1.26 There is international confusion on this topic. The accounting definitions for what should be "on" and "off" balance sheet (eg the identification and reporting of contingent liabilities) are also confusing.
1.27 The underlying criterion adopted by many countries is the Eurostat Directive of Feb 2004, under which, if the completion and either the demand or availability risk is passed to the private sector, then the transaction can be deemed as "off" balance sheet for the host government.
1.28 However, the flaw in this Directive is that it requires an assessment of commercial or physical risk transfer for what is, in reality, a financial risk. PFI is a funding mechanism, no more, no less. It therefore requires a financial assessment (see also para 1.21).
The judgement, therefore, as to whether a particular PFI transaction is "on" or "off" balance sheet should be based on where the financial risks lie.
1.29 It is also important to remember that, as a PFI concession proceeds, the financial risk will change, eg from the construction to the operations period.
1.30 Overall, governments should at least:
(a) record in National Accounts the potential (contingent) liability of any PFI-type transaction entered into; and
(b) provide a weighting, or probability, for such liability arising.
[Note: in the same context, governments should be asked to identify and weight potential contingent liabilities for entities such as Network Rail and state-owned agencies or companies, which are not classified as "PFI" or "PPP"].
Would public sector investment in the last decade have been lower without PFI? If so, by how much?
1.31 In short, probably. The Government have used PFI (and PPP) as a credit card and probably overspent like the rest of us!
1.32 Nevertheless, the use of PFI has not resulted in greater competition in the UK contracting industry or created any new UK-owned and domiciled contractors, rather the opposite has arisen.
1.33 Hence, the value of PFI/PPP to the UK economy as a whole is questionable. Many current PFI concessions, eg GCHQ, M6 Tollroad, and indeed privatised, UK public service utilities too, eg BAA, Thames Water, 90% of our major ports, etc, are non-UK owned, often with the UK "special-purpose" companies paying minimal corporation and capital gains tax. The use of shareholder loans-often at 15-20% interest-to shield tax liabilities has added to the reservations of the value of some of these PFI structures to the UK Exchequer and economy.
What is the impact of the current financial crisis on the PFI market?
1.34 The impact has been:
- there are now fewer lenders in the PFI market, and debt usually represents about 80% of the funding required for PFI transactions;
- the amount any one bank is prepared to lend is 25-50% of what it was two to three years ago;
- loan maturities are now much shorter, with a reduction from 15-25 years or more, to 10-15 years now; and
- the cost (ie margins) for such loans has doubled or more. Margins have increased from, say, 100 "basis points" to 2-250 "basis points" [Note: 100 "basis points" equals 1%, over LIBOR].
The UK PFI sector is not alone in facing these constraints.
Are there realistic alternative roles for private finance than the current PFI-type finance models?
1.35 70 years ago, when faced with similar problems as the UK economy, the US Federal Government introduced tax-free "industrial revenue bonds" to fund new infrastructure developments. Such instruments were attractive as investments for private, long-term investors such as pension funds, life insurance companies and rich savers.
Since then (1930), nearly all US/North American infrastructure investment has been successfully funded this way. Commercial banks have taken "a back seat" in this scenario.
While such bonds contain an element of government subsidy (ie a tax break), they attract a new source of capital, encourage saving and impose a stricter financial regime on borrowers. Further, any Incremental revenues that such investments accrue can be hypothecated, ie dedicated to support project cash-flows and debt service.
[Note: such bonds were precisely what Bob Kiley proposed for funding the London Underground five years ago, but which HM Treasury rejected!]
1.36 Many transport PFI's generate enhanced property values contiguous with the project. Schemes should be developed to encourage the measurement, capture and use of such benefits to fund the underlying infrastructure.
1.37 There is a need for a review of the role of Private Equity in UK public service and infrastructure projects. Abuses have occurred!
[NB. The Treasury Committee's Review of Private Equity in July 2007 omitted this topic.]
1.38 There is also a need to review the role and activities of Partnerships UK, a PPP advisory company or "quango", housed in the Treasury Building, and which enjoys a monopoly of advice to public authorities and municipalities.
Is there an optimal mix for conventional and PFI-type investment in public services?
1.39 In short, no. PFI-type expenditure should be constrained by the extent to which contingent liabilities may be created (ie how much the credit card is to be used by Government). Currently, it is understood that UK Government PFI-type expenditure represents around 15% of the Government's annual investment in public service assets.
1.40 Some countries, eg Brazil, have introduced constraints in their use of PFI structures by relating expenditure to Annual GDP. It is also known that the IMF is concerned by such issues, but to date have failed to produce any guidelines.
1.41 Overall, many of the problems associated with PFI/PPP transactions also encompass expenditures undertaken by state-owned enterprises, which many governments have kept "off balance sheet" for years, eg Network Rail, Electricite de France, the German Landesbanks, etc. It is expected, however, that many governments, including UK Government, will be most reluctant to expose the liabilities for the finances of all the state agencies under their jurisdiction!