7.5.1 This first item in the remit of the Inquiry is to inquire into and report on 'The rationale for the City of Edinburgh Council entering into the PPP1 contract for schools and the effect this financing arrangement may have had on the construction process'.
7.5.2 This remit item needs to be broken down into two distinct questions, the first in relation to whether there was a sustainable rationale for the Council to use access to private finance through the Private Public Partnerships arrangements that were being promoted at the time as a means of upgrading the schools' infrastructure, the second in relation to the potential impact of this decision on the quality of the construction of the completed schools.
7.5.3 There has been considerable political debate and various reports produced over many years since the emergence of the Private Finance Initiative in the early 1990s. The debate and the content of reports have tended to focus on whether the model provided 'value-for-money' and much less on assessing the quality of the buildings, produced under this methodology from either an aesthetic, functional or construction perspective.
7.5.4 The access to private finance offered by the PFI was used across a wide range of public sector organisations to replace or provide necessary new infrastructure, for which public sector capital funding was not being made available. Major programmes were initiated for investment in infrastructure for transport, hospitals, schools and prisons.
7.5.5 Most commentaries suggest that a key underlying factor in the requirement set by Governments to consider PFI as the first procurement option for virtually all schemes of a reasonable size was to facilitate what was effectively a significant increase in Government borrowing but presented in a manner which allowed it, or was at the time interpreted as allowing it, to be treated as 'off balance sheet'. Over time there was an increased awareness in the official guidance of the need to ensure the quality of the product.
7.5.6 The following is an extract from a Report published by the Scrutiny Unit of the House of Commons in June 2008.
"In the past, some advocates of PFI have argued that PFI projects have allowed more investment than would have been possible through conventional procurement methods. Other supporters argue that PFI projects are generally more efficient than projects undertaken through conventional procurement because they enable private sector innovation, and because they allow some risks to be better managed by transferring them to the private sector."
"In 2000 the Treasury Committee reported that "the original justification for PFI in the Autumn Statement of 1992 was that it would enable more investment to take place." The Treasury saw it as a way of tackling past capital under-investment. Later, government announcements tended to focus on PFI generating 'value for money."
"Treasury guidance on PFI, published in November 2006, highlighted value for money as the condition for choosing PFI as a procurement option: "PFI should only be pursued where it represents VfM in procurement. VfM is defined as the optimum combination of whole-of-life costs and quality (or fitness for purpose) of the good or service to meet the user's requirements. VfM is not the choice of goods and services based on the lowest cost bid."
7.5.7 In relation to the funding of projects, this Report is not seeking to form or provide an opinion as to the overall advantages or disadvantages of using private finance as a means of enabling the delivery of public sector projects. Rather its remit is to examine the rationale of the City of Edinburgh Council, in the circumstances that prevailed at the time of the PPP1 project, of adopting it in their programme for the renewal of their schools' infrastructure.
7.5.8 In June 2002, just six months after the contract for Phase 1 PPP1 schools had been signed, this issue was addressed in an Audit Scotland Report examining the growing use of PFI for Scottish schools, which had as part of their exercise used information from PPP programmes for the replacement of schools in six Scottish Council areas including the Edinburgh PPP1 schools.
7.5.9 The Report was entitled 'Taking the Initiative - Using PFI Contracts to Renew Council Schools'. The Report includes the following extracts:
"The single most important driver of PFI as the procurement route for new schools has been the opportunity to obtain substantial additional investment.
There was clear evidence of a high priority for renewal of inadequate, redundant or dilapidated school buildings in each PFI schools project that Audit Scotland examined. But financial considerations were dominant regarding the selection of the PFI procurement route. In practice the Scottish Executive has determined the level of investment in each case as well as the financing/procurement route. Alternative traditionally funded procurement routes have not been a viable option within the financial framework in operation."
7.5.10 The substance of this analysis was repeated in the evidence given to the Inquiry by those witnesses who were involved in the process from the Council or had acted as advisors to the Council at the time of the decision to use PPP.
7.5.11 Since the introduction of PFI, it has been a requirement of Government that prior to approval to PFI funding it is necessary to compare the PFI option with a publicly funded option to demonstrate that it represents value-for-money. This is required to be carried out even though in many, if not most cases, no such public funding is available or likely to become available.
