IS IT WORTH INVESTING IN PFI?

This report looks at the risks involved in investing in PFI projects. Beginning

with the highlighting of main concerns, the paper provides an objective view

on the upsides and downsides of the PFI procurement method. For

successful investments we believe the DONT TOAST principle should be

adopted.

Toby Woodman

Josh Yarrien

Ellie Marsh

Eddie Vander

Zoe Henderson

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Private Finance Initiatives enable the government to deliver public infrastructure such as schools and hospitals. If dependent on economic climate these projects may not have been possible but are viable under PFI, as private capital is invested in the construction and maintenance of these public facilities.

A special purpose vehicle (SPV) funds PFI projects, as seen in Figure 1, and leases them to the government over an agreed period. Repayments are often spread over 25 years with a high rate of interest, which is where investors profit. This report investigates the suitability of PFI schemes for private investment. (Telegraph.co.uk, 2011)

Figure 1 - Partnering companies in a PFI procured project. (H.M Treasury, 2003)

INTRODUCTION

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Project success hinges around several key issues.

Procurement Process

Successful projects require competitive and transparent procurement processes. There have been instances where contracts have been awarded on political or personal grounds, not company suitability and issues with authorities not specifying essential costs and operational data. Starting the project with an appropriate procurement process builds good relationships and expectations, greatly aiding the process. (The Comptroller and Auditor General, 2011)(Hardcastle et al., 2001)

Partnership Involvement

Risks should be allocated properly to establish responsibility for each party, ensuring the right level of commitment. A thorough and realistic assessment of the technical feasibility allows each party to form realistic expectations. This has a major effect on the outcome. (The Comptroller and Auditor General, 2001) (Hardcastle et al., 2001)

Economy

The project must be appropriate for the economic climate at the time and have a sound financial policy, this is especially relevant when funded by several parties so that investors have an assurance that they will make a profit. However, as PFI procurement can be used for essential projects not feasible under public funding, investment is warranted even during unsteady economic times. (Hardcastle et al., 2001)

Project Support

Possibly the biggest factor affecting project success is the political and social support it receives. Without it, projects are likely to be seen as failures even before completion. Generating support makes the whole process, from funding to construction, easier and more effective. (Hardcastle et al., 2001)

KEY ISSUES

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To understand why PFI procurement is a good investment opportunity, we must first understand how it affects the investor.

Risk & Returns

It is common for pension schemes to invest in PFIs as the risk to the investor is low (Pppforum.com, 2015). The main risks are due to incorrect contractual pricing and failure of the contractor to complete the project. The likelihood of these occurring are minimal if well managed.

Pricing must be accurate; unforeseen circumstances that arise will receive little to no compensation. This requires the contractor to ensure that they have properly assessed the project beforehand. You should ensure that the contractor has undertaken sufficient research of potential issues at an early stage in the design process, such that any problems can be taken into account early on in the contract.

Delivery Dates and Overruns

Payments will only commence when the construction of the project is finished, providing a large incentive for the contractor to complete within time. A report (The Comptroller and Auditor General, 2003) compares data analysing delivery dates and cost of projects under traditional vs PFI procurement. 70% were delivered late under traditional methods compared to 24% under PFI, and 73% exceeded cost compared to 22%. As capital returns begin upon completion, this is excellent news for investors.

Conclusions

For investors, profit is generated through buying and selling equity investments. It is recommended

to do this via a larger, more experienced body, who spread and minimise the effects of failed

investment across multiple projects. (News.fool.co.uk, 2015). This reduces risk, but it should be

noted that this comes at a price as these bodies will take a cut. Regardless, with successful projects

the financial returns are regular and long term, making investing an attractive prospect (Pollock and

Price, 2010). Upon entering into a contract the likelihood of failure is low as there are many

incentives for the contractor to complete works to a high standard within the expected timeframe.

BENEFICIAL FACTORS

TO PFI PROCUREMENT

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Complex contracts

The process for procuring the initial contracts can be complicated, inflexible and expensive, which is bad for private investors as it causes undue hassle and high upfront costs. (House of Commons, 2011)(National Audit Office, 2009)

Risk management

PFI procurement involves large investments from private investors at the start of projects but, due to high interests associated with the leasing to and repayments from the government, the investment is more profitable over the whole duration of the contract. This initially places a large amount of risk onto the private investors as if the project fails they will make a loss. This risk needs to be controlled through effective risk management. (HM Treasury, 2006)

The majority of the risk taken by the SPV is tied to the selection of a contractor to deliver the project. If an adequate contractor is proposed then the risks mentioned above are negligible. (Akbiyikli and Eaton, 2004)

