PRECISE. PROVEN. PERFORMANCE.

Public-Private Partnerships in the

United Kingdom

Presentation for Dialogi

Gavin Stoddart

Vladivostok, 30 January 2014

www.moorestephens.ru

History of PPPs in England and Wales

1992

• Norman Lamont makes an announcement about "ways to increase the scope for private financing of capital projects” that launches the Private Finance Initiative (PFI)

1997

• PFI is expanded under the Labour government, which comes to power in 1997.

2003

• Survey by the National Audit Office concludes that, broadly speaking, PFI contracts offer good value for money.

2009

• Following financial crisis mini-bank created within the Treasury to provide loans of up to £2bn to PFI projects frozen due financing problems

2010

• Current Coalition government, formed in May 2010, confirms that it remains committed to the PFI as a way of delivering investment in infrastructure.

2011

• George Osborne announces a review of PFI is to be carried out

2012

• Reform of PFI initiated – reformed version known as Private Finance 2 (PF2)

Some key features of PPPs in the United Kingdom

Used by • PFI is used in both central and local

government.• For local government capital

element funded by central government

• The local authority selects a private company to perform the work

Financed by• Private sector debt (bonds, bank

loans)• Private sector equity• Public sector debt• Public sector equity• May be underwritten by government

Contracts• Usually 25-30 years (may be less

than 20 or more than 40)• Include output specification• Often highly complex

Contractors• Usually a private sector consortium• Consortium usually includes a

construction company and a service provider, may also include a bank

• SPV created for purpose• Many employees transferred from

public to private employment

Some key figures regarding UK PPPs

• Value of capital investment (at 2010 prices) committed by private investors under signed PFI contracts as of March 2011

£60 billion

• Total payment obligation for PFI contracts in the UK as at November 2010

£267 billion

• Value of funding obtained under PFIs during the latest financial year (2012-13)

£1.5 billion

Typical PFI project types

Hospitals Housing

Leisure facilities Waste

RoadsSchools

Social Emergency services

Potential advantages of PPPs

•Encouraging the allocation of risks to those most able to manage them and thus achieving overall cost efficiencies and greater certainty of success.

Better allocation of risks

•Potential to do things that would be difficult using conventional routes. For example, encouraging the development of a new private sector industry.

Wider range of potential projects

•The private sector is not paid until the asset has been delivered which encourages timely delivery. PFI construction contracts are fixed price contracts with financial consequences for contractors if delivered late.

More projects on time and budget

•The banks providing finance conduct checking procedures, known as due diligence, before the contract is signed. This reduces the risk of problems post-contract.

Commercial Due Diligence

•Many conventionally (government) funded projects fail to consider whole-life costs. Involving private companies encourages the construction of more efficient assets with transparent whole-life costs.

Encouraging on going maintenance

•Output specifications for design and construction encourage increased productivity and quality in delivery.

Encouraging innovation and good design

•Specifying service levels and applying penalties to contractors if they fail to deliver encourages better performance.

Incentivising performance

• Using standardised contracts reduces contractual errors.

Fewer contractual errors

Overall evidence of success

• July 2003 survey showed that the only deals that were over budget were those where the public sector changed their minds after deciding what they wanted and from whom they wanted to buy it

• National Audit Office report inn 2009 found that 69% of PFI construction projects between 2003 and 2008 were delivered on time and 65% were delivered at the contracted price

• Salaries for guards lower in PFI prisons than in public prisons but still attract staff

Successful project - Prisons

Building time

• Under PFI as little as 2 years compared to 7 years when constructed by government

Design

• Consider to be better in PFI prisons than in public sector ones (although this may just be to do with age)

Running cost

s

• Running costs lower in PFI - mainly because staff are paid a 25% less than in the public sector (though senior managers are paid more)

Potential disadvantages of PPPs

•Higher cost of finance as bank lending to private sector more expensive than lending to government. Has increased since the Credit Crisis.

Higher finance costs

•The prospect of delivering the asset using private finance may discourage a challenging approach to evaluating whether this route is value for money.

May lead to less rigorous assessment

•The bank loans used to finance construction require a long payback period. This results in long service contracts which may be difficult to change.

Reduced contract flexibility

•The Public pays for the risk inherent in private finance contracts but ultimate risk lies with the public sector.

Paying for Risk that is retained

•Private finance is inherently complicated which can add to timescales and reliance on advisers.

Increased complexity

•High termination costs reflecting long service contracts.

High termination costs

•Increased commercial risks due to long contract period and the high monetary values of contracts.

