1 Departments should obtain unambiguous arrangements for their approval of, and compensation for, increased termination liabilities.
This was stressed in the OGC's guidance for existing contracts issued in November 2000 and in its guidance for new contracts available in draft from autumn 2001 and published in July 2002.
2 Departments should take early legal advice when developing PFI contracts to limit their exposure to increases in termination liabilities.
This is for departments to consider, although the revised OGC guidance stresses the need for departments to have the right to generally approve increases in termination liabilities.
3 PFI deals should not permit perverse incentives which might tempt the private sector to cut and run. Departments should assess the risk of contract termination and should devise a pattern of rewards and penalties which continue to incentivise the consortium throughout the period of a PFI contract.
The revised OGC guidance published in July 2002 says that, when evaluating a refinancing proposal, authorities should consider carefully whether it could reduce incentives for the contractor to achieve sustained service standards, particularly in later years. In our view, however, there is in the new guidance a possible risk of a perverse incentive in respect of the arrangement that allows contractors to retain refinancing gains if their profits have been less than those expected when the contract was let. This could reduce their incentive to perform well, as payment deductions for poor performance could be recouped from subsequent refinancing gains. Both the OGC and PUK consider that there is a low risk of this risk materialising and that underperformance by a contractor would reduce the opportunities for refinancing.
4 When assessing alternative PFI bids, departments should take into account the various revenues that shareholders of a consortium can earn from a PFI project, the likelihood of a refinancing occurring and how this may affect the balance of risk and reward, for both the department and the service provider.
The revised OGC guidance says that refinancing is likely to be a matter for consideration by authorities at different times during the life of a PFI project, including when appraising bids. The guidance also makes various references to the effect refinancings may have on both risks and rewards.
5 Departments should make appropriate use of experienced advisers in developing, and participating in, refinancing negotiations.
The revised guidance says that it is very likely that authorities will need to seek the assistance of appropriate external advisers to ensure that the guidance is properly reflected in contract documentation and to assist with any negotiations with the private sector on proposed refinancings.
6 The Treasury should aim to anticipate future issues where departments may require guidance and should consult experts and the National Audit Office about emerging issues where central guidance would be helpful.
There is a close working relationship between the Treasury, the OGC and the National Audit Office on PFI matters. The National Audit Office is regularly consulted about areas where new central PFI guidance would be appropriate.
7 The Treasury and OGC should complete their planned updating of the central guidance on refinancing as a matter of priority (the PAC's recommendation was made in March 2001).
The OGC's revised guidance for new contracts was available to departments in draft from autumn 2001 and was published in final form in July 2002 (the OGC had already issued new guidance in respect of existing contracts to departments in November 2000). Completion of the revised guidance for new contracts was a priority for the OGC. However, completing the guidance took longer than the Treasury and the OGC had initially expected, because of the many complex detailed issues that the OGC had to consider and the consultation process that was necessary with both departments and the private sector if the new guidance was to have general acceptance in the market.
8 The benefit of improved financing terms that are likely from the successful delivery of the project may be secured through the pricing of the deal or through a share of the subsequent refinancing gains.
This is reflected in the revised OGC guidance on refinancing, which recognises that departments may receive their share of refinancing gains either in a cash sum at the time of the refinancing or by a reduced unitary charge. The guidance also provides for situations where a contractor explicitly offers a lower bid price so that refinancing gains can be captured in the pricing of the deal; in this situation, the subsequent refinancing would be exempted from the gain-sharing arrangements at the time the refinancing is effected.
9 Windfall refinancing benefits that have not arisen through a higher than expected standard of service from the private sector should be shared between departments and the private sector. This will have no impact on the pricing of deals, because deals will not have been priced in anticipation of windfall gains.
The OGC's revised guidance for new contracts expects most refinancing benefits to be shared 50/50 between departments and the private sector. It is also seeking to obtain the right for departments to generally receive 30 per cent of the refinancing gains on those existing contracts that did not give the departments an explicit right to a share of refinancing gains. The OGC will be monitoring whether these arrangements have any impact on the pricing of PFI deals.
10 All departments must give careful consideration to refinancing issues when they develop contractual arrangements with PFI consortia, taking account of the lessons from the Fazakerley prison refinancing and further Treasury/OGC guidance.
The OGC has been in regular contact with departments during the development of the new guidance. The evidence that 75 per cent of contracts let since June 2001 had 50/50 sharing arrangements indicates that most authorities have been adopting the new policy on sharing refinancing gains. Only 24 per cent of project teams, however, had read the PAC report and 38 per cent the NAO report on the Fazakerley prison refinancing, which suggests that more should be done to disseminate the refinancing lessons from these reports.
11 The National Audit Office should carry out a further analysis at the end of 2001 of the extent to which PFI contracts allow departments to share in refinancing gains.
This analysis has been carried out as part of this examination - see paragraphs 2.25-2.26, Figure 12 and Appendix 3.