PFI is dead – or is it?

The announcement by UK Chancellor Phillip Hammond in the autumn budget statement that there would be no further contracts under the Project Finance Initiative (PFI), or its successor, PF2, was unexpected but not unsurprising, given that PFI contracts have long been widely criticized as not delivering sufficient  ‘value for money’ by the National Audit Office and other public watchdogs.

The tone of the message abolishing PFI could not have been stronger: ‘The days of the public sector being a pushover, must end. I have never signed off a PFI contract as Chancellor…and I can confirm today that I never will.'

Yet the Chancellor has left the door open to future private finance procurement, in stating that ‘half of the UK’s £600 billion infrastructure pipeline will be built and financed by the private sector, and I remain committed to the use of public-private partnership where it delivers value for the taxpayer… and genuinely transfers risk to the private sector’.

In abolishing PFI, the Chancellor has snatched at a key policy of the opposition, where the Labour party would have bought PFI contracts back ‘in house’ on the government balance sheet, at estimated cost of £55 billion to the taxpayer in capital costs alone. This would be achieved, by Labour shadow Chancellor John McDonnell, under a ‘People’s QE’, where PFI contracts would be purchased instead of government bonds.

It might strike some as astonishing that with 719 signed PFI contracts since 2002, with a total repayment value of £301 billlion over the life of the contracts, that it is only now the Chancellor has called time on these unpopular PFI schemes. (see Treasury data)

 

UK PFI contracts by department
Department	Total capital costs (£m)	Total repayments
SOURCE: HM Treasury
Cabinet Office	12	39.2
Crown Prosecution Service	18.2	384.22
Department for Business, Innovation and Skills	21.84	42.33
Department for Communities and Local Government	2,240.51	7,730.71
Department for Culture, Media and Sport	348.93	1,353.69
Department for Education	7,731.11	29,463.73
Department for Energy and Climate Change	4.4	15.7
Department for Environment, Food and Rural Affairs	3,843.76	22,705.81
Department for Transport	7,349.42	36,546.01
Department for Work and Pensions	1,085.70	10,402.30
Department of Health	11,614.29	79,157.27
Foreign and Commonwealth Office	91	474.91
GCHQ	331	1,952.00
HM Revenue and Customs	862.1	5,774.62
HM Treasury	141	939
Home Office	850.81	4,086.51
Ministry of Defence	9,131.48	49,755.17
Ministry of Justice	798.6	9,796.05
Northern Ireland Executive	1,999.77	7,211.65
Scottish Government	5,692.80	30,755.49
Welsh Assembly	543.36	2,756.78
Total	54,712.09	301,343.15

Source HM Treasury

 

Hammond’s assertion that the contracts under the last Labour administration have placed a burden on public sector finances are clear, especially in the NHS where PFI payments form a significant part of Trust budgets. But proponents argue that the UK would not have new hospitals and state of the art facilities that make the NHS the best health service in the world without PFI.

It might also be remembered that whilst Tony Blair’s government was the greatest proponent of PFI, initiating NHS Local Improvement Trusts and the Building Schools for the Future programme which saw the building of 70 new schools and the modernization of 50 more, it was Phillip Hammond’s predecessor, John Major who was the architect of PFI.

Whilst PFI contracts were always going to be more expensive than funding new infrastructure directly from HM Treasury coffers, the step up in unitary payments from the public sector to the private sector over the 30 years lifetime of the contract, often meant that the final public cost of the asset was several times greater than its capital cost.

The collapse of major UK contractor Carillion, which was contracted under PFI schemes to build to major new hospitals, Midland Metropolitan and the Royal Liverpool, undoubtedly sounded the death knell for UK PFI, as the government scrambled in a damage limitation exercise. It came to private contractor Amey to step in to rescue several hundred Carillion jobs linked to MoD and rail PFI contracts.

The question now is what will replace PFI as the government moves forward with its current infrastructure plans. It is unlikely that the government will seek to fund new infrastructure projects on the HM Treasury balance sheet, and that some form of risk transfer model that encompasses construction and technical risks for private sector stakeholders will prevail in new procurement.  

What that model may look like might be something akin to the PFI model that has just been abolished, albeit with less punitive public sector repayment plans. Perhaps the new NHS Centre of Excellence, also announced in the budget, will find new ways of developing procurement models that effectively transfer risks to private sector contractors.

According to Joest Bunse, associate director at S&P Global Ratings, ‘the government will continue to make use of public-private partnerships in the future, albeit in a different form. The main alternative option, funding all infrastructure on the public balance sheet, does not seem to be on the table. The government has kept its options open to continue to use PFI under a different name by remaining committed to PPPs… and it’s likely that any new PPP model will closely mirror key features of the PFI framework.’

The UK Chancellor is not alone in criticising inefficient PFI and PPP structures, especially where they have been judged not to deliver value for money. In March this year, the European Court of Public auditors published ‘Special report 09/2018: Public Private Partnerships in the EU: Widespread shortcomings and limited benefits’ in which auditors claimed recent PPPs in member states resulted in ‘€1.5 billion of inefficient and ineffective spending’.

The report states that ‘the auditors assessed 12 EU co-financed PPPs in France, Greece, Ireland and Spain, with a total cost of €9.6 billion and an EU contribution of €2.2 billion, and found that these procurements increased the risk of insufficient competition and were subject to considerable inefficiencies during their construction, with seven of the nine completed projects – corresponding to €7.8 billion – project cost incurring delays and major cost increases’.

Given the widespread misgivings on the efficiencies of PPPs, any new PPP structures that the UK government might develop will need to take account of these audited shortcomings and deliver a more robust procurement process and better value for money for the life of the contract than previous private sector risk transfer models.

Given the hugely ambitious infrastructure plans in the UK outlined in the National Infrastructure Commission’s Assessment, including mega projects such as the expansion of Heathrow and the development of the HS2 high speed rail network, the new model for private finance will need to be hammered out very rapidly to engage private sector participation in public sector projects.

As a UK project finance banker said yesterday, ‘the announcement was a shock, but I still have my job!’ With so much infrastructure to finance, it isn’t time for bankers to hang up their project boots.