After a competitive procurement the price of the deal increased due mainly to survey work and increased financing costs

11  MOD ran a competition amongst UK companies; the final stages of the competition were between Modus and the Modem consortium led by Taylor Woodrow. MOD selected Modus as preferred bidder in January 1999 as its price was £42 million lower than that offered by Modem, its solution complied more closely with the output specification, and more closely met MOD's commercial requirements.

12  The deal was closed in May 2000, 16 months after Modus became preferred bidder. During this period the price increased by £99 million (at 2000 price levels). As has been normal PFI practice interest rate risk rested with the public sector until contract signature. Because of interest rate increases, an increased funding requirement as a result of additional capital expenditure and other movements in the financial markets the price increased by around £60 million during this period. £37 million of the price increase arose mainly because further extensive surveys by Modus showed that additional building work would be required as the building was in a poorer condition than anticipated. MOD wanted to resolve the building issues to ensure that Modus would agree to price certainty but took steps to satisfy itself that the additional work was necessary and the price for the work was reasonable.

13  In June 1999, based on discussions with Modus, MOD expected the deal to be closed within four months and accepted that Modus needed to make a final decision on the type of financing to be used if the timetable was to be achieved. As there was little to choose at that time between the likely costs of bank and bond finance, MOD agreed with Modus' proposal that, on qualitative grounds bank finance should be used. These included some uncertainty by MOD as to whether it would be possible to arrange bond finance for such a large deal on terms which would represent value for money at a time when the bond market for PFI deals was less developed than the PFI bank finance market. It also preferred bank finance for a number of other qualitative factors including that it provided greater flexibility to cope with any necessary contract variations.

14  The deal was not closed in October 1999 as MOD had expected. Between this date and the actual signing of the deal in May 2000, MOD chose to continue with bank finance as the method of financing in the absence of a clear case for change.  In hindsight, following price movements in the markets, bond financing may have provided a less expensive financing cost at the time of closing the deal in May 2000. Bond finance might have been between £1 million and £22 million cheaper at that time. But, because of uncertainties surrounding these estimates1 and how the markets at the time would have priced a bond for this deal, such an outcome from using bond finance, in respect of the pricing and timing of the deal, cannot be viewed with certainty. At the time, MOD saw no durable advantage from changing the financing arrangements. Despite the delays, MOD always believed it was close to signing the contract and did not wish to risk further delays. It continued to have reservations about various aspects of bond finance including the terms on which it could have raised bond finance for such a large deal and therefore whether bond finance would be deliverable. MOD also took into account that the possible cost differential in favour of bond finance was not certain to continue until the contract was ready to be finalised and considered it unlikely that the same degree of risk transfer would have resulted. It also considered that bank financing continued to offer other qualitative advantages.

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1  As explained further on page 23, the upper end of this range is based on the saving that would have been achieved had it been possible for MOD to arrange a bond on the same terms as that achieved in the GCHQ Building deal in June 2000. The terms of the Treasury Building bond in May 2000 would also have produced a similar outcome but the terms were obtained on a considerably smaller redevelopement project. There are uncertainties about whether these terms could have been achieved for the MOD Building deal. The lower end of the range would have arisen if the pricing of the deal had had to be amended in a number of ways from the pricing achieved on the GCHQ and Treasury building deals due to the complexity, size, and length of contract.