7.5.12 The Audit Scotland Report also noted that the centrally imposed process to be used in forming this comparison between the PSC (publicly funded) and the PPP options did not allow the calculations to reflect in the PSC the significantly lower cost of financing available to Local Authorities. It read:
"The cost of private finance is higher than in the public sector. In any project requiring financial investment there is a cost for capital. Where borrowing is the chosen source of funding the cost will be the financing charges made by the lender. Where there is also equity investment, shareholders will seek dividends. In PFI schools projects the overall financing cost incurred by the PFI provider is part of the project costs and adds to the level of charge the council pays in return for the service.
For the six PFI school projects (including Edinburgh) Audit Scotland examined the overall financing cost for the private sector. This cost generally varied in the range of 8% to 10% a year, 2.5% to 4% higher than a council would pay if it borrowed money on its own account for a similar project. This higher cost of capital adds costs of between £0.2 million and £0.3 million a year for each £10 million invested in a project.
This difference has not been reflected in the costings which councils have prepared when comparing the forecast cost of each PFI schools deal with a hypothetical publicly funded alternative (the public sector comparator)
And, despite extensive technical and professional work and input to the costings in each case, there is an emphasis on the bottom line and a perception of the PSC as a simple pass/fail test. The analysis for PFI school projects most often resulted in a set of costings, which indicated the PFI solution was more economic but without an analysis of the reasons. Audit Scotland's analysis is that, in most cases, the main costs underlying the PFI option are not significantly different from or are higher than the equivalent forecast costs under the PSC. In most cases the risk adjustment tipped the balance back in favour of the PFI option.
A further consideration is the inevitable subjectivity that surrounds judgements on which the PSC costings are based and wider decisions regarding the respective merits of the PFI and any alternative solution to providing new schools. Under the terms of the competition for financial support from the Scottish Executive for PFI projects, no funding for the PSC was available. Consequently, if the PSC had suggested that the PFI was not economic it would have proved fatal to the project (no PFI schools project has so far failed this test).
A great deal therefore hangs on professional and technical judgements underpinning the PSC costings. Although the costings invariably involve a significant degree of subjectivity and inherent uncertainty, reliance on them is critical to the decision whether a project will proceed or not. It is important, too, to understand how council borrowing rates, that are typically below actual PFI financing costs in individual school projects, affect the relative costs of the PSC compared to the PFI option. But the method of constructing the PSC means that this important difference in financing costs is not included in the comparison. Audit Scotland considers that, for local authorities, the actual costs of debt financing are a relevant if not necessarily decisive factor in testing the economy and ultimately the value for money of a PFI schools contract."
7.5.13 There have been significant changes in the way such considerations are currently undertaken, however the remit of this Report is to look at the rationale of decisions taken by the City of Edinburgh Council in 2001.
7.5.14 The facts, as stated above in relation to the specifics of the Edinburgh Outline Business Case and procurement process, and the contemporaneous findings by Audit Scotland regarding the political, procedural and economic context at the time the decision was made to use PPP, are relatively clear.
7.5.15 Accordingly, this Inquiry's findings in relation to the first part of the Remit Item 1 are:
1. There was a pressing need to address the condition, configuration, efficiency and capacity of the school estate in Edinburgh, which had suffered from a lack of investment in both maintenance and new infrastructure. This could not reasonably be delayed for any significant period, other than to the detriment of the educational achievement of school-children in Edinburgh.
2. The on-going availability of public sector capital funding was at a totally inadequate level to facilitate the required level of investment and no further funding of this type was available from central Government.
3. The U.K. Government and subsequently the Scottish Executive were actively promoting PPP as their favoured route and were implementing a scheme called 'Levelling the Playing Field' under which they were offering the City of Edinburgh Council an ongoing contribution of £6.2m towards the annual revenue cost of the PPP1 project. This contribution made the PPP scheme affordable to the Council.
4. This model had recently been successfully used by other Local Authorities in Scotland.
5. The Outline and Final Business Cases, as prepared by the City of Edinburgh Council in accordance with the required procedural guidance, demonstrated that the PPP1 process represented value-for-money.
6. The Full Business Case was approved by the Council, Audit Scotland and the Scottish Government.
7.5.16 Based on this analysis the conclusion of the Inquiry on this first point of Remit Item 1 is that, given the above context and circumstances, the City of Edinburgh Council had a sound rationale for their decision to adopt the PPP methodology for the funding and procurement of the PPP1 schools and acted both appropriately and pragmatically in making this decision.