Q601 Baroness Hamwee: It is just a small question arising out of answers that you have given to the last couple of questions really. You have mentioned the fairly standard contract that the Treasury recommends. Are you actually recommending 15% of equity and 85% of debt, or have you moved from that?
Ian Pearson: We do not have a recommendation as such, and typically it would be up to the market to decide the appropriate structuring of a particular transaction.
Q602 Baroness Hamwee: You mentioned the importance of maintenance and I absolutely take that point. We have heard quite a lot about bundling of build and service provision: could the same be achieved without using private debt finance and the higher costs associated with it?
Ian Pearson: I am not sure exactly what you mean by that question. If you mean could it all be conventionally procured, of course it could be. It could all be conventionally procured. But I go back to the point in that case of saying that we would not be going down the PFI route if we did not believe it was the most cost-effective solution. If you mean could it all be private equity funded, I just do not think that that is realistic. As I say, I do not think companies would want to take all the equity risk on their balance sheets. I cannot think of one company that would find that an attractive proposition. Also, they would demand a lot more for it, which would make PFI unaffordable; the debt risk is a lot lower than the equity risk. By and large, if the taxpayer is looking to pay for these projects, we do want to see a high level of debt finance as part of it because, other things being equal, it is going to be cheaper than paying for the equity.
Q603 Chairman: Is it inconceivable to have a private equity skin in the game from the constructor but the debt is produced from the public sector rather than the private sector and these two things sit together?
Ian Pearson: I do not think it is inconceivable. Certainly having that private equity skin in the game is important. I was trying to make the point that having the private debt skin in the game can be very useful as well because it keeps everybody on their mettle as well as the normal contractual management from the client side. But you could conceive of models which had private equity in it and public debt; and indeed, I suppose, if you look at Manchester Waste as a recent PFI scheme, where TIFU helped to fund that, it is a good example of where we helped make up the difference to get the project off the ground in difficult circumstances. Whether you would always want it to be100% public sector funded debt, I do not think there is a compelling reason why it should be that way. As you rightly say, you should not rule it out and it might be an appropriate one in some circumstances.
Q604 Lord Griffiths of Fforestfach: I would like turn back to this question because it is very interesting, and I do so because there are sceptics of the PFI initiative and I would very much like to deal with it. Their argument goes something like this: let us assume you were Chancellor of the Exchequer and you said: "We want to put 15 billion into schools and hospitals and things like that and we have a chance to either go the PFI route or we can go the conventional route", because we know that a conventional route with public sector debt is going to be cheaper, they then argue that it would be conceivable that you could replicate all of the benefits you got from PFI in terms of time and specifications, within that sort of public sector framework. I must say personally I have some doubts about it, but you are there as a Minister. Because we have certainly had people come to us who I think at the back of their minds they are really saying, "We need not go as far as the private finance route; the public sector will do it just as well because we can replicate everything they do and it would be cheaper, so we would get better for value for money."
Ian Pearson: I did make the point earlier that I think there have been some indications that conventional procurement has been more effective in recent years because of a learning effect from experience from private finance/PPP transactions. I would not want to say that necessarily the public sector cannot run things efficiently, because we can think of lots of examples about where the public sector does run things efficiently. What I do think is a difficulty in the argument that some of the people you are talking about put forward is that I do not think they accept the risk transfer process. They want to argue that the Government is not transferring any risk whatsoever and I would want to make the point strongly that if we are transferring risk for the period of the contract, given the risk profile will vary over the life cycle of that contract, typically at the front end of the construction it will be very high, but in terms of operation it might not be, but there are risks there which are being transferred. It has never been obvious to me that with some of the risks we are talking about the public sector is best placed to bear those risks. That is one of the fundamental reasons why I think that PFI projects are an important way of procuring and are likely to be more cost-effective because we do not get saddled with some of the risk.
Q605 Chairman: Is there a distinction between risk that is perceived at the time that the contract is let and risks that then arise over the period of a contract and the contract goes over a period of years? Another of the criticisms laid against PFI projects is that you get tied in to a scenario that was legitimate on day one but 30, 20 or 10 years hence is no longer legitimate, and that to try to get out of that contract is more difficult than it would be under straight procurement. Is there any validity in that argument?
Ian Pearson: In essence I do not think there is much validity in it. If I wanted to try and support that argument, then I would probably point to the IT sector, which has seen substantial changes. As you know, the Government said a number of years ago that because of the rapid pace of technological change the presumption should be against PFI projects in the IT sector. Having said that, and again if I pointed to my own constituency, we have the Dudley Group for Learning which was a pioneering IT project in schools where we have contracted delivery of computers to a company called RM, which has been hugely successful; so even in the IT sector I would not want to rule that out. I think that with contracts over a 20 or 30-year period things are always going to change. I do not think it is beyond the ability of those who are working in this space to be able to sort that out, and I think that modern PFI contracts can be written flexibly enough to take into account the fact that the world might change, and frequently does.
Q606 Lord Forsyth of Drumlean: Chairman, if I could pick up from Lord Griffiths's analogy which was of the Chancellor with £15 billion to spend: I have not got a problem with the idea that if £15 billion is done on a PFI contract and it may provide greater value for money. But the issue for me is that the £15 billion is actually used through a PFI to gear up in much the same way as we have seen with a number of our companies which have been bought by private equity, and very substantial additional gearing, which is fine in the good times but then when the revenues are not there the debt cannot be serviced, and the result is there has to be a great reduction in employment and services. Is there not a danger of this happening in the public sector as well, that PFI has been used as a way of effectively doing what we have seen happening in the private sector, which is introducing long-term gearing which it will be very difficult to meet without reducing services in the long term?
