There is another way, by Nick Prior

29 Nov 07
The PFI has proved its worth in many projects, large and small, but it is not the only funding game in town particularly when flexibility is needed. Nick Prior explains

30 November 2007

The PFI has proved its worth in many projects, large and small, but it is not the only funding game in town – particularly when flexibility is needed. Nick Prior explains

The merit of using the Private Finance Initiative or public-private partnerships to fund public infrastructure or deliver services depends entirely on who you talk to. Some believe the PFI and its health and education derivatives (Local Improvement Finance Trusts and Local Education Partnerships) are here to stay. Others are more critical.

The Labour government, although not the original architect of the PFI, has continued to encourage its use across the public sector – from the smallest school refurbishment project to the Future Strategic Tanker Aircraft (a plan to replace the RAF's aircraft refuelling capability), which is one of the world's largest schemes. As of 2006, the government was committed to projects with a capital value of around £56.8bn. Some of these date back to 1987, and commit around £180bn up to 2032. A succession of further deals, worth about £22bn, are due to be made in the next four years.

Despite the substantive transfer of risk associated with PFI schemes, a considerable element of political risk remains. For example, the future of the scheme would be threatened were it to become permanently associated with expensive failures or even corporate bailouts.

Another change in the offing is when new accounting rules put all PFI/PPP projects 'on-balance sheet'. The industry has broadly welcomed this move, as the initiative has something of an image problem when it comes to transparency and value for money. This is despite the fact that it has been shown to work well time and time again, particularly in local infrastructure projects, such as the refurbishment of schools and hospitals.

In 2005, 66% of public sector responders rated the performance of their service provider as either 'very good' or 'good', in a review of operational PFI/PPP projects carried out by Partnerships UK for the Treasury. Less than 4% rated performance as 'poor' or 'very poor'. The survey also showed that in 82% of projects, problems were always, or almost always, resolved within the time allowed under contract and, in the majority of cases, dispute resolution procedures were never used.

However, the PFI/PPP does not always represent the best funding option, particularly in projects where there is some uncertainty around the objectives or requirements.

The key to avoiding such difficulties is flexibility. Public sector decision-makers need to draw on a broader range of partnership models and make better choices about which type of funding is right for particular projects. PFI/PPP delivers many good things, but the perception of high costs, lengthy procurement and, in particular, inflexibility in coping with changing requirements brought about by policy changes means that public organisations have a duty to consider other options.

More broadly, we also have to consider whether private sector providers will retain their appetite for PFI/PPP as, in the biggest and riskiest projects, they often end up staking their entire businesses on the venture. In a recent survey carried out by the International Project Finance Association, 88% of those involved in PFI/PPP markets (including a small number of public sector responders) believed that the number of contractors bidding for future schemes was going to fall. Respondents cited rising bidding costs, liquidity and access to capital as the main deterrents or barriers to market entry.

Why get involved in an industry, some business leaders argue, where penalties for failure are not matched by rewards for success? Only last month, the CBI business organisation expressed fears for the future of PFI/PPP, saying the government was sending 'mixed signals' about its future intentions and attitude. They cited what they saw as a disconnect between the rhetorical support from ministers and a series of project cancellations. If the UK market doesn't meet expectations, there is a feeling across the industry that companies will look elsewhere.

Health care financing shows how the future use of PFI/PPP must take account of shifting policy drivers. In October, the interim Darzi Review of the NHS set out a vision for health care services to be delivered from community-based locations such as clinics and care centres. While this is being worked up in Whitehall, PFI/PPP projects to build or refurbish the big district general hospitals continue apace all over the UK. What is the point of spending large sums upgrading these facilities if their future use is in doubt? Across the public sector, finance directors need to guard against committing to a service or asset for 30 years when it might become redundant in five.

So what are the alternatives to PFI/PPP, apart from traditional procurement? In the study Building flexibility, my colleagues at Deloitte discuss a series of models that could become more widely used over the coming years. Three in particular stand out.

The first is to take a different approach to the wholesale transfer of risk associated with mainstream PFI/PPP schemes. In a 'derisked' arrangement, value for money could be improved if the commissioning organisation underwrote some of the financial risk during the operational phase. The risks would still be transferred for the design and construction phase, when the threat of delay or total failure are greatest. This sharing of risk reduces the cost because the supplier's risk profile lowers as the project matures.

A second model – 'alliancing' — could be applied when a degree of uncertainty exists around the project. Alliancing is the use of payment mechanisms to ensure that the interests of all parties involved in the project are aligned, to try to balance the traditional trade-off between delivery and supplier profitability. Such schemes often place heavy emphasis on project outcomes by creating integrated project teams to reinforce the collaborative approach to risk and cost.

The management of BAA's Terminal Five project at Heathrow Airport is an example of alliancing in action, as is the Future Carrier Project – a Ministry of Defence-led initiative to build two aircraft carriers.

A third model, for occasions when a project with a very high degree of uncertainty exists, is the 'incremental partnership'. In this scheme, the public sector organisation empowers a partner to procure the deliverables competitively. The commissioning department can 'call off' specific projects as its requirements become clearer, and can use alternative providers if it chooses.

This piecemeal approach avoids committing public sector organisations to projects that are difficult to reverse, because the relationship is formed gradually and commitments remain flexible. The major problem with an 'incremental partnership' is that, unlike mainstream PFI/PPP, the major risks stay with the public sector.

If PFI/PPP is to endure as a viable financing mechanism for future projects, these and other alternative models need to be considered by the public sector. The industry also needs to mount something of a charm offensive to strengthen the initiative's reputation as an effective, efficient provider of infrastructure and services. This means that a fairer representation of its successes and failures needs to be put out into

the public domain, through, for example, more market-wide analysis.

The public needs to have a clear, impartial and transparent assessment of PFI and PPP projects, which charts the occasions when they have transformed public infrastructure for the better and when they have not.

Nick Prior is a partner in the government and infrastructure team at Deloitte. The Public Finance>/Deloitte round table debate on the future of the Private Finance Initiative was held this week. A full report will appear in next week's issue

PFnov2007

Did you enjoy this article?

AddToAny

Top