Circles in the sand

1 September 2012 The PFI review may prove to be a line in the sand for critics, but there are plenty of hints of a return to the origins of PPP in the government’s plans, writes Paul Jarvis
“Two vast and trunkless legs of stone
Stand in the desert. Near them on the sand,
Half sunk, a shattered visage lies”

The words of Percy Shelley’s Ozymandias ring disturbingly true to some interpretations of the UK’s PFI market, as ministers continue to insist the model is dead. But as rumours flew during June and July that the Treasury’s review was to be published, hope grew that the new model would be ready to begin churning out some new deals in the autumn.

Hints and suggestions from Treasury had suggested there may be a big announcement related to PFI before the government went off on its summer holidays. And indeed, there was an announcement, albeit not the one most had anticipated or hoped for, with the Treasury hastily releasing plans for guarantees to help kickstart a variety of infrastructure projects including existing PFI and PPP schemes in procurement.

Now, with only a two-week return to Westminster after the summer recess before the conference season gets underway, any announcement on the PFI review is unlikely to emerge until late autumn at the earliest. Even so, there remain plenty of directions from government and Treasury officials on what the PFI review will focus on tackling.

And there is a growing feeling that what is being cooked up within Treasury will have some familiar rings to it. The UK Guarantees announcement in July is a prime example. Chancellor George Osborne announced that £40bn of private finance in public projects will be underwritten by government guarantees, while Treasury unit Infrastructure UK (IUK) will provide short-term loans to help existing PFI and PPP deals that are struggling to raise finance.

The loans will only be available for the next 12 months, and the Treasury expects them to provide investment to around 30 projects.

“It’s TIFU re-emerging,” says KPMG’s chairman of global infrastructure, James Stewart, referring to the Treasury Infrastructure Financing Unit that was established at the height of the banking crisis to get projects over the line.

Having been involved in that initiative during his time at IUK, Stewart welcomes its latest reincarnation, and suggests its simple presence may be enough to boost the market.

“The original TIFU was to provide capacity if needed. In reality, that backstop was never really used, apart from on Greater Manchester Waste,” he points out, “but it gave banks confidence to commit resources to the project.”

That might not be the case this time around. One source suggests that many banks have responded with scepticism to the plans, arguing that the Treasury’s presence on a deal would only encourage them to steer clear of it. He says the banks will be suspicious of a project that cannot raise funding on ordinary commercial terms. “And they’re also saying the presence of the Treasury on a deal will just make the whole thing take longer,” he adds.

Rather than banks, though, it is the institutional investors that the government is keen to get involved through its latest wheeze. “If what is being suggested is akin to underpinning risk, that is what institutional investors have been looking for,” says Alan Aisbett, a partner at law firm Pinsent Masons. “It can work if it’s seen as mezzanine debt to provide a buffer.”

Robert Marr, director at consultancy Appleyards, is more cautious. “How do you underwrite the construction risk without taking away a massive amount of risk from the contractor,” he asks. “What is the penalty to the contractor if it doesn’t deliver on time and on budget?”

Pipe(line) dreams
Those questions go to the heart of the debate on PFI, and the guarantees announcement sits uncomfortably with the continuing absence of a PFI review decision. Sources suggest the Treasury acknowledges the guarantees announcement has been “slightly rushed through”, so there are still plenty of questions to be answered.

The Treasury insists the announcement is a significant one for PFI – and Stewart agrees it can provide a market stimulation if used in the correct way. But it feels very much like one that focuses on the legacy of PFI deals still in the pipeline, rather than being about creating a new programme of investment.

The very nature of the scheme suggests that only projects currently in procurement will have any chance of accessing the short-term loans being proposed – almost certainly ruling out the Priority School Building Programme for example.

So when the Treasury does finally release the PFI review, the question still begging will be: what investment will it stimulate? “I’m not sure what PFI will be used for,” says Aisbett, pointing out that other than the hugely scaled down schools programme, there is little social infrastructure on the cards.

“The government made such a big thing about the fact it was having a PFI review, but the amount that will be coming through PFI is going to be very limited,” adds Stewart.

While healthcare no longer needs a big investment in large hospitals, other models are taking over. Contractor Ryhurst, for example, has been working on a scheme for NHS Lancashire whereby it manages the trust’s entire estate, generating efficiencies and money for future capital projects by working out what buildings can be closed and which are currently under-used.

The model is similar to the local asset-backed vehicle (LABV) being considered by a number of local authorities to kickstart regeneration – and similarly is a true joint venture partnership between two entities for the long-term.

Stephen Collinson, business development director at Ryhurst, and managing director of the partnership in Lancashire, says the approach is far more flexible than PFI – even going as far as removing exclusivity over the land, meaning that if the partnership decides a new building is required, there is no guarantee the work will go to Ryhurst.

Such an approach is something that can be expected to increase over the years ahead, as private contractors work more collaboratively with authorities. It is a concept previously discussed by Morgan Sindall’s head of regeneration Andrew Savege, who argues a little “pro bono” work by all contractors will benefit the industry as a whole over the long-term.

Making the change
If the government is serious about revamping the PFI model – and possibly rebooting the procurement tool at some point down the line – taking into account the lessons being learnt by these looser partnerships will be crucial.

