Recommendations referring to the Public's share in refinancing gains

Recommendations referring to the Public's share in refinancing gains
Recommendation	Report Source	Treasury response on the extent to which action has been undertaken in order to meet the recommendation1
1 Departments should set out unambiguously in their PFI contracts the circumstances in which they would be required to consent to part, or all, of a proposed refinancing. These should include any situation which may have adverse consequences for departments, for example by increasing their termination liabilities.	1 NAO	This requirement has been present in the standardisation of PFI contracts since July 2002.
2 Departments should share in benefits that will arise through the successful delivery of a PFI project.	2 PAC	Sharing arrangements have been present in the standardisation of PFI contracts since July 2002.
3 Early on in the procurement process, when preparing an Invitation to Tender and when developing the PFI contract, departments should give careful consideration to refinancing issues. They should address whether they should establish within the PFI contract the right for them to share in refinancing benefits.		Sharing arrangements have been present in the standardisation of PFI contracts since July 2002.
4 Given the scale of the improved benefits that have accrued to the consortium from this refinancing, the Service should have sought a more reasonable balance of risk and rewards for both the Service and FPSL. The gains should have been shared more equitably between the consortium and the Service.	2 PAC	All projects signed before 30th September 2002 that do not have specific sharing arrangements are now subject to a voluntary sharing arrangement, "Refinancing of Early PFI Transactions Code of Conduct". The code specifies that gains will be shared 30/70 in favour of the contractor. Projects signed after this date are subject to the gain sharing arrangements in the standardisation of PFI contracts where gains are shared 50/50.
5 The experience of privatisations shows that in some cases private sector investors have made much higher returns than they ever imagined. We advocated that such unexpected gains should be shared. Windfall refinancing benefits on PFI projects which have not arisen through a higher than expected standard of service from the private sector should similarly be shared between departments and the private sector. Because deals will not have been priced in anticipation of such gains arising, the prospect of sharing the gains between the public and private sectors will have no impact on the original pricing of the deals.	2 PAC	Gains made (other than from a level of service that is higher than expected) from refinancing a PFI transaction are shared with the Authority by reference to the rate of return to equity predicted in the opening financial model. It is more difficult to say that there is no impact on the original pricing of such gains. There is certainly no empirical evidence from the experience of Authorities that pricing has risen but there is anecdotal evidence that primary equity returns have remained static when a maturing market would otherwise assume a deeper and more progressive decline in returns.
6 We look to the National Audit Office to carry out a further analysis at the end of 2001 of the extent to which PFI contracts allow departments to share in refinancing gains so that we can monitor progress on these important issues.	2 PAC	This is covered in this current NAO report on Refinancing.
7 Departments should obtain from their contractors sufficient information about their financing to ensure that they are aware of all refinancings for which the benefits should be shared. This information should be sufficient to enable departments to be aware of any significant changes to a project's financing structure and to understand whether or not such changes will create refinancing benefits.	3 NAO	The standardisation of PFI contracts has introduced the obligation on the contractor that many elements of a refinancing now require the consent of the Authority. Failure by the contractor to disclose a qualifying refinancing will lead to termination of the contract with limited and unattractive compensation for the contractor.
8 Departments should gather sufficient information to assess whether their refinancing arrangements are increasing value for money to the taxpayer. This needs to take account of any effect refinancing gain sharing arrangements may have on the pricing of contracts and on incentives to contractors to perform throughout the contract period. The OGC should gather feedback from departments on these matters to enable it to assess the effectiveness of the new approach to refinancing that has been adopted across government.	3 NAO	The Treasury supports the Committees' recommendation. Departments have an important role to play in determining value for money in refinancing. We are not aware of the arrangements put in place by OGC following this review but Treasury retain an active dialogue with Departments on refinancing. Departments consider whether the refinancings they approve are value for money in the context of the pricing of their primary contracts.
9 It is a good negotiating achievement for the OGC to have established with the private sector that refinancing gains on past PFI deals should be shared 70:30. In respect of past deals which had not provided for refinancing gains to be shared, individual departments would have faced an uphill task in arguing to share them. Acting for government as a whole, the OGC was successful in its determined approach to the private sector. There may be other aspects of the PFI where a central approach might be worthwhile: for example in respect of the banks' standard terms for external finance of PFI deals, or for associated financial instruments.	4 PAC	The Treasury welcomed the Committees' findings and continues to review all aspects of PFI policy in the interests of value for money for the taxpayer. In this context the Treasury published a wide ranging program of reform in its paper 'PFI: Meeting the Investment Challenge'.
10 The OGC estimated that the new code sharing refinancing 70:30 on past deals will yield between £175 million and £200 million for the public sector. These impacts are a reflection of the previous work of this Committee and the National Audit Office as well as the more recent work of the OGC. The Treasury should measure the actual impacts from departments applying both the code and also the revised arrangements for new contracts.	4 PAC	The Treasury welcomed the Committee's conclusion. The Government continues to monitor the implementation of the Code as part of its wider commitment to safeguard value for money for the taxpayer. In particular, the specialist Refinancing Taskforce has been established with a remit to monitor the ongoing application of the Code, educate departments on refinancing issues and assist them on transactions. To date Government has realised £160m since introduction of the voluntary code, but stresses VfM outcomes rather than gain sharing maximisation, which would otherwise create perverse incentives.
11 A further reason for departments to resist any upward pressure on contractors' prices is the important caveat in the new arrangements: refinancing gains will be calculated after allowing the private sector a return at least equal to what was projected at contract letting. Such a provision protects the private sector from a shortfall in profits, even if due to its own under-performance or failure to project accurately the likely returns from the project.	4 PAC	The Treasury agreed that departments should resist upward pressure on prices as a result of the change in refinancing provisions. The only area where pricing could be effected is in the pricing of junior finance instruments (equity and shareholder loans). This area of finance is particularly competitive and it is very likely that market pressure will continue to ensure that the levels of return achieved on these instruments are appropriate.
12 There is a risk that, if there is a change in ownership of a PFI project company, the new shareholders may not feel obliged to share refinancing gains under the new voluntary code, particularly if they have no interest in bidding for future PFI contracts. Where there is to be a change in ownership of a PFI project company in a case in which the department needs to rely on the voluntary code for sharing refinancing gains, the department should seek from the new owners a written assurance that they will comply with the code's principles.	4 PAC	The Treasury accepted the Committees' recommendation. While changes in ownership may induce new shareholders to the market who are unaware of the voluntary code, the Treasury would point out that the code applies not only to shareholders, but also the banks that would be providing the finance in each case. On this basis, the likelihood of refinancings occurring outside the code for this reason is unlikely, although not technically impossible.
13 The concept of refinancing gains does not apply so clearly to PFI if financing is provided from a contractor's general finances. The Treasury should monitor whether there is an increase in projects which are being funded in this way. It should take action to share refinancing gains in these projects if there is evidence that contractors are increasingly using such funding arrangements to avoid sharing refinancing gains.	4 PAC	The size of PFI projects and the risk transfer involved means that this particular form of financing continues to remain unattractive to contractors, irrespective of the refinancing provisions that may apply. However, the Treasury fully accepts the need to ensure that effective mechanisms are in place to ensure ongoing compliance with the stringent requirements of SoPC in what can be a complex and technical area.