1. PFI is an arrangement whereby the public sector contracts to purchase services, usually derived from investment in assets, from the private sector on a long-term basis, often between 15 to 30 years. Under PFI, the private sector puts its own money on the line, and only gets paid if it actually delivers the contracted services to an acceptable standard. If costs overrun, or if the service is not provided, the private sector bears the financial consequences. Compared with more conventional forms of asset procurement, the PFI is structured to provide a real incentive on the contractor to deliver the underlying asset/s on time and to budget and provides clarity on the level of service expected throughout the contract term against a fixed price. Typically:
• the private sector will design, construct and maintain infrastructure in order to deliver the services required. The project thus entails a construction phase followed by an operational phase;
• the private sector party contracting with the public sector is usually a Special Purpose Vehicle (SPV): a company formed with the specific goal of delivering the project, and can have one or more shareholders;
• much of the risk assumed by the SPV in the contract is passed to other entities (which sometimes are also shareholders in the SPV) through sub-contracts;
• the SPV manages and delivers the required services to specified standards, while sustaining the quality of underlying assets;
• the SPV uses private finance, usually a mix of equity (share capital injected into the SPV by the project sponsors and/or third party investment companies) and debt (bank loans or bond finance), to fund the construction works or capital assets;
• the SPV is paid a fee for the service it provides to the public sector. There is no separate income stream in respect of the infrastructure or assets. The fee is often referred to as a unitary payment and covers costs related to debt repayment (principle and interest), expected operating costs associated with providing the services delivered and maintaining the assets, and a return to the SPV's shareholders;
• the public sector normally starts to pay the SPV only when construction is complete and once services start being delivered. The pre-agreed unitary payment continues to be made over the rest of the contract life.
• The unitary payment is at risk to the SPV's performance during the life of the contract, such that payment is reduced if performance falls below the required standard.