Quality management

Profits are dependent on how well the contractors do their job, which is judged by a quality assessment after financial close. Repayments do not begin until this is completed leading to delay in investor return, emphasising the importance of thorough and competitive procurement. (CIPS, 2007)

Public sector interaction during a tendering process can be difficult, leading to miscommunication or conflict during the design process. Poorly defined scopes can lead to inadequate design and quality may be sacrificed in order to accelerate the project (RIBA, 2005). As the return to investors is tied to the quality and completion of the project, if this is of low quality the financial returns may not be as expected. (National Audit Office, 2011)

An Audit commission report highlighted issues associated with recently closed school projects. These included: maintenance and building life consideration, architectural design in comparison to traditionally funded schools, flexibility in design and environmental performance (RIBA, 2005)(Audit Commission, 2015). Investment projects with issues in these areas are best avoided.

DETRIMENTAL FACTORS

TO PFI PROCUREMENT

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Governmental Awareness

Previously, returns from PFI projects have been significant for private investors. In the past, the government did not fully understand the costs, but now there is a push for tighter financial control and transparency which makes profits slimmer.

The method has come under scrutiny, with concerns about morality in the industry, having been called perfidious and lacking in financial benefit for the taxpayer. Future investments will be tightly regulated with higher risk to the investor. (Bidgood, 2012)

Conclusion

PFI procured projects can present risk for private investors as their control is minimal and relies heavily upon the competence of the contractor. PFI projects generally see a large profit for investors when they are successful, but it is important for investors to understand the project in order to assess the likelihood of success. Going into the future, with governmental pressures, this financial return is likely to decrease.

As new public projects will always be required, it is a fairly stable market with many opportunities. Nonetheless, it is very important that intelligent investments are made in appropriate projects which have been adequately scoped to avoid losses due to unexpected changes.

DETRIMENTAL FACTORS

TO PFI PROCUREMENT

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The success of a job is subject to the relationships between all partners within a project. The relationship hinges around the initial design process and the ability to communicate with one another throughout.

Effects of Relationships on Perception of the Project

The perception of value for money may be attributed to the strength of the relationship throughout a project. This may lead to issues and delays later on if this is poor.

Figure 2 below shows that the view of relationships is generally positive, with 72% for authorities and 80% for contractors quoting the relationship as either good or very good. This should be seen as a positive for potential investors; in most cases there will be a good working relationship. (The National Audit Office, 2001)

Figure 2 - Relationship perception of PFI procured projects (The National Audit Office, 2001)

RELATIONSHIPS BETWEEN

PFI PARTNERS

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Training

The committee of Public Accounts published a report stating that authorities provide little or no training on contract management (Committee of Public Accounts, 2002) and questions whether more could be done via the Office of Government Commerce to gain a better understanding of the relationship and managerial jurisdiction appropriate for both sides. This is echoed in the National Audit Office report (The National Audit Office, 2001) which has a section reporting that appropriately skilled staff is one of the most important features in ensuring a good relationship and management process.

Conclusion

These points lead back to the requirement for suitable communication from the offset, ensuring all involved parties understand the needs of each other and what the desired outcome is. If you engage with a PFI contract, ensure that you gain either employees or training with the required skills to communicate and build a relationship with all involved partners. An in detail knowledge of the system would be suitable to help check the assigned risk for each contributor and to settle disputes which may occur, whilst maintaining a productive relationship and project.

RELATIONSHIPS BETWEEN

PFI PARTNERS

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For investing into PFI projects our advice would be to follow the DONT TOAST principle. This should help

to reduce the risk to yourselves and ensure the maximum gain for your company.

DONT invest if politically or socially unstable

If the project is not politically or socially stable then it may have issues at both the planning and tender

stage, possibly leading to the project not being undertaken. To avoid this issue you should ensure that

any project you invest in will be well received by any stakeholders.

Transparent procurement method

If the project is procured through illegitimate methods it less likely to succeed due to the possibility of

ill-suited contractors and associated parties. The procurement method should cover all aspects of the

job and not hide away issues for cost reasons or other associated issues. Any procurement which has

these features is best avoided.

Open partnership

Partnerships work most efficiently if all the parties which are involved have prior knowledge of what

they are responsible for and what is expected of them. At an early stage of the project you should

ensure that there is adequate communication between all those that are involved to reduce the

probability of issues at a later stage.

Assessment of economic climate

Whilst PFI procurements allow essential projects to be undertaken, projects which may not be feasible

under public funding during an economical down turn, it should be considered that as an investing party

a sound financial policy should always be confirmed prior to investment.

Solid relationships between partners

A key to large projects is the communication between all parties involved and the relationships which

can be made. If you are able to effectively work with others which are involved in the project then

likelihood of success is significantly increased.

