11 The financial model used to estimate returns is out of date. The financial return to the taxpayer from such a long term land deal is inherently uncertain and is affected by factors including the timing of development and economic conditions. As a result, it is important that EP regularly assesses the impact of changes on expected taxpayer returns by using an up-to-date financial model. The current best estimate derives from a financial model which is now out of date in that it does not reflect the current phasing and timing of development. EP and MDL have been working since end 2006 on a new more sophisticated financial model for estimating the return, but are still in the process of agreeing it, because of the complexity of the model and the contracts on which it rests.
12 Current estimates of the taxpayer's expected return from the deal, though unreliable, show a reduction of £45-60 million compared to initial forecasts. Subject to the caveats in paragraph 11, the current best estimate shows a forecast reduction of between £45-60 million (depending on assumptions about the appropriate discount rate) from the forecast net present value of £216.4 million calculated at the outset of the deal. While it is impossible to be precise about the reduction in value based on the current financial model, delay to the housing development has eroded financial returns, since the present value of future income is lower when received later in time compared to income received earlier because of the time value of money and the greater risks involved.
13 The structure of the deal means that delays have a greater impact on the current estimated returns to the taxpayer than those of the private sector. The terms of the contractual agreements mean that the bulk of EP's returns are generated later in the deal. Delay, therefore, has had a proportionately greater impact on EP than on MDL. EP receives minimum land value payments upfront and most of its profits later in the life of the agreement. In negotiating the deal, EP weighed the arguments for deferring or advancing its share of the profits. Deferring its share would mean that EP benefited if property values rose over the life of the agreement. Advancing its share, by contrast, would mean that EP was less exposed to downturns in property values and delays. EP judged that deferring its profit share was in the interests of the taxpayer, taking into account expected changes in property prices and the need for all parties to have confidence in each other's long term commitment. Without formal levers in place to accelerate the pace of development, EP has, however, had to rely on its influencing and brokering skills to ensure that the project is as profitable for the taxpayer as was first anticipated.
14 EP has started to clarify the detailed operation of profit sharing arrangements on the O2 Arena. EP is entitled to financial returns from The O2 Arena and Waterfront. Following commercial advice in 2002, EP did not take these potential returns into account when appraising the deal. The Committee of Public Accounts recommended in 2005 that Departments should attempt to quantify the likelihood and nature of such upsides to help maximise potential additional benefits to the taxpayer. EP considers that undertaking this exercise before now would not have provided meaningful data as The O2 has only been operational since June 2007 and nor would the timing of the exercise impact on the level of its profit share entitlement which is governed by legal agreements. EP has begun to agree with AEG the practicalities of accessing information and calculating the profit share. The legal agreements provide for full access to the records and accounts of the tenant company, an AEG subsidiary, through which The O2 business is wholly conducted. The legal agreements also contain protection provisions to ensure intra-group costs are validated and relevant records and accounts are provided. EP does not, however, have explicit legal access to the records and accounts of the AEG Group and it is not clear whether it will be difficult in future to access all relevant information to scrutinise and, if necessary, challenge the allocation of costs.