Ian Pearson: I do think it is important that the unitary payments associated with PFI projects should be sustainable for the long term, and that needs to be taken into account, as I indicated, right at the start of any process. You mentioned some of the risks abut revenue declining in the long term, and you can see in the private sector how there is a significant market risk. I think that risk is likely to be less when you are talking about operating a school or an NHS hospital. That is not to say that over a period of time there might not be some risks associated with that. Catchment levels might drop dramatically, the school might become unpopular and the local authority might decide that it does not really need that school in the future. Similarly, the health service economy could change quite significantly. Those are different risks to the sort of market risks that I think you were talking about. I think when it comes to the organisations in the PFI consortium, at least they can be assured that the covenant of the local authority or the NHS trust or the central government department is a very good and sustainable one.
Q607 Lord Forsyth of Drumlean: On a slightly different tack, we have heard from several witnesses, including the NAO, that cost modelling tests for "public versus private" should only be one factor in the procurement choice, but that other factors are taken into account-ability to deliver on time-are hard to assess objectively, so that the final judgment is pretty subjective. You touched on this earlier in responding to Baroness Kingsmill. Do you agree with that?
Ian Pearson: I would never want to disagree with the National Audit Office without good reason because they produce a lot of very good work. I have to say I do not think that their most recent report on PFI was amongst their best. What I would say is that, yes, I would accept, when it comes to looking at a public sector comparator and making judgments on this, there is undoubtedly the ability to flex approaches and to deliver different results as a result of that. What I would come back to is that it is important all those assumptions are rigorously looked at, analysed and tested, to make sure that this really does give best value for money.
Q608 Lord Forsyth of Drumlean: Does that make the public sector comparator irrelevant in most cases then?
Ian Pearson: I do not think it makes it irrelevant. A lot of detailed work has gone on in terms of defining how you construct a proper public sector comparator. A lot of that can be found in the Treasury Green Book as to how things should be applied. What I am saying is-and you would expect a Treasury Minister to say this-rigorous application of Treasury Green Book principles is a good thing and should happen in all circumstances. Lord Forsyth of Drumlean: A comforting thought!
Q609 Lord Best: Do we know the answer to this one: what proportion of private finance projects is not included in the statistics of public sector net debt? Do we know the value and percentage of those projects? Have we got those figures? We do have some conflicting views on what they are. Ian Pearson: Let me give you the figures that I have available to me, and then if there is any clarification that is required later, I am more than happy to ask my officials to provide further information. The information I have is that of current signed deals 12.94 billion is on the Government's balance sheet and its national accounts, and 41.6 billion is off the Government's balance sheet; so we are talking about 24% on, versus 76% off. I would say as well, as part of this, that the Treasury has always been clear in its guidance to departments how these things should be accounted for. As I said right at the start, we have different ways, as a result of different accounting standards, as to how these things are treated, but there is a lot of information out there at the moment. I was asking where it was in the Pre-Budget Report, and if you look at the supplementary material to the 2009 Pre-Budget Report, for example on page 34, you will have in table 2.4 the department estimate of capital spending by private sector signed deals under the private finance initiative, and it is listed there for each department. The Treasury website itself contains details on operational PFI projects. We are committed to ensuring transparency in these deals, and transparency in the way they are accounted as I have indicated already.
Q610 Lord Lipsey: I just want to take you back to the question of maintenance and the fact that PFI contracts make it very difficult to cut maintenance. I was thinking, as I heard this, that there speaks a Treasury Minister who has never had to go through a cuts exercise, as indeed no Treasury Minister has for some20years-but I see Lord Griffiths-both he and I have, in government, had experience of cuts exercises. When you have cuts exercises, you are trying to find savings wherever you possibly can, and having a bit of maintenance to chop temporarily is one of the less painful ways of doing it. Therefore, I am wondering; is there a danger that we have built in to our public finances another bit of something that is totally inflexible, and that we are going to regret that very much in the eye-watering retrenchment of the public sector that is about to come upon us?
Ian Pearson: I think you ask a very fair question. First, I have not always been a Treasury Minister; I was a Minister in Defra, where we had to make some financial reductions. I have been a Minister in other government departments as well, where we have had to make some fairly tough decisions; and I have been through a zero-based budgeting review process in a number of departments as well. It is certainly right to say, however, that the scale of what we are going to have to do over the next few years is radically different from anything that we have experienced in the last twelve years, that much is clear. The question is therefore: through the PFI deals that have been signed, are we constraining actions? Clearly, there are legally binding contractual commitments as part of PFI deals, and when I was going through those cuts exercises in the past the first question you looked at was, what were the things you were legally contracted to or that were inescapable. I think it is right to say that in most cases PFI deals would fall into that category. The question then is: can you point to any department or agency or within local government where the level of unitary payment is likely to cause a serious problem when it comes to resource decisions because it is so high compared with the rest of the budget that is under financial pressure? I am not aware that is going to be a significant issue, but I cannot pretend to you that I have got all the detail of it; but given that PFI has been a relatively small percentage of overall transactions when it comes to procurement, I do not think you should automatically assume there is likely to be a big problem. Hand on heart, I cannot say to you there is no problem whatsoever because I simply would not have the evidence of that.