10. The provision of equity finance enables projects to be financed where there are risks which the providers of debt finance are unwilling to bear. As a result, the providers of equity finance should bear the risk of losing some or all of their investment if the project does not go well and should expect to earn more than the returns to the providers of debt finance if the project is successful.
11. As the PFI market has matured it has become quite common for the initial investors in PFI projects to sell their investments, either to one of the initial investors or to new investors in the emerging PFI secondary equity market (Figure 3). The Treasury has always anticipated that some PFI investors would only invest for the short term and that they would make profits if the projects were performing. For example, the contractor Carillion had sold some of its PFI investments which had cost £24 million for proceeds of £46 million. The Treasury acknowledges that the early PFI deals gave investors the potential to make these types of gains but the deals had been priced on terms available at the time reflecting the risks of a new market.10
Figure 3: Incidence of PFI share sales
| Number of projects
| % |
Within one year of contract letting | 1 |
|
One to two years after contract letting | 2 |
|
Two to three years after contract letting | 4 |
|
More than three years after contract letting | 25 |
|
| 32 | 40 |
Share sales have not occurred | 48 |
|
Total | 80 | 100 |
The National Audit Office asked all 123 PFI projects which it had surveyed for the purposes of the C&AG's Report whether there had been a share sale. 80 projects responded to this question. |
|
|
Source: C&AG's Report, Figure 15, page 29
12. Unlike debt refinancing where the Treasury requires investor gains to be shared with the public sector the Treasury does not require investors' gains on selling equity in PFI projects to be shared with the projects. They take the view that, whereas a debt refinancing affects the public sector's rights and interests as a purchaser, a change in the equity ownership of the project is a transaction outside the project which does not affect the public sector's interests if the PFI equity market is operating efficiently. As equity investors take the risk of incurring losses on their investments, they might also seek higher equity prices in new PFI contracts to compensate if they were required to share equity gains. An alternative would be for the government to take an equity stake in PFI projects to enable it to share in the equity profits, but this would also expose it to the financial risks of the project failing.
13. The achievement of value for money in a long-term market depends, to a large extent, on competition and improved terms as the market matures. The large investor returns which arose on some early PFI deals showed that there was the potential for improving the pricing of deals. Better prices are available on current deals, although the introduction of new sources of capital through the PFI secondary market funds creates the possibility of further reducing the cost of equity finance through increased competition between investors for new PFI contracts.11
14. There is, however, a potential risk that, if the current trend for some large contractors and secondary market funds to build up portfolios of PFI investments continues, then some investors may come to dominate the market. Other parties might then be discouraged from entering into bidding competitions for new contracts and, without publicly funded projects to act as a benchmark, it would become difficult to demonstrate that value for money was being achieved. The Treasury acknowledges that reduced competition would be a concern, but believes that the market remains competitive between around ten large contractors and secondary market funds.12
15. Where an equity investor is involved with a portfolio of PFI projects there may be the opportunity for further benefits from greater operating efficiencies. There is the potential for such efficiencies to benefit the pricing of both current and future deals. Investors, however, will not all have the same approach to managing PFI projects. Some investors may place greater emphasis on earning short term gains which might not be consistent with sharing benefits with the public sector. The public sector cannot determine who the investors should be, so it is important that the public sector understands how the aims of their PFI investors may impact on the projects.13
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10 C&AG's Report, paras 3.1-3.3; Qq 102-104, 109-122
12 C&AG's Report, para 3.9; Qq 47-54