1 Through our previous work in the area of PFI we have established that allocating contractual risks, such as insurable or non-insurable events, or the risk that demand for the service is not at the anticipated level, is a key contributor to achieving value for money. Allocating these risks to the party best able to manage them is fundamental to achieving value for money in PFI. Value for money will be optimised as the parties best able to manage a risk will be able to deal with the circumstances surrounding the risk efficiently and cost-effectively.
2 Identifying risks to the successful delivery of the project is a key part of the PFI procurement process. Once risks are identified, the parties must agree which risks will be retained, which ones will be transferred and which ones will be shared. The process to agree the risk allocation will often involve a number of techniques including financial analysis, negotiation and the following of best practice and guidance. Guidance includes the Treasury's Standardisation of PFI contracts (SOPC) Version 4 which is the latest version of standard wording and guidance to be used by public sector bodies and their advisers when drafting PFI contracts. Once agreed the risks can then be managed effectively in the in-service phase of the project.
3 We found that in the Ministry of Defence, the process for arriving at the allocation of risk is similar to that seen in other departments. This often involves both analysis and negotiation between bidders and Authorities to ensure that the risk transfer is optimised to the satisfaction of all parties.
4 In addition to negotiation between the parties, the risk process typically also involves significant specialist input from technical, financial and legal advisers. The appropriateness of the risk transfer will be evaluated throughout the process both by the public sector, for example via the approvals process, and by the bidders and their funders. The use of private finance means that those intending to provide the finance will be concerned to ensure the risks will be managed well, so that there will be confidence that debt finance will be repaid and that the equity investors earn their expected returns. The evaluation of risks undertaken by lenders and investors is known as due diligence.
5 The decision regarding who is best placed to manage a risk may be based on an assessment of competence, or the track records of either party in managing particular risks. It may also be based on an assessment of who can best control the factors that make up the risk. For example, the risk of constructing assets is usually passed to the private sector contractor as they are in the best position to manage factors such as performance of sub-contractors.