Should the public sector share in gains on sale of PFI equity, and what impact would this have on investment appetite and pricing? 

SFT believes that the differential pricing of equity (including subordinated debt) between the primary market (new projects) and the secondary market (generally equity changing hands on projects in their operational phase) is too high. The returns tendered in the primary market do not appear to be commensurate with the level of risk being taken. The opportunity to make significant and in our view to a real extent unwarranted, profit from a sale in the secondary market where investors have become comfortable with a significantly lower return broadly commensurate with risk taken remains. 

Taking a share of gains from equity sales would be one way to counteract this situation. For future projects it would be possible to implement such a sharing albeit that the provisions required may become complex given that equity is often sold in portfolios.  For existing projects it is very unlikely to be applicable retrospectively as the party making the gain is almost by definition not part of the project any more. Prospective application on existing projects would potentially be possible by way of a voluntary code with industry but the level of benefit to be gained overall from that would be likely to be minimal with the majority of projects that are likely to change hands for the first time following construction completion, having done so already. Gains in further sales are likely to be significantly lower.

In SFT's view, the best way to address this issue for new projects is at source - by regulating (through the contract) the level of equity returns  on projects and having these bid competitively as part of the procurement. This return will always be a market decision, but in our view steps can be taken to allow investors to take a new and different view of primary returns: 

a)  The NPD structure requires bidders to properly consider the equity return required rather than allow it to be driven by bank cover ratios. As discussed in Q6e, the return of surpluses to the procurer means that not all "free cash" has to go to equity after the cover ratios have been met. This allows lower returns to be modelled whilst meeting senior funder requirements. 

b)  Risks have been re-allocated such that investors are not required to price in margin for risks that they are not reasonably able to manage; 

c)  The shortening of procurements, with a lesser requirement to invest heavily in design work in the bidding phase means that bidding costs are reduced and margins to make up for the cost of lost bids should not need to be so high. 

Together with a highly competitive market, these steps should allow the gap between primary and secondary returns to be lowered (by lowering primary returns) such that any gain on sale may reasonably be considered as a proper reward for taking (in many cases) bidding risk, and the higher risk of construction and handover phases.