Private Finance Initiative

2.18 PFI is an arrangement whereby the public sector contracts to purchase services, usually derived from an investment in assets, from the private sector on a long-term basis, often between 15 to 30 years. An example of a PFI project is St James' University Hospital (see Example 2.1). Typically:

∙ the private sector will construct and maintain infrastructure in order to deliver the services required. The project thus entails a construction phase followed by an operational phase;

∙ the private sector party contracting with the public sector is usually a special purpose vehicle (SPV): a company with the specific goal of delivering the project, and can have one or more shareholders;

∙ much of the risk assumed by the SPV is passed to other entities (which sometimes are also shareholders in the SPV) through sub-contracts;

∙ the SPV uses private finance, usually a mix of equity and debt, to fund the up-front construction works;

∙ the SPV is paid a fee for the service it provides to the public sector. The fee is often referred to as a unitary payment and includes principal and interest payments on the debt and a return to the SPV's shareholders, as well as an amount based on the expected operating cost of providing the services delivered and maintaining the assets. The unitary payment normally commences after completion of construction once services start being delivered and continues over the rest of the contract life. The unitary payment is at risk to the SPV's performance during the life of the contract, such that payment is reduced if performance falls below the required standard; and

∙ the SPV manages and delivers the required services to specified standards, while sustaining the quality of underlying assets.

PFI has evolved since its introduction and the standardisation of PFI contracts (SoPC4) now sets out the standard approach to risk allocation between the public and private sectors and includes mandatory principles and drafting for certain key contractual clauses.

2.19 A PFI contract may be suitable where:

∙ there is a major capital investment need, requiring effective management of risks associated with construction and delivery;

∙ the nature of the service allows the public sector to define its needs as service outputs that can be adequately contracted for in a way that ensures effective and accountable delivery of public services over the long term, and where risk allocation between the public and private sectors can be clearly made and enforced;

∙ the nature of the assets and services identified as part of the scheme, as well as the associated risks, are capable of being costed on a whole-of-life, long-term basis;

∙ the capital value of the project is above £20 million to ensure that procurement costs are not disproportionate;

∙ the technology and other aspects of the sector are stable, and not susceptible to fast-paced change; and

∙ planning horizons are long-term, with confidence that the assets and services provided are intended to be used for a long period into the future.