with the added benefit that the cost to the state is off balance sheet.

Yes, lessons need to be learnt and contracts need to be more efficient for the taxpayer – but lessons should always be learnt, whether it’s the public sector or whether it’s the private sector on the learning curve. This will mean reviewing past projects
to understand exactly how they pan out and ensuring those involved have top-notch skills and use the most experienced financial, legal and technical advisers to scrutinise every aspect of the deal – because crying foul after the event is not going to get anyone anywhere.

The recent campaign by UK Member of Parliament Jesse Norman to get rebates from private sector contractors is a case in point.

This campaign faces two big obstacles. The first begs the question as to why the private sector contractor should come to the table to re-negotiate a deal that is well into the post-financial close/operational period; and, second, how the government intends seeking to achieve rebates or re-opening done deals.

The contracts were agreed often after very lengthy competitive tender processes. How can the terms be changed after the event?

It would make a mockery of the tendering process and almost certainly pique the legal eagles in Brussels, not to mention the failed rival bidders.

Rather, PFI needs to be looked at holistically. PFI projects can cost several millions or several billions of pounds – money the country does not have. And, as already discussed, not only do they provide much needed assets – the roads, the hospitals, the prisons, the schools – they also provide much needed jobs. They create demand that will stimulate growth, which stimulates demand,
which stimulates growth – real value creation, in other words.

The critics continue to carp but have not proposed clear, workable alternative solutions. Industry is considering a number of different funding structures and there is a lot of debate around what would be appropriate, including the Regulated Asset Base (RAB) model.

The RAB has been around for some time and has been successfully used in certain regulated sectors such as airports, energy, water and social housing. It involves investment in a regulated asset via longterm borrowing and the regulated company receiving a return from the investment by passing the risk to customers, which allows the company to repay its debt. It works by raising money from an income-generating asset and the regulation helps to ensure that risks are kept to a minimum to enable affordable financing. This de-risks investment in infrastructure by passing on the sunk costs associated with capital investment to the customer – the key feature being that the risk needs to be transferred to the customers.

PFI still centre stage

The government’s National Infrastructure Plan contemplates RAB having a significant role going forward in stimulating investment, and hence the economy, but while extending RAB is attractive, it still isn’t clear how it would work in sectors where there is no current income stream, such as roads. Toll roads have historically not been a success in the UK and, given the element of passing risk to the customer, there are affordability issues.

RAB probably does have an expanded role to play and the government is expected to issue a report on this, with the waste sector likely to be a target and possibly rail. But just how widely it can be used is still unknown, leaving PFI centre stage once more.

Project finance is an important area of research and innovation – a prime subject for think-tanks to look into. Meanwhile, public private partnerships seem to be here to stay as they are the only way the UK can afford the levels of investment demanded by the 21st century and required to help rebuild the economy. Changes in the near future are likely to be little more than rebranding exercises in the hope of calming the hysteria.