12. Mr Gershon, you have described this report as a useful wake-up call. As far as I understand it we are 400 contracts and £100 billion down the road. What happened to your alarm clock?
(Mr Gershon) I described it as a wake-up call in terms of helping to focus attention on the importance of contract management, not in the sense that it is not happening today. It is, but it is a very powerful reminder that we need to continue to maintain and strengthen the focus on this area. That is entirely consistent with the remit of the OGC which was created in April 2000 to look at procurement in a whole life sense from cradle to grave, whereas historically procurement much more closely followed what happened pre-award. The Gateway process is a demonstrable example of how we have introduced a technique to support that whole life approach. I use this term in the sense that anything of this nature which helps draw to the attention of top management across the Civil Service to the importance of these disciplines I regard as being entirely helpful to my cause.
13. You do? Do you not regret that they were not there before?
(Mr Gershon) Of course I do.
14. Are you not alarmed? For example, if I look at page 11, in banner headlines in the last column it says "Value for money mechanisms are needed". How is it that they are still needed at this stage? You yourself said that you are not actually monitoring; you are getting some information, but there seems to be no scientific assessment of value for money. Indeed, in the NAO report it is impressionistic whether it is good value for money or not. There is no empirical evidence here that it is good value for money. It is just the contractor saying it is good value for money and the people who enter into the contract say it is good value for money, but neither of them are going to throw up their hands up and say, "We got it wrong", are they?
(Mr Gershon) What this report is looking at is what has happened over time between contract as contracts move into their implementation and operational service phase.
15. No, no. The question is value for money. All we have here is impressionistic analysis of the views of the authorities and of the contractors on whether it was good value for money or not. You agreed this report.
(Mr Gershon) Yes.
16. If it does say value for money mechanisms are needed you must agree with me and with the report and with your department that indeed they are needed. Why are they so slow in coming?
(Mr Gershon) As standardisation and advice and guidance affects more and more of the contracts they will include mechanisms for determining the ongoing value for money during the life of the contract. I referred to one example and, if you recollect, I was last in this room with Sir Andrew Turnbull when we looked at GOGGS. That has in it, for example, the provision at various points in the contract to re-complete the soft FM aspects of the contract which provides a real test as to whether that aspect of the contract is continuing to provide value for money.
17. You quoted one example out of a hundred. You have agreed that there is a need, a gap, for mechanisms. Either you agree there is a gap or you do not. If you do not agree why did you sign up to the report?
(Mr Gershon) If you look at the text that underpins this it highlights what authorities are already doing.
18. Yes. That is what they are already doing but it says more are needed.
(Mr Gershon) Yes.
19. But it is 400 contracts. You quote one example.
(Mr Gershon) You are assuming that in 400 contracts there are no value for money mechanisms in place. That is not the case. In a number of instances mechanisms such as the re-competing of the soft FM contracts may not yet have been triggered because insufficient time has passed in the life of the contract because typically that will happen at the five or seven year point.
20. That would sound more impressive if it were not for the other side of the page. If you look at page 10, second column, again in banner headlines which you have signed up to it says that further understanding is required of the returns contractors earn. If you do not actually understand the returns they earn how do you know whether they are giving you good value for money or not? It just reinforces what I have said about the value for money inadequacies.
(Mr Gershon) I am sorry, I do not agree. Firstly, this does not say that there is no understanding today of what contractors earn. It says there needs to be further understanding, but the critical test of value for money if you run a competition is-
21. You are misunderstanding me. We have £100 billion already committed and you do not even have any meaningful information to give this Committee on rates of returns for contractors. Let us give you an example we had a little while ago when we were dealing with the prisons in the last Parliament. The contract-was it for Fazakerley, or was it Parc, Sir John?
(Sir John Bourn) Fazakerley.
22. The contractor said that they required a 50 per cent premium on their normal rate of return for a prison PFI contract, 50 per cent on top of what they would normally expect with a conventional building contract. That seems somewhat obscene.
(Mr Gershon) That was a very early prison in a very novel market where for the private sector there would have been very significant risk. As the market matures that risk declines and you would expect therefore the rate of return that a contractor expects to decline. This was against a background that in the history of public sector procurement in areas like prisons there were significant cost and time overruns on which the contractor was being asked to take the risk as it moved across from the public to the private sector.
