1. Order, order, Welcome to the Committee of Public Accounts. Today we are looking at the redevelopment of MOD Main Building. We are delighted to welcome Sir Kevin Tebbit who is the Permanent Under-Secretary of State at the Ministry of Defence. We also welcome Mr Matthew Webber who is Chairman of Modus Services Limited. Do you want to introduce your colleague?
(Sir Kevin Tebbit) On my right is the Project Director, Jonathan Hoyle; Matthew Webber the Chairman and Les Mitchell the Managing Director of Modus as well.
2. May I start with you, Sir Kevin? We have a PFI contract here which is committing you to these arrangements with Modus for 30 years. What are the benefits which outweigh tying MOD to Modus for such a very long period?
(Sir Kevin Tebbit) As you have seen from the Report, the actual cost of going with a PFI partner as distinct from conventional procurement is about the same. The benefits are in other areas to which we attach a great deal of importance. The first is that we get greater price certainty throughout the period than would otherwise be the case. Second, the way in which the PFI contract is designed, means that there is a huge incentive on the contractor to complete on time. The penalties if he does not are very severe. Third, the payments under the contract are linked to delivering services at specified qualities based in terms of outputs of what we need and that covers the whole of the contract period. In other words, at year 29 and year 30 he is still having to deliver the same quality services to us as he is in year one. That is actually quite important these days. As you know, many of our problems across Government now are the result of disinvestment in infrastructure and across the whole of the public estate we have clapped out systems which now require huge investment. This sort of thing sustains a constant level of investment throughout the project life. Finally, by putting the design, the build, the maintenance and the operation of the project under one contractor, we ensure that he is going to take a rigorous approach to the whole life of the project. In other words, he is going to want to put in high quality infrastructure, cabling, water, heating, because if he does not, he is the one who has to pay the price when it goes wrong. He has to rectify it and he may have to pay penalty charges. It is those broader considerations about price certainty, about timely completion and about quality which are really the ones which are driving us.
3. As you said, the costs compared with a conventional deal are very similar. You mentioned other benefits, but is it beyond the capability of your Department to deliver these other benefits without resorting to a PFI deal?
(Sir Kevin Tebbit) It is a matter of choice. It is a judgement. Most of the accommodation and building activities which are involved here are not core business for the Ministry of Defence, that is not what we do. They are core business for these people and therefore one goes to where it is most appropriately provided. It is not that we could not do this, it is a matter of choosing not to for the benefits which are here. There is no question that we had to do something because the present situation is simply untenable; we could not have stayed where we are. The Health and Safety inspectors would not give us certification unless we guaranteed that we were doing these changes one way or the other. We judged that on balance this was a better way of doing it than by conventional procurement.
4. Let us examine some of these aspects of losing some flexibility. We already know from paragraphs 1.21 and 1.22 that there were non-Head Office staff for whom additional accommodation in central London had to be found. That just shows some of the dangers of tying yourself in for a long period in advance. Do you think you would have achieved better value for money if you had included this requirement in the Main Building PFI deal?
(Sir Kevin Tebbit) May I just comment on this flexibility point? The way the contract is drawn up does give us a lot of flexibility, flexibility to vary our numbers through the life of the contract. If we want less space as we go through, we can do that and the contract makes provision for that to happen and other tenants to come in and take over space. Flexibility is built into the arrangements. On the specific matter of the non-Head Office staff but nevertheless staff we need in London, we did look at whether it would be sensible to put them into the Main Building redevelopment, but judged that the number of changes which would have been necessary to the work, filling in the centre spaces or taking down walls and widening the building, would have just put too much risk and cost on the project. The solution we took was again taken on value for money grounds. It is a good deal to take the building we have taken in St Giles Court. If it were not value for money, we would not be doing that.
5. May I turn to the cost? You have agreed, and this is all set out in table 1 on page 7, that the cost is very similar to conventional procurement. I know that cost is not the only consideration; you mentioned other considerations. Can you tell us a bit more about why you were not able to generate any financial savings against the likely cost of conventional procurement?
(Sir Kevin Tebbit) We originally expected to be generating savings but in the latter stages of the project, the costs increased to bring them in at around the level of the public sector comparator. That is just how it came out. It would have been nice to have had slightly larger savings there, but in fact we were satisfied that this was the real cost of the project.
6. I am glad my colleague Mr Williams has come in, because I suspect this might be a question which would interest him. Here we have a public sector comparator of £746.2 million. You have a PFI deal of £746.1 million. That is very close, is it not? What you came out with at the end in your PFI deal was extraordinarily close to what is a public sector comparator. Some might think this was a fix.
(Sir Kevin Tebbit) I am sure you would not think that. I am sure this august Committee would not think that. The closeness is a virtue not a sin. I shall now illustrate, particularly for Mr Williams's benefit, why I say that. It came out a little higher and in order to negotiate as toughly as we could our negotiators said they wanted money off this price so that it was at least down to the public sector comparator and they shaved £4 million with tears running down the cheeks of my colleagues on the left here in the final knockings. This was as a result of tough negotiation by the Ministry of Defence, which, as you know, is a tough negotiator in the market, rather than some accidental precision at £742 million. It is quite clear that the costs were greater than we had hoped, partly because of the state of the building which they found, which only underlines the importance of doing this work-when the more detailed surveys were done it required an awful lot more doing to it than we had hoped-and partly because of interest rate movements and the cost of raising capital in the markets which is one of these things; they can go up, they can go down. Unfortunately they were on a slightly rising trend.
