Q401 Lord Lipsey: Reading through the amount of evidence we have had I am very struck by the range of views expressed from those who think that PFIs are the finest thing since sliced bread to one academic witness who could not think of a single thing to be said in its favour. I wonder if you could bring to our attention any particular project or group of projects which appear to you to have delivered significant innovation that would not have come about without the PFI model.
Mr Pokora: There is one particular scheme that I have been involved in which was regeneration of an area in the West Midlands for which it was absolutely essential that a regional development agency funding was secured. Without that funding this particular project in this particular area, and therefore this area of the community, could not form the hub of the regeneration effort. It was quite clear that without the private sector involvement in putting together the bid for that and actually the fact that the private sectors are willing to put finance into that scheme itself and take the risk on the development, that money would not have been available to the public sector, to the NHS and the local authority particularly. For us that is one very specific example where we could do that and the value again of the LIFT company being around not just for that one project but for that plus other projects into the future was a key factor in the success of winning that particular funding.
Mr Dwan: To pick up on the community point and also James's point about joining up a community project, we have been able as an industry-I can forward you numerous examples of this-to ensure that community assets are developed and allow the parties taking part to run at their own pace, so if their party has not got funding in place and is not able to co-locate we can chaperone the development, host it, make it available and hold it in time. A development of this approach is the total system change which is taking place in the NHS at the moment where ownership of the asset is being detached from the service provider so that we are providing a hosted infrastructure into which service providers can be asked to perform services on an individual episode of care, on a daily or weekly basis. Without an independent party that is able to pull together the range of skills required to achieve this, this kind of system change could not have happened.
Mr Stewart: Can I just tackle it from a slightly different place? I think you see a different form of innovation in these programmes. One of the changes that has taken place in the market in the last five years is that, as we have gone to these smaller projects being parts of programmes, the private sector has reconfigured the way they manage their resources. What you have seen in the private sector is specific sector based teams as opposed to a generic PPP team. You will see a LIFT team or you will see a team focussing on the schools sector, or you will see a team focussing on the waste sector. What that has enabled is research and development-which ultimately will hopefully lead to innovation-being thought about on a long term basis across the programme rather than on the individual deal. When you are in the midst of an individual deal and you are bidding it is very difficult to really create innovation because you are always against the clock, you are always justifying the cost of that R&D on the basis of that single bid, and that is always very difficult. Whereas if you are in a programme people will take a longer term view. It is boring things like going out and researching the best form of door in a school and then bulk buying it for the future and things like that which will reduce the whole life cost. I think in these programmes we are definitely seeing more innovation than on the individual deals.
Q402 Chairman: This question sounds a bit like an exam question but we have had some rather conflicting evidence about the numbers so possibly you, Mr Stewart, can tell us how many private finance projects and their aggregate value are included in the national debt figures and how many are not?
Mr Stewart: Unfortunately you are going to have to ask the Treasury. I sat in a PAC hearing alongside a member of the Treasury who was asked a very similar question and he did provide a note to the Committee. If I gave you an answer I would not give you the proper answer.
Q403 Chairman: Since devising the question we have heard from the Office of National Statistics and I think the figure may be that there are £64 billion worth of schemes, including the London Underground public/private partnership, £51 billion operational or under construction and about £25 billion of this total are designated as on-balance sheet schemes for the purposes of the accounts of the public sector bodies concerned. So it looks as if about half may be the answer.
Mr Stewart: I would say those sums seem a little bit low to me but that is off the top of my head.
Q404 Lord Eatwell: I am intrigued by the development of the secondary market in the financial instruments used to fund PFIs. The development of the secondary market in finance has brought us to the pretty path that we are in now in the sense that what happened, as we know, is that bankers in the mortgage market took insufficient care in to whom they leant money because they could then securitize and sell on the debt, the consequences of which we are living with now. Do you think that similar consequences could arise from a secondary market in financial instruments associated with PFI so that there would be less care taken over the construction of the project at its initial stage?
Mr Stewart: The first thing I would say is that there is not only a secondary market there is a tertiary market and whatever the one beyond tertiary is. Generally these assets tend to change hands once the construction is complete and the reason for that is because contractors are happy to hold their equity stakes for the construction phase and typically one year into operation, but then a number of contractors wish to recycle that equity back into new projects once they get through the construction phase and do not see themselves as the long term holders of those assets. There are some exceptions to that. Balfour Beatty, for example-I think you had someone from Balfour Beatty in front of you-have held onto their PFI investments on their balance sheets but other construction companies would look to recycle their capital and hopefully take some profits. From a public policy point of view recycling is encouraged.