23. They were making so much profit on their existing PFI contracts that they were using the profit to invest in new PFI contracts because they were such a good deal. Let us take it a stage further. We at that time also, and this is dealt with here, discovered that they had made significant bonus profit as a result of re- financing. I tabled a question and Sir John and his colleagues very kindly prepared a memorandum based on the questions I tabled to every department. Out of a relatively small proportion of these 400 contracts they found that in only 15 percent1 was there any understanding to share in re-financing profits. We well understand how they arise. The risk is early on- borrow short and high interest rates at the beginning. When the income flow comes in as you get to the building phase you have got the income flow and you now go to a lower rate of interest and longer term borrowing. That is predictable. It was in some of the early contracts in relation to railways but it was not in the later ones. Where was the monitoring of that? Where was the value for money there? Why did Treasury in its guidance tell departments and authorities that they were not to seek any share in re-financing windfall profits? It is in the report and it was in their guidance. They, you were told, are now re-writing that guidance. Is it re-written yet and what is the outcome?
(Mr Gershon) If I can clarify the position on that, in 1999 we alerted departments to the issue of re-financing and said it was an issue that they needed to take into account. Last year we issued further guidance to departments on the subject of re-financing. The revision of the Standardisation of PFI Contracts that is currently out for consultation, and which we expect to publish by next March, explicitly steers clients towards a 50-50 share of re-financing gains and approval of all re-financing.
24. You have got there after all this time. Oh, no, you have not got there because you still have some consultation. We do not know, as it is only out to consultation, that that is what the guidance will state at the end, do we? It is conceivable if you do not get the results you want in the consultation that it may not happen. You have not exactly been expeditious.
(Mr Gershon) It is also the case that if the OGC is now consulted by departments on the subject of re-financing and for a new contract they get a very clear steer in advance of the revision of standardisation which is 50-50.
25. There you are. It shows that some of the shouting that government departments get in this Committee does at least achieve something. Let us move to the contractual side. I am in favour of PFI but I want it to work properly. I want it to be a good deal for everyone. I want contractors to get a reasonable rate of profit but I want the taxpayer to get a reasonable deal. I have no objection in principle, unlike some people, to the PFI notion. I want it to work effectively. On risk transfer how much further ahead have we gone since we ran into the nonsenses we had with the Passport Office and so on when they incurred costs of £12.5 million as a result of the failure of Siemens, and that two weeks before a hearing here, they were only able to get Siemens to pay £2.5 million towards the losses? That did not seem much of a risk transfer. The fault was mainly that of the company and its computer system and yet the costs were borne by the department. Are we advanced on that now?
(Mr Gershon) I think there is a much better understanding amongst public sector clients that there are certain aspects of the risk that cannot be transferred, particularly the ultimate responsibility for delivering a public service. As risk management techniques develop within the public sector-and the understanding that there is a retained risk-that is sharpening up focus as to what sort of risks you can sensibly seek to transfer to the public sector, and those that you have to be mindful to retain in the public sector and that should influence how you select and manage your private sector contractor. I am very mindful of the report that came out recently from this Committee about its hearing on the NAO report on risk management where what you advocated was that in the selection of partners (not just private sector partners but also other partners) clients need to understand and satisfy themselves about the risk management systems in their partners. That is certainly one of the things that we take on board. We do not necessarily use the same language but if you look at the guidelines around the Gateway review process that is one of the things that is tested by these independent reviews. We are also in the process of developing enhanced guidance for accounting officers about seeking value for money in complex procurements, not just PFI but PFI is a good example of a complex procurement, and we have factored in that aspect about looking at risk management systems in that advice. You would say, "Bloody slow; they ought to be doing it faster", but-
26. In slightly more delicate language that is exactly what I would have said.
(Mr Gershon) In our pedestrian way we are slowly but surely trying to get to where you would have liked us to be a long time ago.
Mr Williams: I think you have successfully talked me through my 15 minutes so I give in at this stage.
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1 C&AG's Report, figure 8, p 13. An earlier memorandum, summarising the answers to Parliamentary Questions in July 2000, showed that 24 per cent of 105 PFI contracts listed by departments included arrangements entitling departments to share in refinancing gains: The Refinancing of the Fazakerley PFI Prison Contract, 13th Report from the Committee of Public Accounts (HC 372, Session 2000-01), Appendix 3, para 5.