Q101 Austin Mitchell: And you will be working to reduce those costs on PFIs?
Andrew Hudson: Well, the mechanisms we have to reduce our costs on PFI are the refinancing provisions which we talked about, which were strengthened a couple of years ago. So that's what we'll be looking to do, as and when market conditions permit.
Q102 Austin Mitchell: Not for new projects?
Andrew Hudson: Well, for new contracts we need to continue with public funding reduced all round; we need to be tougher than ever at driving value for money, but I would not want that to imply that we have not been rigorous in that before.
Q103 Chair: There's a queue of people wanting to ask questions. The loan rates aren't going down so does this mean there is no future for PFI? Andy Rose: Well, again-
Q104 Chair: We are in a much more stable financial market, but the loan rates are staying high.
Andy Rose: I think there are a number of issues; if I may just touch on a couple of them? On the "screwed by the banks" point, the reality is the banks were passing on a lot of their own increased funding costs, rather than making enormous profits at that time, because it is a reality that their own funding costs in the long-term capital markets were increasing dramatically. In terms of looking at new funding sources: we are absolutely keen on bringing pension funds into the market and interestingly there was a recent transaction earlier this year, which was the Southmead Hospital in Bristol, where the bidder ran a competition between bank finance and bond finance and the bank finance came out cheaper. As Treasury we did not think it was appropriate to tell the Southmead Trust to pay more for the bond finance than the bank finance. So there is competition in the market and the bond finance was more expensive.
Q105 Austin Mitchell: Not much.
Andy Rose: Not, not much, but remember this is money raised by the private sector and the public sector has a huge interest in that it pays unitary charge and therefore had they selected the more expensive finance that would have been passed on to the Southmead Trust. I think the IUK document, and I work for IUK, as Andrew suggested, looks at a number of different markets and not just PFI but very much economic infrastructure as well, where a lot of the finance is raised in a very different way; it is more private to private. These aren't concessions left by the public sector. Yes, I think looking at reducing the cost of capital-there will be a regulatory review undertaken over the next few months-is critically important. Yes, absolutely we need to continue to explore different forms of finance.
Q106 Chair: Can I just ask the question: is there a future for PFI in this? You are looking at all these alternatives; given where we are on loan rates, is there a future for PFI?
Andy Rose: Again, I think it goes back to the selection of the authority of a prudent methodology and whether that's value for money. The view, as Charles articulated earlier, is that, based on individual deals at these margins, it can be value for money, yes.
Q107 Chair: Amyas, Jo and then Stephen.
Amyas Morse: Thank you Chair. I just want to make sure of some of the points in the report. Although we said that the additional funding costs in the special circumstances and with the policy direction were overall value for money, we made some, I thought, intentionally trenchant points. First of all it wasn't just additional financing costs, it was also transfer of risks by the banks to the Government. So they took the chance to improve their position there. Secondly, going forward we are very clear that we think much tougher criteria need to be applied in assessing value for money on PFI projects in future and, if there are changes in the financing cost component, the margin of tolerance that the Treasury will accept before requiring a restated business case should in future be much narrower. We made all of that very clear, so I think we should let the market decide if there is a future for PFI and if it doesn't meet those tough criteria then let the answer be what it may. If I may, one thing, Chair, is I thought Mr Swales's comment about the very substantial amount of the value in any PFI deal that represents the maintenance and operating agreement-I felt we passed by that without really hearing a very full answer, if I may say so.
Q108 Chair: Mr Hudson.
Andrew Hudson: I think on Mr Morse's points-the more exacting tests-I stressed all along that we have been rigorous in assessing value for money but, as I said just now, public money is a whole lot tighter and we certainly need to keep our eye very much on that ball. As to the threshold, whether we should have a specific number and what that should be, that's under consideration and we're going to put out some more guidance shortly, but we'll draw together the lessons of the whole of this episode, and we'll take a final decision on whether to have a specific threshold above which projects need to come back for re-approval or some demanding test, but not a point estimate, in the course of that piece of work.
I'm sorry if we didn't cover between us the point that Mr Swales was driving at, and Charles Lloyd may want to say a bit more, but the way I see it is that through the construction phase there is a considerable risk and that is reflected in the premiums that are paid. After that, the risk comes down; it isn't eliminated altogether and, as Charles explained, there are reasons why the financing, the design, the building and the operating are held together in these contracts, because that gives the incentive for the private sector provider to take the right decisions at the design stage and the right decisions in preparing its operations to provide best value for money over the lifetime of the project. That's why the financing is integrated but with these strengthened provisions for the public sector to benefit once the risk reduces as the construction is completed.
Q109 Ian Swales: My point was really that the fantastically complex structure of these deals means that the whole risk is tied together. You have people assessing everything from the construction of something to how something might operate in 20 years' time. As the report says, that can deter people from getting involved, including pension funds, because they may not have the resources to assess all that risk. So my question was: is there a way of unbundling it so that we get the proper risk premium separately on the two key stages of any deal?
Andrew Hudson: Do you want to say a bit more about how these risk premiums are worked through?
Charles Lloyd: Yes, I suppose conventional capital procurement in Government is an unbundling of the risk, so we get a construction contract and then offer an operations and maintenance contract. That is certainly one way to do it and indeed the great majority of capital is procured in that way, as opposed to on a PFI basis. The problem with that though is that the public sector, the client, sits in the middle and at the point where the construction risk switches to the operations and maintenance risk, what is passed back to the public sector is the risk that the building was built inadequately in the first place or was not suitable for the most efficient form of maintenance. Yes, absolutely, we can do that, but we shouldn't do that and pretend there is no risk in that to the Government.
Q110 Ian Swales: Well all I'm saying is it's two packages, not one, isn't it on most of these projects? The building of a hospital is entirely separate to the operating of the hospital-
Charles Lloyd: But if you-
Ian Swales: Sorry, just to finish my point-with usually completely different commercial players carrying out the work. So, Shepherd Construction might build a hospital, but they are not going to operate the hospital.
Ed Humpherson: Can I make an intervention here and ask, Mr Lloyd, particularly about the bundling of facilities management services into PFI contracts, because I think that goes to the heart of the point Mr Swales is making. It is not simply a bundling of capital with the maintenance, but it's the bundling of the capital with the maintenance, which one understands makes some sense, with things like security and cleaning and catering, all of those things, which add to the complexity.