9.24 Flexibility is important in the delivery of public service investment in PFI, just as in conventional procurement, to take account of major changes in requirements or technology in the long term. Natural limits are placed on flexibility by the very nature of the capital assets being built, and they are present in both PFI and in conventional procurement. However, the means by which this flexibility is realised differ in the case of PFI, and Chapter 3 outlined the measures in place in standard PFI contracts to deploy that flexibility. In brief, these measures are:
• the public sector has a right to change any aspect of the building or service provision, subject to agreement with the PFI contractor on cost;
• to ensure agreement is reached quickly and that value for money is maintained, for changes over £100,000 in value, the public sector can require a competitive tender for any works, to be appropriately audited; and
• where there is a requirement to change service configuration, there is a similar right for the public sector to change any aspect of service provision, subject to agreement on costs, with the ability to require a competition for the services provided to ensure best value for money. This is in addition to their rights to re-tender service provision regularly throughout the contract's life.
9.25 In very rare circumstances, where there is an unanticipated wholesale change in the public sector's needs which makes public infrastructure redundant, or requires very radical change in its use, the public sector will need to be able to implement such change whatever the procurement route originally chosen.
9.26 In conventional public sector procurement there will be costs in implementing such change. As in PFI, the costs may relate to the financing arrangements, and may involve the termination of service provision contracts. When a public sector project is financed by the Government, it typically issues gilts to fund the project. Even if the building is now redundant the Government will still need to repay and meet the interest costs of the gilt issue over its remaining life. Likewise any service contracts terminated would also lead to compensation. This would typically be calculated as a payment of foregone profits for an agreed period.
9.27 If the Government voluntarily terminates a PFI contract in such circumstances (rather than where the private sector is in default) it will face similar costs. There are, however, areas where PFI contracts are more expensive to terminate. In a standard PFI contract, shareholders would receive compensation for their loss of profit from the PFI project. This would typically amount to a present value of the foregone profits. The level of this compensation is dependent upon the performance of the project as well as the proportion of equity in the deal. Generally the low level of equity in the financing of these projects reduces the significance of this element of compensation.
9.28 The other elements of compensation on a PFI contract in these circumstances relating to the private finance elements of the project can represent an unnecessary cost. In particular, the Spens formula which is normally applied to the termination of PFI-linked bond issues - a small proportion of PFI projects - can be an unnecessary cost in the voluntary termination of a project, as it compensates the bond holder for the risk margin on the debt for the remaining life of the bond. The hedging of interest rate risk in a PFI project can give rise to similar issues.
9.29 To examine these issues further, the Government will be consulting with the public and private sectors on the role of the Spens formula in limiting flexibility in project termination, and on hedging risk.