1.16 Contracts without arrangements to share refinancing gains had been concluded by departments on the basis that they would deliver value for money to the taxpayer. This was usually based on the results of a competitive procurement and a comparison with a conventional procurement option (the public sector comparator). But often the initial evaluation was without full information on the possible effect of a future refinancing. Contractors cannot be certain when bidding for a contract that they will be able to refinance the project and have generally not disclosed when bidding what the effect of a refinancing would be. But it has, nevertheless, become a reasonable expectation that many projects will be refinanced assuming they are delivered successfully. As the PAC has pointed out, where a private sector contractor is able, from refinancing, to significantly increase its rewards in excess of those disclosed when bidding for the contract as reasonable for the risks being borne, this can create a perception that there may have been scope at the outset to improve the deal for the public sector. If the prospect of refinancing, and its impact on returns from the project, had been a factor in negotiations at the outset, this might have changed the assessment of value for money at contract letting.
1.17 Following NAO and PAC concerns about the lack of sharing of refinancing benefits, the OGC has made new arrangements for helping departments to share refinancing gains on early PFI deals. OGC drew heavily upon the expertise of PUK, which was set up to assist in such matters, and also received assistance from the Treasury Private Finance Unit. Establishing such arrangements has not been easy, given that in many cases the private sector has been under no contractual obligation to share refinancing benefits. Drawing upon extensive research commissioned from PUK, the OGC evaluated the following options in respect of these early deals:
a) To let refinancings on early deals be dealt with in accordance with each individual deal's specific contract terms. This would generally give departments little or no share of refinancing gains.
b) To encourage public sector project teams to negotiate individually for a share of the refinancing gain on each deal where there was no contractual sharing provision. For example, by using as a negotiating lever any requirement to approve all or part of any refinancing (e.g. where increases in termination liabilities would arise).
c) To draw up a code of practice stating that the public sector should receive a specified share of the gains from future refinancings of early deals; to be implemented by authorities with additional dedicated central support made available to the public sector in the form of a PUK refinancing taskforce.
1.18 All three options would only apply to deals that are refinanced after the OGC reaches agreement with the private sector about these new arrangements and would therefore not re-open deals which have already been refinanced.
1.19 The OGC decided to pursue option c), a code of practice. The OGC considered this would achieve the best outcome for the public sector by using the negotiating power of central government acting collectively, making use of considerable assistance from PUK to implement such a code. This option would also produce an outcome that could be applied consistently to future refinancings of existing PFI contracts and would reduce the need for each project team to spend time negotiating with their contractors over how refinancing gains should be shared. The OGC considers that a voluntary agreement will also minimise the risk of adverse consequences for the PFI market and wider damage to private sector willingness to contract with the public sector for fear of retrospective government action.
1.20 Because many of the early PFI deals do not have contractual arrangements to share refinancing gains, there is no contractual obligation on the private sector to agree to sharing. This meant that the OGC had to discuss with representatives of the private sector a level of gain sharing that would be considered reasonable by both sides.
1.21 The OGC decided to seek a 30 per cent share of the refinancing benefits on these early contracts. The OGC took into account that, although its aim was to seek a 50 per cent share in future new contracts, it would be unreasonable to expect this percentage in existing situations where the contracts did not provide for sharing refinancing gains. It was aware that a 30 per cent share had been built into a number of new contracts in the interim period in 2000-2001 while it was revising its guidance on refinancing and considered that this would be a very good outcome to achieve on the early deals. Early deals previously assessed as value for money but without a right to share refinancing gains would be even better value for money if the public sector obtained 30 per cent of any refinancing gains.
1.22 Following extensive discussions with a range of private sector stakeholders, the OGC launched in October 2002 a voluntary code of practice for early PFI deals. The code was launched with the support of the CBI. Under this code, departments will generally seek to receive 30 per cent8 of any future refinancing gains on early deals where the contract does not explicitly provide for a share of such gains. This applies to all deals entered into before the OGC's arrangements for new contracts to include 50/50 sharing came into operation. If achieved, a 30 per cent share for departments of the refinancing gains on early PFI deals will be a considerable improvement over what the contract terms for most of these deals would have achieved.
1.23 Private sector representatives told us that they had always considered it had a reasonable right to retain refinancing gains on early PFI deals as a reward for taking on the risks of these new projects. Although most early PFI deals had not contractually required the private sector to share refinancing gains, the private sector had entered into the discussions with the OGC about sharing the refinancing gains on these deals in response to strong pressure from the OGC that this issue should be addressed. There was a concern that refinancing gains might create adverse perceptions about the value for money of PFI deals that could damage the PFI market. The OGC has gained the private sector's acceptance that some of the gains from refinancing existing deals should be shared as a way of further developing the PFI market. The private sector recognises the high standards of public accountability that are required in PFI deals. They told us they had sought to be helpful in agreeing to share refinancing gains on early deals but stressed that further clawbacks of profits by the public sector could result in reduced interest by contractors, banks, and other investors in participating in future PFI projects.
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8 Where existing PFI deals have clear contractual arrangements for the public sector to receive a share of refinancing gains then those arrangements will continue to apply, except in certain cases where the contractual share to the public sector is less than 30 per cent and where the public sector's approval for the refinancing is required or where the private sector has sought to improve its returns through other renegotiations of the contract. In those circumstances, the public sector will expect to apply the code to improve its share of the refinancing gains to a share not exceeding 30 per cent.