3. The evolution of PFI/PPP over the past 18 years has modified the thinking and discussion around risk. The original debate on PFI was not really on risk, this only emerged as part of the early attempts to create deals. The operating lease approach and off balance sheet status were early attractions of PFI. With the introduction of FRS5 by the UK accounting profession, the early focus on risk was largely driven by an on/off balance sheet classification and not really an issue in its own right. It was only as early deals emerged did risk to the public sector begin to be debated properly.
4. Since accounting treatment of PFI deals under FRS5 was based on substance of the deal over form, the treatment of risk (i.e. seeing the deal in entirety) or rather allocation of risk, that became the guiding focus for early deals. This aligned well with the principles of project finance which focused on risks being allocated to the parties best able to manage and control them.
5. However, many instances in early deals of authorities pushing for more and more risk transfer often resulted in bidders agreeing to irrational deals and then subsequently 'correcting' the risk allocation in the Preferred Bidder phase resulting in extended procurement timescales.
6. The mantra of 'risks should be allocated to the parties best able to manage and control them' was widespread (and MOD policy) but often misunderstood, e.g. early attempts to transfer demand risk where demand control is owned by the MOD and not in the control of industry.
7. Understanding risk is also critical to the investment appraisal process which is a vehicle for applying some mathematical based justification for the selection of one form of deal (or risk allocation) over another. The big problem however is a woeful lack of historic data about actual costs and risks to delivery of defence capability. There is also a common theme that the more investigation is done into existing risks of delivery the larger the retained risk seems to become, i.e. the MOD is always far too optimistic about its estimates - and this was the reason for optimism bias being introduced into investment appraisals.
8. All too often in the public sector, when risks do materialise, the benefits are absorbed into current budgets and downsides are swept under the carpet. In the public sector we don't have equity at risk and therefore the same critical focus on risk as industry does. Detailed analysis of risk throughout the project lifecycle and external scrutiny of it is therefore critical to address this inherent weakness in the public sector.