Operation preparations - scrubbing up for PFI

David Finlay from the National Audit Office examines some of the difficulties faced with projects in operation

With around 700 contracts now let, the number and range of PFI projects continues to grow. The projects then face different challenges as they move from the pre-contract negotiations to service delivery and the operational phase.

With about half of the contracts now at the operational phase some of the key issues which projects in operation are facing include :

• Contract management - what skills are needed to ensure that the vision of what the project is supposed to achieve becomes a reality?
• Dealing with change - it is very likely that requirements will change over time but how should this be addressed within the project?
• Refinancing- the concept of sharing refinancing gains is now well established but can there be risks as well as benefits from a refinancing?

Contract management

The National Audit Office (NAO) carried out a survey of over 100 PFI projects in operation gathering feedback from both the public and private sector participants on a range of issues which affected their management of the projects. The results of this work were summarised in the NAO report on managing PFI relationships (HC375 2001-02).

One of the key conclusions of this NAO report was that to make a success of a project in the long term you need both a good contract and a good relationship between the public and private sector sides. Any project which only has one of these foundations is much more likely to find the going tough over a 20 or 30 year contract period. Projects in operation soon realise how critical effective relations will be to the ongoing success of the project. Good relationships will help both with sorting out minor day to day problems on the project and also the bigger issues such as how the project can be adapted to changing requirements.

The NAO has, for the past 18 months, been running one day workshops for PFI project teams on the theme of managing PFI relationships to achieve success. Some of the ideas to assist the formation of good working relationships which have emerged from the discussions at these workshops are set out in Figure 1.

A key aspect of contract management is performance management - the monitoring of the contractor’s performance and the payment mechanism whereby the contractor will receive full payment if performance is satisfactory but will suffer payment deductions if standards slip. Those embarking on a PFI project for the first time would do well to speak to similar projects which are now in the operational phase to learn about their experience of using particular methods of performance management. Some of these issues were dealt with in the recent NAO report Darent Valley: the PFI Contract in Operation (HC 209 2004-05) - for example, the importance, where possible, of avoiding subjectivity in the way that performance is measured. Wherever possible clear measures, which are unlikely to be disputed, will assist the smooth operation of performance monitoring.

A further issue on contract management which is likely to become more important now that increasing numbers of projects have been operational for a few years is the need to plan how the prices of services will be benchmarked - most contracts provide for some benchmarking or market testing of facilities management services after the opening period of operations, normally five years, has elapsed.

Dealing with change

Two statistics from NAO surveys highlight the fact that dealing with change is a feature which will affect many PFI projects:

• In the survey on managing PFI relationships the NAO found that 55%, over half of PFI contracts had been varied in some form within the first few years of contract letting. These changes related to alterations in services covered by the original specification, the introduction of new services, additional building works or design changes and amendments to performance measurement arrangements. While a number of these variations were relatively minor there were also more substantial variations of the services being delivered.
• This was further borne out by a second survey for the NAO report PFI Construction performance (HC 371 2002/03) in February 2003 which found that in 22% of central government PFI building projects the public authority had requested additional building work within two or three years of contract letting. Where prices has increased, the report found that departments had carried out benchmarking in less than half the cases to satisfy themselves that price increase was reasonable. This is important because such changes take place without competitive pressure.

These statistics should not be too surprising given the rate of change in the way that public services are delivered. The important point is that project teams need to plan ahead for the factors which might necessitate change to their project. The contracts need to have flexibility to be able to cope with change and also arrangements whereby the private sector will be required to demonstrate that the pricing of any additional requirements is value for money. Project teams need to also think about what the impact would be of a downturn in demand for the services being delivered by the project.


Projects which have been successfully delivered may be suitable for refinancing. This is particularly the case with early PFI projects where the financing was arranged when the PFI market was relatively new. Refinancing has the potential to deliver benefits to both the public and private sector sides to a deal following the introduction in 2002 of arrangements to share the benefits of refinancing.

As well as the financial benefits which refinancings can bring, there may also be risks for the public sector which need to be thought through before the public sector consents to a refinancing proposal. One particular issue which has attracted recent interest is the effect on public sector termination liabilities of refinancings which involve the private sector project company in increasing its level of debt. This form of refinancing was described in the recent NAO Darent Valley report and also the report on the Norfolk & Norwich PFI hospital refinancing (HC 78 2005-06).

In the light of these NAO reports the Treasury has underlined to departments various aspects of its existing refinancing guidance. These include:

• The importance of a rigorous value for money analysis of any refinancing proposal;
• The need for appropriate advice, particularly where the refinancing proposals involve the private sector increasing its levels of debt;
• Not accepting increased termination liabilities without fully evaluating alternative refinancing terms involving no increase to termination liabilities.

In conclusion, projects which are in the operational phase will throw up many challenges. As with all project management thinking ahead to plan for issues which are likely to emerge will be the key to success.