16. You told us just now that the MOD is a very tough negotiator and as a result of this you managed to reduce the price by £4 million on the day of the contract by pointing out that otherwise the contract would not come in below the public service comparator. If you are such a good negotiator why had you not been able to bring down the price by £4 million even before then?
(Sir Kevin Tebbit) I did not personally negotiate it, but I think one would say that the pressure of the negotiation was at its greatest in that last day, as negotiating pressures usually are. We were not exactly up against a deadline but we made it clear that we were expected to come out of that with a solution.
17. Why did you not demand a greater reduction?
They seem to have been perfectly happy to give you £4 million on the spot.
(Sir Kevin Tebbit) I think you will find that assumption unfounded. They were not happy to give us that £4 million; they are still talking about it today.
18. Are you convinced that £4 million was an absolute maximum you could get out of them at that time?
(Sir Kevin Tebbit) Yes, in that area of the negotiation. Of course there was a lot more in the negotiation than just that. There were all the various other conditions affecting performance, for example. In terms of the cash, I am satisfied our people got the maximum they could at that point.
19. My understanding is that the increase at the last moment was due to an increase in rates, not least because everybody knew that a big deal was about to be done, so the rates went up.
(Sir Kevin Tebbit) Yes.
20. What would have happened if rates had gone up at such a rate that you had gone £6 million over the public sector comparator? Would you have dropped the deal on the grounds that the public sector comparator was then better and if you could only get £4 million out of them it would still have been £2 million above the public sector comparator?
(Sir Kevin Tebbit) I cannot be that precise, but you are quite right, the on-the-spot rates were moving during that day and we were not the only Department which got caught by that increasing price. A number of other PFI deals got caught at the same time. Placing £0.5 billion of loan in the market does have that effect unfortunately.
21. So you are telling us that the Government decided to put a whole lot of contracts out to the market on the same day, in spite of the fact that this was likely to raise rates and therefore raise the price for the Government. Was that not a bit daft?
(Sir Kevin Tebbit) It was not actually the same day; another one came shortly after.
22. I am sorry, I thought you said the same day.
(Sir Kevin Tebbit) Around the same time. The trouble is that the markets are aware of what is happening within a week or two's timescale.
23. Even that is a bit daft, is it not? If the Government are going to put out these huge contracts and they are going to make a difference to market rates, you would think they had the sense to put them out at different times, so you do not suddenly have a huge amount of debt coming onto the market which was going to affect rates rather more?
(Sir Kevin Tebbit) That is a pretty sensible conclusion. This was the biggest loan that we had sought to raise in PFI. It was a pathfinder project. The one which came afterwards was a hospital. There are other considerations about when one needs to go to the market; that is not the only factor.
24. If on the day you discover that you are, for reasons of rates changing or whatever else, above the public sector comparator, do you then decide that you will not go ahead? Are you that tied by the public sector comparator that you cannot go ahead even if you are above it?
(Sir Kevin Tebbit) No, not at all, it is within a broad band. The public sector comparator has a wide range of about £100 million. There is no absolute magic about this, no. We used that figure in order to negotiate down the price. It was not otherwise absolutely critical.
25. So you were fooling them in saying that you had to get it down below the public sector comparator otherwise you would not go ahead.
(Sir Kevin Tebbit) It was a tactical point.
26. I congratulate you on fooling them because you got the price down.
(Sir Kevin Tebbit) It was a tactical point.
27. With the Treasury building we were told there was some sort of a funding competition to get the best way of funding the deal. Why did that not happen with this building?
(Mr Hoyle) The Treasury was the first project to run a funding competition and in fact they were trialing it with their project and we were running slightly ahead of them in terms of when we were going to sign the contract. It had never been done before. It would have been wrong to run a project with a £550 million placement as a trial of a funding competition. If we were starting now, we would learn the lessons from the Treasury and go down that route.
28. I am sorry, why was it the wrong project to start on?
(Mr Hoyle) Because it was just so big in comparison with the Treasury; the amount of money to be raised was about four times more.