Q405 Lord Eatwell: Surely then all this stuff about life time that we have been so concerned about no long applies because the originator is stepping out.
Mr Stewart: In a typical project you would normally have more than one equity provider at the outset. You would typically have maybe a couple of private sector contractors, it might be the builder, might be the FM provider as well and you might also have some third party equity. Therefore you would have potentially some continuity from the third party equity provider who would probably be in there for the long term. Typically these assets will then get sold to secondary fund and I think it has been disappointing that the secondary funds, when they set themselves up, did market themselves as being in for the long term. That has not proved to be the case and they have tended to sell the assets on again at some point. That was partly driven by quite an active secondary market and the fact that the prices available were very good. That has corrected itself so what we are beginning to see now are the assets being held by funds who are in for the long term and for the operational phase of these projects, but we are not in a perfect world yet.
Q406 Lord Moonie: What incentive is there for a constructor to innovate if he knows he can get his money out as soon as the thing is built?
Mr Stewart: Do you mean during the operational phase?
Q407 Lord Moonie: Yes, look for new methods which will be of benefit to the 30 year project rather than his one year horizon.
Mr Stewart: I would argue quite strongly that there is a greater incentive because the secondary investor will need to innovate partly to get an enhanced return. You might say that is the wrong kind of innovation but in practice they have to do things to the project to make that project better from both the public sector's point of view and the private sector's point of view so they will be re-energised to work quite hard on that project.
Mr Dwan: If you take the LIFT market we have today-and I cannot foresee it for the moment-there has been no secondary market interest because these are living, breathing companies carrying out a rolling programme. As a result of that we have no contractors who are equity holders in the LIFT companies themselves; contractors are market tested and appointed on a project by project basis so their incentive is to get the next project, give the best price and to innovate at that point. This type of programme, as James alluded to before, has created a different type of equity partner and participant in LIFTCo who genuinely has a long term interest because they are going to make a long term return that increases or ebbs and flows as to how well they perform over that period.
Mr Pokora: The only additional comment I would make is that the operational transfer of risk does not change whoever holds the equity, whether it is primary, secondary or tertiary investor. The actual contractual terms on which that facility is being run do not change as a result of who the investor is, so from a public sector perspective they get the same service provision to the same standard, to the same cost irrespective; it is the private sector secondary investor who is taking on that risk.
Q408 Lord Eatwell: That may be true but the question is whether the initial contractor takes the full care with respect to the life time of the project that he or she would if they were literally in it for the lifetime. If they can get out then worrying about, for example, the durability of your door in 15 years' time if you are getting out in 10 may be not quite so important.
Mr Stewart: There are three phases to a project. People often forget the first phase. The first phase is bidding. So the people who take the bid cost risks are generally the first people who provide the equity and once you have won the contract and you have then signed the contract you are into a construction phase which is the second phase. The third phase is the operational phase. My view is that the people who put the equity into the bid phase and the construction phase are a different animal to the people who should have their equity invested in the operational phase of these contracts and therefore I have not objection to people recycling their equity. What you then want is people in for the duration of the operational phase who have expertise and experience in that phase. When it comes to innovation, I think the innovation you require in the operational phase is very different to the innovation you are looking for in a bid phase or a construction phase.
Q409 Baroness Hamwee: Can I just pursue that to understand it? Are you saying that you cannot get out entirely because the liability remains? Is that what Mr Pokora was saying?
Mr Pokora: The contract that was originally signed has within it the clauses for availability or whatever performance obligations there are on either the special purpose vehicle-in our case the LIFT company-and those obligations do not change irrespective of who the investors are.
Q410 Baroness Hamwee: You are not assigning the liability.
Mr Pokora: No. I think the point is well made and again it comes back to a question of where it is a single project procurement that is being handled, it comes back to the relationship, it comes back to the trust, it comes back to the actual qualitative assessment one makes of the bidders in terms of what they are offering because to me I have spent time both sides of the fence and I know that I was looking for a flexible friend, not in terms of credit facilities but certainly a partner who would work with me to deal with the changes that would inevitably be required over the time and therefore that does require someone who has invested in the outset in the best way of this facility being run not just built.