In the context of procuring residual waste infrastructure, unlike PFI projects, there are no templates setting out required risk transfer arrangements for projects procured using Prudential Borrowing. Instead, there is a range of possible contractual structures which might use Prudential Borrowing. Three examples are given here to illustrate the breadth of this range.
a) An Authority lets separate contracts for the construction and the operation/maintenance of a facility which it will own. Prudential Borrowings in this case forms part of the overall internal Authority funds available to meet the on-going costs of the facility, whether as progress payments made to a construction contractor, or to meet maintenance costs. A variation of this could be where the Authority lets a single "design, build and operation" contract (but still owns the assets itself);
b) An Authority lets a PFI or PPP contract, but wishes to make a capital contribution up-front (e.g. for the purchase of land, or as payment towards construction costs) financed by Prudential Borrowings, the effect of the capital contribution being to reduce the gate fee from the level at which it would otherwise be set. Such contributions under PFI are generally limited to 10% of the capital cost (see Question 11. below). A variation would be where the Authority makes its capital contribution in the form of an equity subscription to a joint venture with the chosen PPP contractor, which then jointly own the facilities;
c) After completion of construction of a facility funded using private finance and after a suitably long period of successful and reliable operation of the facility, an Authority decides to make one or more (over time) lump-sum payments to the contractor which are applied to pay-off a matching amount of private sector senior loan capital. In respect of each such lump sum payment made, the subsequent gate fees payable by the Authority are reduced pro rata (this option is sometimes referred to as ‟hybrid funding‟).
In each of these cases the deployment of Prudential Borrowing means low cost borrowing but raises the following risk issues.
By way of illustration only: the approach to procurement in (a) provides the Authority with no protection for unforeseen life-cycle costs; in the case of (b), the Authority's sunk capital is not recoverable in the case of a contractor insolvency (although any compensation on termination payment made by the Authority will be reduced given the Unitary Charge is reduced by the Authority's capital contributions) and in the case of (c), incentives for private sector performance are substantially reduced. A discussion of all the value-for-money issues raised by these and other uses of Prudential Borrowings lies outside the scope of this note. 3 Nonetheless, all of these issues would need to be quantified and included within a formal value-for-money assessment.
Under Prudential Borrowing, the Authority will typically obtain a loan from the PWLB. The Authority will be responsible for making the interest and capital repayments due on the loan (and therefore the Authority will need to ensure that there are sufficiently reliable sources of funding available to repay the loan), regardless of the performance of the waste facility the Prudential Borrowings are financing. This is in stark contrast to PFI arrangements where no performance equals no payment by the Authority, and consequently the Contactor may be unable to service its debts.
Clearly, where the performance and budgetary risks inherent in the facility are lower, the complexity of the funder risks are reduced and the arguments in favour of Prudential Borrowing may become stronger. This may mean that assets such as land, Household Waste Recycling Centres and composting facilities are judged to offer good value-for-money under conventional procurements supported by Prudential Borrowings. In each case, a comprehensive value-for-money assessment should be made before a procurement route can be chosen.
When considering contractual structures proposed in relation to Prudentially Borrowed procurements, Authorities should also be cognisant of legal issues that arise such as for example whether the proposed contractual structure would be intra vires.
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3 WIDP acknowledges that in principle, it is open to authorities to fund projects by drawing down on reserves. However in practice most authorities are likely to have to borrow given the sums involved and therefore an assumption has been made for the purposes of this note that borrowing will be required.