29. So there was that much more to save than the Treasury.
(Sir Kevin Tebbit) The advice we had at the time in connection with the Treasury competition was that something of our size would bring diseconomies if we tried to do it by the same method and have that sort of competition. Theirs was £125 million: ours was £550 million. A much greater risk associated with a flotation of that size.
30. I am sorry, I do not quite understand. Are you saying that there would be a greater risk of running a competition than not running a competition? Are you saying that you would risk having to spend more by running a competition?
(Sir Kevin Tebbit) The advice we had was that it was much more sensible to go for a bank finance rather than a bond finance or a competition on bonds because the size of the financing for our project was so large that there would be diseconomies of scale if we tried to go for a bond.
31. That decision was what made all the difference to whether or not you would go for a competition. Had you gone the other way and gone for a bond you might have gone for a competition.
(Sir Kevin Tebbit) No, that was not why we did not go for a competition. We did not go for a competition because it was such a big flotation that the judgement was that this was not the right sort of size of thing to do as the experiment, whereas the Treasury was much smaller and therefore more susceptible to trialing.
32. I am not quite sure I understand the logic behind not trialing it just because it is big when you have greater potential savings when it is big. I can see you see some logic in it. If the difference between bank and bond financing is so marginal, do you always have to take a decision long before the moment of truth as you are signing the contract or can you go forward with the two potential methods of financing the deal and choose when you know which is better on the day?
(Sir Kevin Tebbit) We do use bond now rather more regularly as these things are becoming more normal. The choice between them varies according to project and varies according to market condition. There is no absolute rule as to whether to go for one or the other.
33. That was not the question I asked. What I asked was: do you leave it until the actual day to make that decision when you know which is going to be the cheaper?
(Sir Kevin Tebbit) You have to offset against that the extra cost of running two plans in parallel because you have to do the legal and the due diligence work for both and therefore there would always be a trade-off between those if you were trying to do it like that. I am not sure, I cannot say, whether the cost of running two routes together with the due diligence associated with both would outweigh whatever benefit there was between bank or bond but that is the calculation one has to make.
34. In future you would always make that calculation.
(Sir Kevin Tebbit) We often do; I cannot say we always do.
35. Did you make it in this case?
(Sir Kevin Tebbit) No, I do not think we did. We knew that it would be very expensive to do due diligence for both routes and it was quite clear that those who would put the money up wanted clarity as to what we were intending to do. In this case it would have been very expensive to have tried to do both.
(Mr Hoyle) The risk of raising the finance actually rested with Modus. So strictly it was their decision as to whether at that time under policy we went bank or bond. They came to us with a recommended solution which we examined and decided in June 1999 that we would prefer bank for a number of reasons. To have gone beyond that point running both meant there was a strong chance that the bond arrangers would have walked away anyway because of the expense to them of employing lawyers to do the due diligence on the contract and technical due diligence on the project which would have cost them substantial sums of money unless we had been willing to recompense them.
36. My understanding is that in the end the bond probably would have been rather cheaper on the day as it turned out. Have you done any calculation of whether you could have saved money if you had gone through the necessary legal processes to make it possible still to go for a bond on the last day?
(Sir Kevin Tebbit) At the time of the decision it was the right choice. I do not know whether we did any subsequent calculations.
(Mr Hoyle) We have looked at what might have been, the hypothetical scenario. We think the saving, if we had managed to maintain the same terms and conditions we had achieved with banks, if we had managed to transfer those conditions to the bond arrangement, would have been a few million pounds. The NAO Report refers to the hypothetical scenario that if we had had the GCHQ terms and conditions the saving would have been of the order of £22 million. But that is a greenfield site with a different risk profile.
37. Turning now to paragraph 6, whose last sentence is, "In addition, there will be significant unquantified benefits to working efficiency arising from the improved accommodation", how do you judge a project if you have no idea of how great the benefits are going to be?