Increased commercial risks

Assessing value for money

• The benefits and disadvantages of PPPs each have differing impacts on the overall value for money of a project

• Some may not materialise on any given project

• Some of (both positive and negative) may also apply to other forms of procurement

• The key question to consider is whether or not the actual benefits unique to PPPs outweigh the disadvantages unique to them

Example to illustrateRelative cost of capital - Government vs PPP

• This example is from real life and relates to a hospital project which required £244 million in capital expenditure.

• The contract is expected to run for 34 years, including a 4-year construction period and a 30-year management phase in which the private partner will deliver maintenance services

• During the management phase, the Trust will pay to the private partner a periodic unitary charge. This provides the private partner with a revenue stream from which to meet operational costs (primarily maintenance and lifecycle costs, along with the costs of running an office and paying insurance), and financial costs.

• The additional financial cost of PFI can be derived by discounting the stream of cash-flows at the relevant discount rate—which is taken to be the "gross redemption yield" on government "gilts" of the approximately the same maturity as the PFI loans (i.e. 30 year gilts). This is 4.2%.

• Discounting the Project Cash-Flow stream at 4.2% produces an NPV of £175 million. This figure represents the additional financial cost of using private, rather than public finance, to deliver that amount of capital expenditure.

Other criticisms of PFI

• Skills of the private sector in innovating not always harnessed

Ineffective use of private sector

• PFI projects long term and not responsive to changes in public sector service needsLack of flexibility

• True cost of projects not always understood• Accounting rules driving the process - “off balance sheet”Poor transparency

• Wrong decisions about who best able to handle risk• Risk not always transferred effectively to Private sector

Poor Risk Management

• Criticisms of the way the procurement process has been run both time to make a decision and costs involved

Inefficient Procurement Process

Failed project – London Underground

• In 2003 London Underground lines and rolling stock were effectively privatised and passed to two companies – Metronet and Tube Lines

• The cost of writing the £15.7 billion contracts to upgrade the underground was around £400m

• When Metronet, collapsed in 2007, it emerged that 95% of its bank loans had been underwritten by the government, which had to come up with £1.7 billion as a result.

• Government Transport Committee conclusion that it should not be taken for granted that private sector involvement will bring efficiency

PFI Reform

PFI Reform

Long term value for money

More effective use

of private sector

Reducing costs

Improving flexibility

Increasing transparency

PF2 – Reform of PFI - Approach

Harness Private Innovation• Use private

sector innovation to deliver services more cost effectively.

Expand sources of finance • To reduce cost• To include

pension fund investment

Balance Risk• Strike a better

balance between risk and reward to the private sector.

• Maintain the incentive on the private sector to deliver projects per contract

Improve flexibility• Ensure greater

flexibility to accommodate changing public service needs.

Streamline procurement• Deliver an

accelerated and cheaper procurement process

Greater financial transparency• Ensure that

public sector is confident that it is getting what it paid

PF2 – Changes

Equity

• Minority public equity stake (typical level 20%.)managed by a unit separate from the procuring authority.

• Introduce funding competitions for a proportion of equity in order to attract long-term investors into projects

Delivery

• Ensure that the tendering phase of PF2 projects to take longer than 18 months.• Introduce a standardised and approach to PF2 procurement and publish a

comprehensive suite of standard documents. • Introduce additional HM Treasury checks at the pre-procurement stage ensure that

projects do not go to market before they are fully prepared.

Flexibility

• "Soft" services such as cleaning and catering will removed from projects.• Discretion on minor maintenance activities at the outset. Flexibility to add or remove.• Mechanism to share any surplus lifecycle funding.• Periodic reviews of service provision will be introduced.

PF2 – Changes

Transparen

cy

• Control total for all commitments arising from off-balance sheet PF2 contracts signed. • Information on private sector to be published.• Publish an annual report on all projects in which the government an equity stake.• More information on HM Treasury's website,

Risk Allocation

• New internal rules within government for the management of the risk of additional capital expenditure arising from issues such as an unforeseen general change in law; utilities costs; site contamination; insurance

Value for

money

• Proposes changes to “Value for Money” regulations

Lessons to be learnt

Assess every project individually• Decisions should not be made based

on dogma or laziness• Full financial and non-financial

analysis of the benefits of all potential forms of funding

Risk Allocation• Look carefully at who really bears the

risk• Ensure the risk premium paid is

appropriate to the transfer of risk

Value for money• Ensure that contracts are designed to

ensure value for money• Ensure contracts include the right

incentives / penalties for performance• Ensure that contracts can be

cancelled easily if value for money is not obtained

Process• Ensure that there is a clear,

understandable and efficient tendering process

• Standardise as much as possible• Spend enough time carrying out the

necessary assessments