So what can we expect to change?

It is almost certain that soft facilities management (FM) services are now out of future PFI deals. It has already been announced that soft FM will no longer form part of the Priority School Building Programme PFI contracts, and the Treasury is unlikely to object. Many of the responses to the review pointed to taking out soft services such as cleaning as a way to reduce the overall headline costs of PFI deals.

And the FM providers themselves are not opposed to the idea, admitting that such a move will save them money from the point of view of upfront costs – but warn issues over interfacing with the hard FM provider could have a significant impact on longer term costs for the public sector as roles are duplicated.

Nonetheless, this approach is currently taken in Scotland, where the non-profit distributing model has already broached this subject. Scottish Futures Trust (SFT) chief executive Barry White argues the approach provides “long-term flexibility” by turning the building into something akin to a regulated asset, whereby basic standards of maintenance are retained. “That helps enormously to get a good credit rating,” he adds.

South of the border, the truth is that soft services have increasingly been left out of PFI deals for schools and hospitals over the past few years. “Many hospitals already don’t have soft FM,” says Meriel Bennett, partner at lawyers Speechly Bircham. “Richard Glenn’s review back in 2006 focused on that to some extent.”

NHS trusts have generally forced the private sector to take on the interface risk – but that consequently means such risk will be priced back in by the contractor within the initial contract.

Risk transfer is another area expected to come under the spotlight from the Treasury’s review. Various risks that potentially make more sense remaining with the public sector, but have traditionally been transferred to the private contractor, are likely to be repatriated within the new model.

But Stewart warns efforts to bring in pension funds by substantially reducing the amount of risk taken by the private sector may undermine the whole concept of PFI.

“People cast envious glances at the property leasing market, where a pension fund on a project effectively buys the yield. That is a very efficient financing market,” he explains. “It’s quite possible to construct a PFI on that basis.”

But doing so threatens to emasculate the amount of risk being borne by the public sector. “Is the public sector fully quantifying the risk that it retains,” he asks. “Also, you have to ask whether you are transferring sufficient risk and reward to incentivise the private sector to manage the operation efficiently and effectively and optimise whole life costs.”

Simply keeping the risk in the public sector does not mean it disappears, or is not paid for at some other, less transparent point. Once again, this question brings us back to the founding principles of PFI.

Flexible friend
Flexibility is the watchword around the government’s plans for a new model these days, and that means making in-roads into the lifecycle fund.

“I’ve just done some work with one trust and found there is a huge pot of cash that is just sitting there in the lifecycle,” says one technical adviser. “But it’s controlled by the banks so using it is very difficult. If you could get the banks to each agree to release a portion from the lifecycle, it would make a huge amount of money available.”

Tackling lifecycle and trying to release some of the funds is now big business for advisers, with some looking at ways to demonstrate the amount of money been used in a project to date, against the original amount set aside, with the difference then being released for potential new investment.

“It’s becoming more of a science than in the past,” says Marr. “It used to be that no-one had much data to benchmark against, but there is a whole wealth of information available now.”

“Housing has already tackled this issue,” says Aisbett. “Local authorities transferred their stock to Housing Associations, which borrowed against a business plan which had within it a degree of flexibility. Most achieved their targets over five to seven years, but it gives more flexibility on timing over 30 years.”

The problem with PFI is that any attempt to move around maintenance dates leaves the private sector open to penalties for failure to carry out the terms of the contract. “The whole point of our unique approach is that any changes must be managed in partnership, so it can be changed but the trust will need to understand the implications of such change,” says Ryhurst’s Collinson. “I know, having been there [as a former NHS trust chief executive] that there are times when a trust needs the money because of the crisis.”

Not everyone is convinced, though. “You lose cost certainty and the ability to ensure the contractor puts in good quality products, for example a boiler, that will last because they are incentivised to keep it running,” says Bennett.

It is also doubtful as to how much money the lifecycle fund might release for the public sector to do anything with. “The private sector often see the lifecycle pot as their money because they priced the risk,” says one adviser.

There may be plenty of political pressure on the private contractors to be generous to their public partners, but the harsh reality is that financial pressures may reduce the likelihood of that happening.

The other threat is that the lifecycle fund is effectively eroded as the public sector agrees to put off some maintenance for a few years. Collinson agrees it’s difficult to ensure the building is kept up to standard. “If some works were not completed at a normal expected frequency then that would be an informed choice for the Trust to make and the consequences accepted,” he adds.

“PFI has made people think about lifecycle cost, factor it into their budgets and monitor it,” says Marr. Taking that discipline away would again beg the question of whether using the model is appropriate at all.

For some, the inevitable conclusion of the government’s review of PFI could lead it back down a well-worn path: the development of a central body to oversee the delivery of privately funded projects. A single body of expertise is, unsurprisingly, supported by the SFT’s White, who argues this has enabled its own alternatives to PFI to flourish. “Through Hub, NPD and other programmes we know what projects are being planned and what is being redeveloped,” he says. “So we have a good insight into when land and buildings will become free.”

“It will come full circle,” adds one adviser, referring to the previous existence of Partnerships UK. “There is a dilution of focus in IUK right now, therefore the output inevitably gets impacted.”

This page was last updated on:
7 November 2012.

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