Training and sufficient knowledge before investment

To ensure all of the above, it is essential that you either employ people with the required knowledge or

allow for training before investing in a PFI project. This will allow early insight into what you should

expect and provide experience into the appropriate course of action if issues do occur.

RECOMMENDATIONS

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Telegraph.co.uk, (2011). Private Finance Initiative: where did all go wrong?. [online] Available at:

http://www.telegraph.co.uk/news/health/news/8779598/Private-Finance-Initiative-where-did-all-go-

wrong.html [Accessed 18 Mar. 2015].

H.M. Treasury, (2003) PFI: meeting the investment challenge. The Crown. Page 37

Hardcastle, C., Edwards, P., Akintoye, A. and Li, B. (2001). Critical Success Factors for PPP/PFI Projects in the UK Construction Industry: A Factor Analysis Approach.

Comptroller and Auditor General,(2001). Managing the relationship to secure a successful partnership in PFI projects.

Comptroller and Auditor General, (2011). Lessons from PFI and other projects.

Pppforum.com, (2015). Current Questions about PFI | PPP Forum. [online] Available at:

http://www.pppforum.com/current-questions-about-pfi#Answer654 [Accessed 24 Mar. 2015].

The Comptroller and Auditor General, (2003). PFI: Construction Performance. [online] Available at:

http://www.nao.org.uk/wp-content/uploads/2003/02/0203371es.pdf [Accessed 24 Mar. 2015].

News.fool.co.uk, (2011). The Pros And Cons Of PFI - 10/01/2011. [online] Available at:

http://news.fool.co.uk/news/investing/2011/01/10/the-pros-and-cons-of-pfi.aspx [Accessed 24 Mar.

2015].

Pollock, A. and Price, D. (2010). The private finance initiative: the gift that goes on taking. BMJ,

341(dec15 2), pp.c7175-c7175.

House of Commons, (2011). Private Finance Initiative. [online] Available at:

http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/1146/1146.pdf [Accessed 22

Mar. 2015].

National Audit Office, (2009). Private Finance Projects. [online] Available at: http://www.nao.org.uk/wp-

content/uploads/2009/11/HL_Private_Finance_Projects.pdf [Accessed 22 Mar. 2015].

HM Treasury, (2006). Value for Money Assessment Guidance. [online] The Crown. Available at:

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/252858/vfm_assessm

entguidance061006opt.pdf [Accessed 19 Mar. 2015].

REFERENCES

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Akbiyikli, R. and Eaton, D. (2004). Rick Management in PFI Procurement: A Holistic Approach. [online]

Available at: http://www.arcom.ac.uk/-docs/proceedings/ar2004-1269-1279_Akbiyikli_and_Eaton.pdf

[Accessed 19 Mar. 2015].

CIPS, 2007. Private Finance Initiatives (PFI). Knowledge Summary. [online] Available from:

https://www.cips.org/Documents/Resources/Knowledge%20Summary/Private%20Finance%20Initia

tives.pdf [Accessed 24 Mar. 2015].

RIBA, (2005). RIBA Consultation: Introducing Smart PFI. [online] Available at:

http://www.architecture.com/Files/RIBAHoldings/PolicyandInternationalRelations/Policy/SmartPFI/Intr

oducingSmartPFI.pdf [Accessed 20 Mar. 2015].

The National Audit Office, (2001). Managing the relationship to secure a successful partnership in PFI

projects. [online] Available at:

http://dera.ioe.ac.uk/10110/1/Managing_the_relationship_to_secure_a_successful_partnership_in_PFI

_projects.pdf [Accessed 21 Mar. 2015].

Audit Commission, (2015). PFI in schools. [online] Available at: http://archive.audit-

commission.gov.uk/auditcommission/sitecollectiondocuments/AuditCommissionReports/NationalStudie

s/pfi_report.pdf [Accessed 22 Mar. 2015].

Bidgood, E. (2012). PFI: Still the Only Game in Town?. [online] Available at:

http://www.civitas.org.uk/nhs/PFIDec2012.pdf [Accessed 24 Mar. 2015].

The National Audit Office, (2001). Managing the relationship to secure a successful partnership in PFI

projects. [online] Available at:

http://dera.ioe.ac.uk/10110/1/Managing_the_relationship_to_secure_a_successful_partnership_in_PFI

_projects.pdf [Accessed 21 Mar. 2015].

Committee of Public Accounts, (2002). Public Accounts - Forty-Second Report. [online] Available at:

http://www.publications.parliament.uk/pa/cm200102/cmselect/cmpubacc/460/46003.htm [Accessed

21 Mar. 2015].

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