In a critical condition

I'm going to you something controversial,” says Gershon Cohen, head of global project finance at Lloyds Banking Group, smiling: “I believe the doom and gloom surrounding the Private Finance Initiative (PFI) is being overplayed. I think this pause in procurement
after the election, especially in a year of austerity, is not surprising.”

“But if you look more closely,” he adds, “you will find the pipeline of UK PFI projects remains strong following the government’s recent spending review, proving PFI can be a procurement tool that levers the private sector for the overall benefit of the taxpayer.”

Cohen’s view is, if not exactly unheard of, certainly contrary to the prevailing mood regarding PFI, the country’s standardised process of procuring public-private partnerships (PPPs).

Launched in the 1990s under the then Conservative government, PFI found its stride with Tony Blair’s New Labour government, when it was used to build everything from hospitals and schools to waste plants.

In many ways, Cohen is right not to be overly pessimistic. As he points out, there are many projects still earmarked for procurement,including big PFI deals such as the Thameslink and Intercity Express rolling stock projects; Crossrail, an ambitious venture to build a series of new railway links under central London; or highway PFIs in Sheffield and Hounslow.

But the flipside is the mounting political campaign that has been all-but-calling for PFI to be scrapped ever since the new coalition government decided to bring more than £200 billion (€232 billion;$318 billion) of PFI liabilities back onto the public balance sheet. The gist of this campaign is that PFI is a massively expensive procurement method, misused by the previous government, which serves as little more than a tool to offer obscene profits to the private sector on a plate.

Jesse Norman, a Conservative Member of Parliament (MP), is leading the charge, calling on government to put pressure on PFI investors to reduce the payments they receive from public institutions by between 0.02 percent and 0.03 percent per year, a move that could save the public purse between £500 million and £1 billion.

A ‘swindle’Norman’s view on PFI is representative of the current political cognoscenti. As he wrote in a recent opinion article in the Telegraph, a newspaper that has traditionally given its support to the Conservatives, the bigger half of the ruling coalition government: “A slew of revelations about the PFI’s eye-popping cost have emerged. It is now apparent that the country was sold a pup.”

The article describes PFI as little more than a swindle, with Norman saying that PFI “was sold as offering the best of all worlds. Rather than having to spend billions upfront on new schools and hospitals, we would get private companies to build them for us; the result would be gorgeous, state-of-the-art facilities, funded over many years via a series of easy payments.”

He continues: “This meant keeping the debt off the balance sheet, building up a gigantic – but invisible – burden on the country’s finances.” In Norman’s version of PFI, the private sector has little incentive to do anything once it wins a contract, except cash in on the availability payments owed to them by government (his article’s title: “It is time to derail the PFI gravy train”).

Apparently forgetting that these government payments will decline unless the private sector maintains an asset to certain standards, Norman goes on to say that, under PFI, “the contractor has far less of an interest in keeping the property in good condition, because he normally has the right to sell the hospital or school back to the government after 25 or 30 years”.

In fact, the private sector doesn’t sell assets back to the government: they revert automatically once contracts expire, unless a concession is renewed.

Rotten deal

The argument that taxpayers have received a rotten deal continues in the Telegraph’s pages, this time in a series of in-house reports: “Official figures show that, under PFI schemes, British taxpayers are committed to pay £229 billion for new hospitals, schools and other projects with a capital value of just £56 billion.”

Lloyds’ Cohen is familiar with this misperception about PFI’s real costs. “PFI prices long-term costs over the life of an asset whereas traditional procurement doesn’t. Until the argument of whole life costing is better articulated and understood, incorrect assumptions will be made, often for political or other agendas, and drown out the reasoned view,” he says.

What the current discussion on PFI is not balancing is the issue of flexibility. In responding to the public sector’s output specification, financeable solutions require a turnkey procurement method and a robust contractual framework over the life of the concession, explains Cohen.

Historically, this is not what the public sector is used to, he adds, since it is more familiar with constant changes to the initial requirements and offers no allowance for lifecycle maintenance. This has led to the sort of contractual changes and cost overruns the public sector has been notorious for. As Cohen puts it: “The public sector is probably not going to welcome a detailed analysis of just how badly wrong a conventionally procured project can go, in terms of value for money to the taxpayer.”

Nick Dawson, managing director at Bilfinger Berger Project Investments, recently wrote back to the Telegraph detailing the downside of public procurement: “It has quickly been forgotten how bad the public sector was at procuring infrastructure. The first PFI hospital was delivered in 1995, on time and on budget. The last acute hospital delivered by the NHS, before PFI was introduced, was delivered three times over budget and three years late.”

At a conference late last year promoted by the European Investment Bank (EIB), Vincent Piron, of the European Construction Industry Federation, estimated that “the global saving [of PPPs] is probably around 25 percent compared to classical procurement, although more ex post observations should be done to support this figure”.

No response

Still, it is not for those claiming back money from PFI to defend the model; it is for the industry built around it to do so. And in this respect, the various branches of the industry have not produced a coordinated response.

“As a collective, we have been very poor in making the case,” admits Cohen. “If you are involved in finance, you are already starting with one hand tied behind your back,” he says.

But one thing is certain: if the industry doesn’t do a better job of defending itself, it certainly won’t win the argument.

‘Banks not natural holders of infra debt’

Many of the current discussions on the Private Finance Initiative (PFI) have centred on the increasing cost of bank debt. Late last year, the UK’s public accounts committee, an investigative body made up of cross-party MPs, asked the Treasury and Infrastructure UK: “Given where we are on loan rates, is there a future for PFI?”

Lloyds Banking Group’s Gershon Cohen is aware of the increased cost of bank debt, but warns there is a “direct correlation between the cost of government borrowing and bank lending,” pointing out that both have increased in tandem.

“I have always argued that banks are not the natural long-term holders of infrastructure debt,” he offers. “There are other financial institutions, such as public and private pension schemes, that are in a better position to do so, owing to the long-term, stable, and partially indexed characteristic of the underlying cash flows.”

He continues: “Banks are very good at structuring these transactions. But banks need a number of distribution channels to manage their balance sheets, and if these are not active, then costs will increase. This is currently penalising the asset class,” he admits.

Institutions like pensions, however, are unlikely to hold infrastructure debt without a little help from the government.

“Perhaps there is a role for government to intervene in ensuring that other pools of institutional capital can be used by offering selective use of guarantees, and even by taking up tranches in debt securitisation vehicles. Other countries, like France, are beginning to take a lead in this and, as the market leader in public-private procurement, we should be driving solutions,” argues Cohen.