Britain’s next top model

As is made clear from the articles that precede and follow this one, the UK government appears to be far from enamoured with projects procured through the Private Finance Initiative (PFI). The question begged by this stance, as far as those with a vested interest in the PFI market is concerned, is ‘what do you propose to replace it with?’

“The question is how to create a new private finance model that works efficiently and delivers the pipeline of projects that needs delivering,” says Laughlan Waterston, head of infrastructure & PPP at banking group SMBC Europe in London. “I think PFI will survive in some shape or form but it may be re-named or even changed structurally to appease some people.”

The reaction of market participants can be quite defensive when reminded of the verbal pasting PFI has taken from certain members of the coalition government.

(Some are not slow to point out that it was the Conservative Party, now leading the coalition, which introduced PFI back in the early 1990s).

In to administration They ask why contractors should be asked to voluntarily pay back profits from successful PFI projects [a request made by Conservative Member of Parliament Jesse Norman] when they have made big losses on others. “One project contractor lost £70 million (€83 million; $112 million) on the construction of a hospital. The downside risk is always ignored,” says one market source. Another points out that two UK construction firms, Connaught and Rok, went into administration towards the end of last year – both with substantial exposure to the PFI market. This hardly fits with the caricature drawn recently by Cabinet Officeminister Francis Maude of private sector PFI participants “laughing all the way to the bank”.

The message now being issued by central government to the UK’s local authorities is that PFI is no longer the only game in town – as it was perceived to be under the previous new Labour administration – and that each individual project should use whatever procurement method suits it best. But this comes back to the question of what are the alternatives.

“We’re in a period of uncertainty where the existing model is taking a hit but it’s not really clear what any new model might look like,” says Stephen Kenny, a partner in the energy, infrastructure and regulation team at Birmingham-based law firm Wragge & Co.

Infrastructure UK, which was launched by the Treasury in June 2010 to advise on long-term infrastructure planning, is currently reviewing possible alternative procurement options and is believed to favour extending the use of regulated asset base (RAB)-type models. The RAB is a mechanism that commits governments to the costs the private sector has “sunk” to develop an asset by guaranteeing (and capping) shareholder returns via the asset’s customer/taxpayer base.

The RAB has thus far been applied only to economic infrastructure,in particular utilities. Market participants canvassed by Infrastructure Investor express scepticism regarding its potential applicability to social infrastructure such as schools and hospitals. “I can’t see how it will work. It sounds like one of those great ideas that came out of a brainstorming session,” quips one source.

The need for greater clarity is pressing.

After the scrapping of more than 700 school building projects that were procured under the Labour government’s Building Schools for the Future scheme, the PFI pipeline has taken a major hit. Many of the projects which have carried on have been in the waste sector, but with waste policy now the subject of a special review, the future of these projects is far from clear – especially as some have had their PFI credits [grants provided by central government] withdrawn.

The problem with all this is the potential damage being done to the UK’s social infrastructure all the while local authorities are left in limbo regarding whether – and how – to procure projects. Bruno Alves points out on page 12, this sits oddly with the UK government’s determined focus on economic infrastructure through the £200 billion National Infrastructure Plan. “The bit that’s dropping away is social infrastructure,” reflects Kenny.

Kenny argues that this is unecessary and that all that’s needed to restore confidence to politicians and investors alike, is an evolution of the PFI model rather than its replacement. “To deliver the infrastructure that the UK needs, it needs private finance.

No one is suggesting it can be delivered by the public sector like it was 15 to 20 years ago. So much time and expertise has gone into PFI and there is a really well developed industry of service providers who can deliver.

What should happen is that you refine the model and focus it on those areas where it works really well.”

Above all, what’s required is a grown-up debate. “Since its inception, the PFI programme has been a magnet for criticism based on half-truths, political polemic and arguments of assertion,” argues Robert Bain, an infrastructure consultant. “It is happening again now and simply causes confusion and scepticism among the public and policy-makers alike. What are most needed – particularly
at this point in time – are adult conversations aimed at informing and lifting the debate about our infrastructure needs and how these should be funded and financed.”

Applying the squeeze

In January this year, Infrastructure UK issued draft guidance to UK local authorities regarding how, in relation to PFI projects, they could “reduce costs while maintaining frontline services” as a way “to put public services on a sustainable long-term footing”. Some of the ‘checks’ suggested by Infrastructure UK are detailed opposite.

Some local authorities have been seeking to make savings by initiating so-called “shared service models” where certain functions – such as waste collections, for example – are shared with other,neighbouring authorities.

It’s a tougher ask, however, to extract savings from existing contracts. One possibility is to lower performance standards, which would in turn lower capital costs. So, for example, social accommodation may be built to a slightly lower standard than originally planned.

Stephen Kenny of law firm Wragge & Co says that contractors are more likely to negotiate the terms of existing contracts if the government is able to offer them greater visibility of the future deal flow. This kind of trade off looks unlikely, however, thanks to the lack of clarity emerging from central government at present. Investors will certainly think twice about renegotiating existing contracts when few new ones will be up for grabs.

Action suggested by Infrastructure UK in relation to PFI projects:

Preliminary actions:
• Manage existing contract properly
• Check insurance cost sharing provisions
• Optimise management and use of asset
• Consider mothballing spare capacity (if avoidable costs offer value for money)
• Consider the costs and benefits of changing the contract
• If contract changes are likely to be required, agree suitable cost transparency measures and variation protocol
• Share/benchmark/obtain cost information
• Communicate with departmental PFUs [Private Finance Units]
Explore savings such as:
• Review service scope & standards
• Introduce value testing (for services that would be value tested were the contract based on SoPC4 [Version 4 of Standardisation of PFI Contract Terms])
• Coordinate value testing processes
• Take back PFI provider’s share of general change in law capital cost risk
• Smarter energy procurement and consumption/user behaviour