(Sir Kevin Tebbit) These were not benefits which we sought to bring into the value for money equation. They were just general efficiency benefits from co-locating staff in one building rather than more and working in more open plan environments for team working and shortening the distances between working areas and lifts and that sort of thing. We never attempted to put a financial value on that because it is a very soft concept. Nevertheless, I am very satisfied that we are going to have much more efficient use of the new building. We did not try to capture it financially because it would have been impossible to justify any particular figure we put on it.
38. Let me turn to paragraph 1.26 where the sentence at the bottom of page 13 reads, "In addition, MOD did not transfer IT risk to Modus for the decant buildings as it did not know when procuring the contract how many different systems were extant". I do not know whether I have misunderstood this, but that seems to say that the MOD did not know how many computer systems it had. Is that right?
(Sir Kevin Tebbit) No. We have all the IT trunking and cabling up to the desks, as it were. What we have not done is decided precisely what type of system goes on the desktop, the hardware, the software. That is because that will need to be linked to our overall defence information infrastructure which we are developing separately. At the time the contract was crystallised, we had not got a clear enough view of that and with technology moving so quickly, we did not want to capture it at that stage. So we carried on doing that separately.
39. The IT systems you did not know were around, were future IT systems. Is that what you are saying? Or you did not know how many systems you had at that time.
(Mr Hoyle) At the time we were putting together the specification there were of the order of 200 systems in the Ministry of Defence headquarters. If we had specified that number to be moved, we would have lost money because in the end we actually only had to move 90 systems into the decant buildings because some became redundant.
40. Why did you not try to find out how many systems you had which would need to move?
(Mr Hoyle) They are owned by various agencies within the Department. Some of them are stand-alone system, some of them are wide area networks, some of them just became time expired and we did not know whether they would need to be replaced. We were looking at this in 1996-97 and with the way IT systems move forward, with technological change, it would have been a guess in the dark as to how many systems we would need to move in 2004.
41. I want to couple this with paragraph 1.21, where we are told ". . . a month before the contract was signed, MOD . . . identified that there were up to 1,000 non-Head Office staff who should remain in London. Some of those, however, would have had no accommodation after 2002" had there not been some change to the plan. It does strike me that you were going ahead with this major project, without knowing exactly what IT you had, without knowing exactly what staff you had. There seems to be a dangerous lack of information on which to base a major project.
(Sir Kevin Tebbit) We knew what IT we had. The point was that we did not know precisely what IT configuration we would require in 2004.
42. But you could have discovered before going ahead.
(Sir Kevin Tebbit) No, we could not; not in 1997-98. We could not have predicted at that point the IT configuration which would be best for the Department in 2004 so we decided not to incorporate that element. We are doing that separately as part of a wider defence information infrastructure because Head Office needs to be linked to all its operating agencies and budget areas. As far as staff numbers are concerned, the Report implies that we suddenly discovered these 1,000 people. They were always there. These were not Head Office people.
43. This is an agreed report and therefore presumably it is true, you accepted that you suddenly discovered the 1,000.
(Sir Kevin Tebbit) The word is not "discovered". These were not Head Office staff, these were staff where we decided at that point that we would keep them in London because that is the best place for them although they are not Head Office. It is mainly the Defence Export Services Organisation. It became cost effective to take St Giles Court, a third building on a different basis than before and cheaper than trying to build it into the Main Building contract.
44. Given what you have said about the number of Government contracts going ahead at the same time, what are you going to do in future to make sure there are not a large number of Government contracts going ahead more or less at the same date and therefore raising rates unnecessarily at the last moment?
(Sir Kevin Tebbit) That is not for me exactly. It is helpful that we now have an Office of Government Commerce that Peter Gershon is running which does co-ordinate the various activities which different Departments are engaged in, which helps a lot. I do have to come back to the point that the Project Director mentioned. At the end of the day, it is the contractor who is borrowing the money, not us, the PFI partner. This is also something which has to be borne in mind with them. The Office of Government Commerce does help in this area now.