It has been argued in this paper that the benefits of senior debt are concentrated at the front end of projects; risk analysis and allocation; and due diligence. There have been several moves towards replicating these benefits outside PFI:
• Processes designed to increase the senior level scrutiny of major projects before they are given the green light, such as the Major Projects Review Group announced in SLTP. This has recently got underway, reviewing, among other projects, the Personal Accounts programme and the carbon capture and storage project.
• The application of due diligence disciplines by the public sector to non-PFI projects. For instance, the MOD has put in place procedures to carry out commercial assurance and due diligence on its major procurements. This internally led exercise emphasises the independence of those carrying out the due diligence from those who negotiated the contracts. The commercial assurance and due diligence exercise aims to ensure that the contract about to be signed is consistent with the terms originally proposed, and approved, for the contract.
These are recent developments, and it is too early to assess their effectiveness. However, as noted earlier, one of the most powerful features of senior lenders' due diligence is that it is carried out on behalf of entities with an asymmetric exposure to risk, and hence no incentive to
pursue projects come what may. Public sector projects can suffer from what might be termed momentum risk - the difficulty of stopping, or significantly modifying, a project once it is underway. It remains to be seen how far these new processes can mitigate that risk.
The greater the degree of distance and independence from government which any review process has, the greater (arguably) would be its ability to spot and stop misconceived projects. It has even been suggested that the public sector should subject itself to a completely external discipline, such as assessment of projects by ratings agencies. Illustratively, it has been argued, that government could decline to back a project without some form of external accreditation from a ratings agency. This is an interesting concept but harder to apply than it may at first appear. Ratings agencies' fundamental skills rest in assessing the risk of default by a borrower. The use of a ratings agency could therefore be applicable in situations where government was lending to a project or otherwise taking senior credit risk (as in the case of debt underpinning - see below) as a means of external assurance. However, it is hard to see how the concept could be applied, except metaphorically, to conventionally funded projects, although the rating agencies or similar organisations could be used to review the underlying business (not financial) risks. In particular, structuring a project so as to achieve an investment grade credit rating often involves shifting risk from senior debt to equity or to the ultimate customer (i.e. government). In conventionally funded projects it is the same party - the public sector - which plays all three of these roles.
The overall conclusion is therefore that, while there are steps which the public sector can (and is) taking to replicate the disciplines imposed on projects by senior lenders, it is doubtful whether any process will be as effective as one which (a) requires an independent party to reach a view on a project and (b) exposes that party financially if they are wrong.