There Returns to PFI investors

7 . The financing structure of a PFI contract typically consists of 90% debt, in the form of bank loans, and 10% equity provided by investors.27 Private investors require a return on their investments to compensate for risks transferred to them under a PFI deal. Investors fall into two categories: primary investors and secondary investors. Primary investors usually invest during the construction stage of a project, and typically sell after construction to secondary investors who want to invest in an operational project, because the risk of project failure is much lower after the asset has been built.28 In some PFI deals equity investors have been able to generate high returns, particularly when equity is sold after construction.29 Shareholders in the M25 PFI deal, for example, made estimated returns over an eight-year period equivalent to 31% a year when selling their stake in the project.30 This is more than double the typical 12-15% returns investors can expect to receive over the life of a PFI project.31 In written evidence, Professor Dexter Whitfeld, Director of the European Services Strategy Unit, told us that returns to investors in excess of 25% are not uncommon in PFI projects. His analysis of 118 transactions that involved the sale of equity revealed an average return to investors of 28.7%.32 Equity returns this large may reflect errors by departments in their pricing of risk transfer to the private sector at the time they entered into the contracts.33 We examined equity returns in 2010 and concluded that excessive gains may indicate overpriced PFI contracts.34

8. The previous Committee suspected in 2011 that initial investors were able to make excessive profits from selling PFI shares, but lacked the information to be sure. It believed that there was a strong case for sharing these gains with the government. The Committee recommended that the Treasury should introduce arrangements for sharing in investors' gains.35 The Treasury partially accepted this recommendation saying that consideration would be given to the sharing of gains from PFI equity investors.36 However, the Treasury told us that it had decided against introducing sharing arrangements, despite other countries using such arrangements.37 Instead the Treasury sought to address the problem by introducing equity funding competitions.38 These competitions are intended to drive down the price of equity by creating competitive tension between bidders seeking to invest in a portion of the project equity.39 Government has only used an equity funding competition in one PF2 deal to date, and while this successfully resulted in lowering the returns to equity investors, the approach is relatively untested.40 Moreover, the changes only affect future PF2 deals, and do nothing about excessive returns investors can make on the historic stock of over 700 projects. The public sector will also invest as minority equity stake in all future PF2 deals, which should increase transparency to these returns as the public sector will have a seat on the PFI provider's Board.41

9. We were concerned to hear of high profile cases where the equity element of PFI contracts have been sold to offshore investment funds that pay little or no corporation tax in the UK, which we first drew to the Treasury's attention in 2011.42 The previous Committee highlighted the potential for tax avoidance through the sale of equity in the secondary market to investors non-domiciled in the UK.43 The Treasury told us that, while the vast majority of PFI companies are UK tax domiciled and pay corporation tax, public procurement rules prevent discrimination against non-UK domiciled companies and investors.44 As a result, the Treasury cannot control where secondary PFI investors are located, and can only take action if there is evidence of inappropriate tax evasion.45 Professor Whitfield told us that offshore infrastructure funds owned around half of the equity in PFI and PF2 projects, with the five largest offshore infrastructure funds making profits of £2.9 billion in the 5 year period between 2001-2017, and paying less than 1% in tax on their PFI profits.46 The Treasury's rules require departments to undertake a value for money assessment of a PFI or PF2 deal, and the amount of corporation tax a private company is expected to pay is one component of this. The higher the amount that the company is expected to pay, the more likely that the PFI option will be judged value for money. These tax adjustments have historically been criticised for being too high.47 If the calculations do not reflect the reality that offshore investors dominate the secondary market, then the estimated benefits will be overstated.48 We were concerned that this could lead to an incorrect conclusion that the PFI or PF2 deal offers better value than the project being financed by the public sector.49