The historic focus by Government on achieving 'off balance sheet' deals as a prime driver for advocating private ownership has been a major contributor to the use of the high risk transfer and contractually rigid approach of the PFI market, with a high cost of finance as a consequence.
On the one hand, if balance sheet treatment were a secondary consideration, it could allow a more collaborative, low-cost model to evolve, getting the best from both sectors.
On the other hand, as recent deals have proved, the long-term model described in this and TIF's earlier paper can be off balance sheet for the right deals, so would be attractive to those that still prioritise balance sheet treatment. The public sector can enjoy low-cost private ownership, which if combined with long-term public-ethos governance, offers an attractive alternative to public sector ownership.
The historic focus on PFIs in the UK has been as much driven by their ability to get the investment off Government's balance sheet as by any belief in optimal risk transfer and private sector delivery. The so-called 'additionality' meant that it allowed deals to proceed which Departments would not otherwise have been able to afford.
But this has forced private sector procurement down a particular path to pass the high bar of off balance sheet treatment, with high levels of risk transfer covering construction and operation under fixed priced 30-year contracts. The private sector has had to finance itself with relatively high cost of capital to absorb that risk, and financiers have passed key risks to their contractors, who have sometimes struggled to deliver.
Just because one can transfer such risks, does not mean one should. The approach has led to many of the difficulties described earlier in this paper.
If balance sheet were not a prime driver, it would more readily allow consideration of when private sector ownership is attractive because of their delivery skills, focus, detailed due diligence and costing, cost controls, lack of annual funding constraints and clarity of purpose. If these disciplines could be introduced at a cost of capital not much above Government's, combined with attractive governance, then this premium could be worth paying even if the assets were on balance sheet. It would make it clear that the option to use private ownership is being considered because of its efficiency, not its balance sheet treatment.
If balance sheet treatment were secondary, the low-cost model could be considered as an option even for projects where a Department has the budget available to finance them on balance sheet and where the model would not achieve off balance sheet classification, because government, not consumers, is paying directly for the project.
But at the same time, being pragmatic, this 'additionality' of off balance sheet treatment is still a key consideration for Government and where it could be satisfied could lead to more deals being undertaken. So, if the new model can achieve off balance sheet treatment, then that is a bonus.
The Thames Tideway model did achieve an off balance sheet status. This was for a variety of complex inter-related reasons, first amongst which was that a degree of cost risk could be absorbed by the project company (whose cost of finance was therefore lower), by adding it to a Regulated Asset Base on which a return will be paid by customers (not Government). So, where a new deal can be structured where consumers, not government, partly absorb risk, deals may be capable of being classified as off balance sheet, as the risk is more evenly shared by parties other than Government.
In addition, the use of TrustCo or similar institutionalised public ethos governance actually increases the likelihood of an off balance sheet treatment. This is because if such governance could reduce Government's direct control (e.g. less onerous contracts, less intrusive, high level regulation, or no need for golden shares) then the assets are more likely to be deemed as separate from Government.
It is not hypocritical on the one hand to strongly recommend that balance sheet treatment is a poor reason to advocate a particular procurement route, but on the other to recognise that the model described here may still be capable of satisfying that condition, appeasing those who still think it important.
In conclusion, there is an opportunity to overhaul the relationship between the public sector and private sector. The public sector needs to consider how to get the best from the private sector, developing long-term, more trusted relationships. In turn, the private sector has the opportunity to radically change the way it behaves and is seen to behave, with a stronger more trusted, less regulated relationship with government. It needs to take the initiative to demonstrate how both sides can benefit from a longer-term, more trusted working relationship. The breakdown in trust and confidence in private ownership is widespread; it needs to be addressed now.