1 PFI debt refinancing experience

1.  In 2002, following pressure from this Committee, the government introduced arrangements for the private sector to share debt refinancing gains with the public sector. On early PFI deals there is now a code which expects the private sector to voluntarily share 30% of refinancing gains with the public sector. PFI deals signed after July 2002 incorporate a 50:50 sharing arrangement.2

2.  Prior to 2002 the Treasury had outlined in guidance the advantages and disadvantages of departments seeking shares of debt refinancing gains. It had left it to departments to consider in terms of value for money whether to include gain sharing arrangements. Most early PFI contracts did not include such arrangements. Whilst introducing them earlier would have given individual projects greater certainty over the sharing of refinancing gains, the Treasury was influenced by market considerations such as the possible risk that sharing arrangements might affect the private sector's interest in bidding for the early PFI contracts.3

3.  Although the Treasury provides guidance and is responsible for monitoring the refinancing of PFI deals it leaves the commercial negotiations on the detailed terms of the gain sharing to local project teams. Some of the locally negotiated debt refinancings, whilst providing the public sector with the 30% share in accordance with the refinancing code, have allowed the equity investors to achieve very large increases in their returns from the project (Figure 1).4

Figure 1 : Projects with high investor returns following refinancing

Note : These four projects had the highest rate of increase in their investors internal rate of return (IRR) on refinancing from the projects surveyed in the C&AG's report.

Source : C&AG's report Appendix 9.

4.  The Treasury acknowledges these examples of very high investor returns following refinancing but argues that they are balanced by the fact that investors have lost money on some projects. The Treasury also argues that the focus should be on whether value for money is being achieved for the public sector from these deals, pointing to their having generally delivered the right projects for the public sector with a much better record than previous conventional procurement. The examples of high investor returns within a few years of contracts being awarded, combined with added risks for the public sector would, however, suggest that value for money is not being optimised.5

5.  Returns to early participants in the PFI debt market reflected the uncertain risk they were taking on. The very high investor returns on these early debt refinancings have, however, been further enhanced in situations where the public sector accepted, as part of the refinancings, increased risks in the form of higher termination liabilities or extended contract periods. The acceptance of additional risks reflected a lack of commercial awareness by public sector officials at the local level. Although the projects may have been delivered, the full effect of the refinancing will only be capable of being assessed at a later stage in contract periods which will run for 30 or more years.6

6.  The Treasury has a Refinancing Taskforce to advise project teams on refinancing issues which is, however, a limited resource comprising two people. There is no requirement for local officials to seek Treasury approval for the terms of a refinancing deal. The Treasury policy of leaving it to departments to achieve value for money from refinancing failed to prevent situations where investors increased their refinancing gains by passing added risks to the public sector.7

7.  The Office of Government Commerce told us in 2003 that it expected the public sector would receive refinancing gains of £175-200 million from the voluntary sharing arrangements on early deals. When we took evidence from the Treasury in December 2006 the government had only secured the right to receive £93 million (Figure 2, overleaf), of which £60 million had arisen from three hospital refinancings where there had been high investor returns and significant increased risks for the public sector.8

Figure 2 : The government's share of refinancings from the voluntary code for early PFI deals

Notes:

1)  In addition to the 30% voluntary code sharing on the original project debt the authority secured a further 14% of the total refinancing gain relating to gains on additional debt being used to carry out further work.

2)  The average gain secured of 23% on these projects was less than the usual voluntary share of 30% as three projects did not share gains (C&AG's Report, paras 1.29-1.33) and in some further projects the code permitted the private sector to share less than 30% as, prior to the refinancing, the investors had been earning less than their target return.

3)  The £92.5 million includes refinancings, where the government received the right to £21.0 million, which were completed after the publication of the C&AG's report in April 2006 when the total gains for the public sector had been £71.5 million.

8. The Treasury attributed the shortfall in gains secured for the public sector to the OGC 2003 prediction being an uncertain estimate that had turned out not to be correct in respect of refinancing experience to date. The Treasury did not believe that the increasing trend for investors to sell shares in PFI projects had caused a reduction in refinancing activity. But with just four hospital refinancings accounting for most of what the public sector has received (Figure 2), other refinancings may have been deferred as investors can receive part of the value relating to a project's refinancing potential when they sell their shares. The amount that the public sector has received has also been limited because the voluntary code gives it a fixed 30% share even where the investors have earned very high returns with increased risks for the public sector.9

9.  The Treasury has allowed local projects the freedom to decide whether they will take their share of refinancing gains as a lump sum, over the life of the contract period or in the form of services provided by the project company. The Department of Health has required NHS Trusts to take their share of refinancing benefits over time so that the benefit is received evenly over the life of the contract. The private sector, however, will wish to take the gains from refinancing immediately to reduce their risks from investing in the project. The Department of Health acknowledged during our previous examination of the Norfolk and Norwich PFI Hospital refinancing that if a private sector consortium fails financially, a Trust would not be certain of receiving its share of the refinancing gains, whereas there would have been certainty if it had taken the gains as cash at the time of the refinancing.

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2  C&AG's Report, para 1.1

3  Qq 27, 115, 135, 137-146; Ev 16

4  C&AG's Report, Figure 12, page 21; Appendix 9; Qq 31-45

5  Qq 1-3, 97-100

6  C&AG's Report, paras 2.6-2.12; Qq 83, 108

7  Qq 30-40, 42, 55, 64

8  Committee of Public Accounts, Twenty-second Report of Session 2002-03, PFI refinancing update, HC 203; Qq 24-28, 126-129

9  C&AG's Report, para 1.4; Qq 20-28, 77-82, 117, 123-129, 136