1.16 Since its inception, PFI has been used across a broad spectrum of projects. It has become evident over time that significant aspects of PFI need to be reformed. There have also been cases where PFI has been used inappropriately and these projects have failed to deliver value for money to the taxpayer. Some features of PFI have, however, worked well in the past in providing incentives on the private sector to manage risks effectively and to maintain assets throughout their life.
1.17 Government policy has been to use PFI only where it is appropriate and where it is expected to deliver value for money. The cost of financing a project by traditional procurement will inevitably be less than the cost of private finance since the Government can borrow at a lower rate than private sector entities. The economic case for private finance projects has, therefore, rested on achieving better value for money than conventional procurement, through cost savings in the construction and operation of the project; or through the delivery of a qualitatively superior project.
1.18 Experience in past projects has demonstrated that significant aspects of PFI have been unsatisfactory for the following reasons:
• the private sector has made windfall gains on projects, through the refinancing of debt and the sale of equity investment to third parties. This has led to concerns about the value for money of projects;
• there has been a lack of transparency on the financial performance of projects and the returns made by investors. It has also been considered that there has been insufficient transparency on the future liabilities to the taxpayer created by PFI projects;
• there have been poor relationships between the public and private sectors which have hindered effective contract management;
• the PFI procurement process has often been lengthy and costly for both the public and private sectors, on average taking just under three years to tender and close a deal. This has adversely affected value for money for the taxpayer;
• there has been insufficient flexibility during the operational period of projects and, therefore, the ability to make alterations in response to changing public sector service requirements has been inadequate. In 2008, the National audit Office (NAO) concluded that changes to operational PFI projects are often poor value for money1 (see Box 1.B); and
• inappropriate risks have been transferred to the private sector resulting in a higher risk premium being charged to the public sector or an inefficient capital structure, and/or capital reserves being maintained.
| Box 1.B: Making changes to the Avon and Somerset courts project In a 2008 report on Making changes in operational PFI projects1, the NAO highlighted that under the Avon and Somerset courts project an extra 15 per cent was charged by the project company for a major change request. When the procuring authority challenged the project company on where the contract stated that a fee could be charged for a major change, the project company responded by arguing that the contract did not specify that it could not be charged. |
1.19 It is also evident that, too often, PFI has been used on projects on which its application has been unsuitable and has, therefore, failed to deliver value for money. PFI has proven to be unsuitable where:
• the transaction costs of pursuing the PFI route are disproportionate compared to the value of the project;
• fast paced technological changes make it difficult to establish requirements in the long term;
• the nature of the services being delivered do not allow the public sector to clearly define its needs over the long term;
• insufficient attention has been paid to forecasting demand for the asset over the long term. Due to the long term nature of the contractual commitments under PFI it is more costly for the public sector to unwind a PFI project than a conventionally procured project if it is not required in the future; and
• the delivery route has been pursued to secure the budgetary incentives presented by the previous Government's PFI credit regime rather than due to a genuine appraisal of the optimal delivery model.
1.20 However, the evidence has confirmed that elements of PFI can, however, be appropriate for the delivery of major and complex capital projects with significant ongoing maintenance requirements. Here, the private sector can offer project management skills, innovation and risk management expertise that can bring benefits. Features of PFI that can be successful, where appropriately implemented, include the following:
• PFI ensures that buildings are constructed to a high quality;
• assets are maintained to a high standard throughout their life due to the long term nature of the PFI contractual commitments. The public sector has benefitted directly from the private sector's consideration of costs over the entire length of the contract, rather than just the during design and construction phase;
• facilities are completed on time and within budget (see Box 1.C);
• the private sector is incentivised to manage risks effectively. In 2009, the NAO reported that the use of private finance can deliver real risk transfer with a good contract2. Risk transfer has proved successful as the public sector has been protected when projects have gone wrong (see Box 1.D);
• the structure of the PFI payment stream from the public to the private sector allows deductions to be made if the project does not meet the contractual requirements. This means that the public sector can be confident that it only pays for services it receives; and
• output-based specifications have allowed bidders to develop innovative approaches which deliver value for money for the public sector.
| Box 1.C: Delivery to time and to price The NAO's 2009 report, Private Finance Projects2, highlighted that PFI contracts are fixed price and that they impose heavy financial costs on the project company if they do not deliver on time and this can incentivise the timely delivery of projects. In response to a survey undertaken by the NAO on projects between 2003 and 2008, it was found that 69 per cent of projects reported delivery to the contracted timetable and 65 per cent to contracted price. |
| Box 1.D: Jarvis In its 2012 report Equity investment in privately financed projects3 the NAO highlighted a number of projects where equity losses have occurred in projects. In 2004, the construction costs of several projects involving Jarvis companies exceeded those anticipated during the bidding process. Jarvis plc and other PFI investors bore the costs of filling the £120million funding gap in projects including Whittington Hospital, Tyne and Wear fire stations, Lancaster University and Wirral Schools. |
1.21 Recent economic developments have also led to a need to respond to increasingly challenging conditions to raise private finance for projects. The Eurozone sovereign debt crisis, combined with a downturn in the global economy and new bank regulatory requirements, has had a major impact on debt markets. The cost of long-term borrowing for infrastructure projects has increased and the availability of long-term bank debt has materially diminished. In some cases, traditional project finance banks have withdrawn from the market altogether. This is threatening the value for money of projects.
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1 National Audit Office, Making changes in operational PFI projects, January 2008
2 National Audit Office, Private Finance Projects, November 2009
3 National Audit Office, Equity investment in privately financed projects, February 2012