Feature Story

Pricing up the benefits

NAO Head of Corporate Finance and Infrastructure David Finlay speaks to Editor of the PPP Journal, Tom Reynolds about why exercising care is now key when deciding the financing of new contracts.

Following intensive political lambasting of the Private Finance Initiative (PFI) of the past few years, in November Her Majesty's Treasury announced a sweeping review of the model in order to find a cheaper solution for the financing of infrastructure projects. Announcing the review, Chancellor George Osborne said: "We have consistently voiced concerns about the misuse of PFI in the past and we have already taken steps to reduce costs and improve transparency." As Osborne went on to explain, the review "will take this a step further with a fundamental reassessment of PFI. We want a new delivery model that draws on private sector innovation, but at a lower cost to the taxpayer and with better value for public services." The Treasury will launch a call for evidence from experts commencing on 1st December.

As the National Audit Office's (NAO) Head of Corporate Finance and Infrastructure, David Finlay has years of experience in scrutinising and analysing partnership deals; PPP Journal asks what lessons have emerged.

Over the last 20 years, in the round, has PFI delivered value for money for the public sector?
I think you have to look at the different ways PFI has been used and the current financial environment compared to that before the credit crisis. PFI has been successful by enabling many hundreds of public buildings, such as hospitals and schools, which were greatly needed by towns and cities around the country, to be built, generally on time and to the cost expected by the public sector. This was a better outcome than had previously been achieved under conventional procurement. Generally, the services offered by PFI providers have been delivered to a satisfactory standard over the period of the contract.

What has clearly changed is the potential cost of new contracts since the credit crisis. In 2010, we issued a report on debt finance that showed that the cost of financing PFI deals has increased by between 20% and 33%. Our report also noted that, if you translated that increased cost of finance into the actual contract price, it would increase the price of a typical project by 6% to 7%. In many projects the increase of the contract price has been more than that. The effect of that additional cost is that, while PFI may have been very good at delivering assets in the past, you can't assume now that it's definitely going to be good value for money in the future.

What considerations does the public sector need to give in order to be an intelligent customer?
We issued a report earlier this year called 'Lessons from PFI and other projects' that brought together many of the issues that we had written about in recent years, including how the public sector ought to be a more intelligent customer. First of all, it is absolutely vital that public authorities consider all possible financing options before they embark on a project. This is particularly important in the current economic climate, given the higher cost of bank finance. A recent NAO report found that the Highway's Agency embarked on a PFI project to widen the M25 despite there being an alternative that would have met the requirement at a significantly lower cost. Being an intelligent customer involves looking at all the options at the outset before embarking on a particular course of action.

Is there now a robust mechanism in place to monitor the performance of PFI, and what can be done better to performance manage contracts in the operational phrase?
Previously, in the run-up to letting a PFI contract, quite a lot of effort went into evaluating the costs of using private finance. We'd like to also see a similar level of evaluation go into monitoring the performance of privately financed projects once they become operational. Generally speaking, the contracts themselves do have quite well-defined performance management procedures. The public sector needs to impose appropriate penalty arrangements if the PFI provider's performance falls down. The authority should also work with the private sector to see whether there are any ways in which the efficiency of the contract and the cost of services can be improved. There is quite a large exercise at the moment going on across government, overseen by the Treasury, to try to get better deals on existing PFI contracts.

Has the political discourse around PFI led to the model becoming a 'toxic' brand?
We are currently in an environment of constrained budgets, but it is difficult to achieve significant savings with a contractual arrangement that is relatively fixed over such a long period as a PFI. Clearly it will be very interesting to see the outcome of the current exercise to get a better deal from PFI, and to see to what extent departments are able to make genuine savings without significantly compromising the quality of the services. In the current environment, clearly, one does have to be cautious about entering into very fixed arrangements for many years ahead.

Doesn't being tied into a contract on a long-term basis mean the planning of large and expensive infrastructure is better with a longer-term view?
If you sink a lot of money into a construction project, whether it is PFI or another form of procurement, a large investment has been made. Therefore you would hope that the asset will be needed for a long time to justify the construction costs. Where an asset is required for a long period, PFI offers the opportunity for the public sector to work with the private sector to deliver efficiencies. The problem is that it is a fact of life that, for a number of reasons, a building can become obsolete before the end of the contract period. The issue that we were setting out in our 'Lessons learned' report was that, while that can happen whatever the procurement method, with PFI you have signed up for 30 years of services and it can be very expensive to get out of a contract.

What skills are lacking in the monitoring of contracts?
First of all, the public sector, as we said in a report we published two years ago on commercial skills for complex projects, often isn't able to afford all the people with very good commercial experience that it might ideally like. There is a scarcity of commercial skills within the public sector. It is very important that local public sector project teams, which are staffed by people who perhaps have not had that experience before of a complex transaction, are supplemented by people within government who have the right level of experience. You need to deploy the good commercial skills you've got in the public sector to very best effect to give support, where possible, to local teams who themselves may lack the necessary experience.

Can devolution of responsibility to local level and national economies of scale both be achieved?
There clearly has been a trend in recent times to devolve decision-making and contractual matters to local bodies. It is certainly important, as I have said before, that those teams are supplemented by people from the centre who have got good commercial experience. There is a tension between, on the one hand, local contracting that allows decisions to be made locally based on local requirements and, on the other, trying to harness government's purchasing power that is best orchestrated from the centre. If you are entering into lots of local contracts, you may not be making the most of government's purchasing power.

Given your experience around infrastructure and financing, what options are open to government as it procures large-scale projects?
The increased cost of private finance makes it all the more important to exercise care when deciding on whether to finance new contracts privately. On the other hand, public funding is very tight at the moment. What the NAO has said is that the public sector, and in particular the Treasury, should explore whether there are other sources of money, for example from pension funds, which might be brought into public infrastructure projects. Different options need to be explored but you can't simply assume that PFI can be used in exactly the same way as in the past.


David Finlay
Head of Corporate Finance and Infrastructure
National Audit Office