7. I suspect that one of the reasons why you want to do this PFI deal is that you were hoping to save £100 million. It was not to be. We know from paragraph 2.24 that it took 16 months to close the deal from selection of preferred bidder during which the price increased by £99 million. What lessons have you drawn from this experience?
(Sir Kevin Tebbit) We were not hoping to save £100 million; it was not to be. We were hoping to ensure that we got the best value for money in a project which needed to happen and we believe that we still have that. That basically is the story of this Report. It would have been nice to have got a lower price, but there we are, this is the economic cost and we had it carefully validated and benchmarked by independent authorities to make sure that was true.
8. Let us leave that and let us go on to the price increasing by £99 million in the last 16 months. What lessons have you drawn from this experience?
(Sir Kevin Tebbit) It would be nice to say that you could do it in a shorter period than 16 months and that the time between best and final offers and finally closing the contract could have been reduced. I wondered at the time myself whether we could have done it faster and I wanted to push the negotiators. They always said to me that they could get it done now but they would pay more for it and that I should leave them to negotiate because it was going to be a 30-year deal rather than something which should happen fast before they had it fully thought through. I am satisfied more or less that 16 months was needed. One looks at some of these easier projects in the sense that they are template projects e.g. for hospital buildings. I noted that they take about a year. This was a one-off very complex project with three separate elements to it, so I do not think 16 months was unreasonable.
9. Let us look at what happened during that 16-month period. The deal was bank financed at a time when the Treasury building redevelopment, which we all visited last week and were very impressed by, and the new GCHQ were bond financed. We also note in paragraph 2.42 of the Report that bond financing might have saved you up to £22 million. Why was your approach to financing different to the Treasury and to GCHQ?
(Sir Kevin Tebbit) You are right in saying that it might have done; the Report says that is highly speculative. The GCHQ deal was later than ours; it came a month later. At the time we were operating, in June and July 1999, the largest bond which had been floated was just over £100 million. Ours was £550 million, a very big loan indeed, bigger than the Treasury's £125 million, bigger than GCHQ's eventually which was £407 million. The view taken by our advisers was that there are diseconomies in very, very large bonds and that this was a better way to go. The other deals were also less complex. This one was first to operate the existing buildings, organise a decant of staff, then operate a new set of buildings; not a greenfield site project, therefore more risks associated with what was actually on there. A different contract period from the others, greater value here and higher risk. The judgement we took on the basis of the best advice we could have at the time was that this was the better way to go. There was also a feeling that bank finance gave us a bit more flexibility, a bit more control over some of the aspects of the project than would otherwise be the case. At the time we were all satisfied that it was the right decision to take.
10. What steps are you taking to ensure that you can share in refinancing benefits which may arise in the future?
(Sir Kevin Tebbit) We have clauses in the contract. There is a 15-year value for money review.
11. I should remind you that paragraph 1.32c says that the MOD does not have a specific contractual right to share refinancing gains.
(Sir Kevin Tebbit) I do not dispute that. We did not have a refinancing clause in there at the time. At the time of the deal, it was not the policy to have refinancing clauses in. What I am saying is that we have alternative means in the contract. One is the value for money review at the 15-year point, which could involve anything, including refinancing. The other one is that if the company wants to seek refinancing, we effectively have the right then to set conditions which include a share in the refinancing if there is a benefit.
12. Is that right, Mr Webber? If Modus want to refinance the project, can MOD share these benefits?
(Mr Webber) Yes, is the short answer. If we sought to replace the existing debt with more debt, because of certain clauses in the agreement, I am sure we would have to come to the Ministry of Defence and ask for their approval to changes in the contract. As seems to be the practice in other PFI projects at present, that would give us an opportunity to renegotiate that part of the transaction.
13. This Committee has often in the past expressed concern about refinancing. So you have this commitment to contracted expenditure for 30 years. You have an increasing number of these sorts of commitments. Will that constrain your ability to be flexible in managing the defence budget in future?
(Sir Kevin Tebbit) No, Chairman. At the moment we have about 43 PFI projects in defence with a value of about £2 billion of finance brought in. The servicing of that represents about 3% of our budget. Coming down the pipe are a similar number of projects which would add about £12 billion capital coming in, if they all happened. That would bring us up to about 8 %. We are not at a silting up point.
14. We would not be in a position where you are in hock for 30 years and you cannot afford the ships and soldiers you need because you are paying for Offices? Would you say that was an over-simplistic question?
(Sir Kevin Tebbit) I would not quite put it as being in hock either. I come back to the fundamental point: this represents best value for money for delivering the services we need to run the Armed Forces worldwide and to run defence policy.
15. Before I hand over, I should like to welcome the Financial Secretary to the Treasury to our proceedings, she is of course a member of this Committee, but I do not think she wants to ask any questions. She is here as a courtesy visit.
(Sir Kevin Tebbit) We are a supporter of her policies.
Chairman: She has other duties to attend to in the Treasury, so she will be having to leave us, but I do welcome you to the Committee. Thank you very much for coming.