PFI in perspective

22 January 2018

In our latest blog, Martin Blaiklock discuses the collapse of Carillion in relation to private finance initiatives (PFI) and Private Finance 2 (PF2)

The collapse of Carillion, plus the publication of the National Audit Office’s (NAO) timely and perceptive report (www.nao.org.uk/wp-content/uploads/2018/01/PFI-and-PF2.pdf) on private finance initiatives (PFI) and Private Finance 2 (PF2), has sparked renewed public focus on the impact of such events on government finances. This has led to some scaremongering from the media:

‘PFI deals costing taxpayers billions.’ BBC, January 18

‘Billions lost by taxpayer on wasteful PFI projects.’ The Times, January 18

‘UK finance watchdog exposes lost PFI billions.’ The Financial Times, January 18

Such headlines provide a far from sober perspective.

First, PFI represents a relatively small proportion of the UK government’s annual capital investment programme in infrastructure and public service assets. According to the NAO report, ‘more than 90% of the government’s capital investment is publicly financed’.

Secondly, there is no free lunch for either the government or the public. The BBC recently quoted the NAO report that the government and the taxpayer are committed to spend ‘a further £199 billion by the 2040s’ on PFI deals, implying that, if there were no such PFI deals, then there would be no cost to the taxpayer.

What some commentators fail to appreciate is that if there was no PFI, then the government would have to pay a similar amount (not necessarily the same amount, because private capital is more expensive) for the investment and delivery of services that the PFI deals would otherwise have provided.

That said, PFI is by no means a panacea even though some governments employ the mechanism as such. It is simply an optional way of financing infrastructure assets and delivering a public service.

What is clear from the current discussion, nevertheless, is that the government has not been clever and, on occasion, can be said to have acted imprudently (eg, in relation to London Underground PPP, NHS hospital investment etc.) by choosing the PFI mechanism when it was not suitable.

There are a number of pros and cons to PFI:

1. Construction costs: generally speaking, a privately owned and contracted project, where the owner’s equity is at risk, is more likely to be completed on time and budget than for a publicly owned venture. This is a benefit of PFI. However, one must caveat this by remarking that, because of the state’s experience of PFI-type deals over the last 20 years, many of the UK’s public/state agencies have improved significantly their procurement and contracting practices; therefore, the difference may not be so stark today. In the context of Carillion’s PFI deals, however, it does seem that the reasons for cost overruns or delays, which gave rise to cash flow problems, may be due to events which could have arisen just as easily for public sector contractors as for Carillion. But that story has yet to fully unfold.
2. Infrastructure assets have a long shelf life and, necessarily, have to be funded with long-term finance. As a result, PFI deals represent long-term contracts, which are somewhat inflexible and costly to adjust. In the light of this, PFI should only be used when the specification of the underlying assets and services to be delivered are to remain the same over many years. Not surprisingly, therefore, the use of PFI for NHS hospital investment, for example, where the underlying specification as to how patients are treated changes constantly, is inadvisable. Similarly, PFI is often unsuited to IT investment projects.
3. PFI deals are contractually complex (which is great news for lawyers and advisors!). Such deals tend to take twice as long to negotiate as conventional government funding and cost twice as much to put together in the first place. Hence, if the investment demand is urgent, PFI is not the answer.
4. On the plus side for PFI, privately owned assets are generally better maintained than those in public ownership, not least because the owner gets paid only if the assets are kept and maintained in good order. Furthermore, at the end of a PFI concession, the assets have to be handed back to the state in the condition in which they were built. This does not mean that the actual task of delivering the service and maintaining the assets is much different, whether carried out by publicly or privately employed staff, but government budgets often get cut over time and one of the first items to be trimmed is the maintenance budget.
5. The issue as to the impact of PFI on the government’s balance sheet is a technical criterion for HM Treasury. The measure focuses on the degree of risk transfer to the private sector or concessionaire for a particular PFI deal and, with ‘risk’ being a subjective judgement, there is some room for interpretative manipulation. Today, however, the UK government takes a more prudent view as to the contingent liability created by PFI than hitherto.
6. The quantitative analysis underpinning the decision as to when, or not, to use PFI (ie, the Value for Money assessment between the public/government way of funding investment (the Public Sector Comparator) versus PFI) is key. Unfortunately, the methodology employed in the UK (the Green Book) has its flaws, and warrants review. Not before time, the NAO report makes a number of comments reflecting such weaknesses. A subject for later comment!

Indeed, anyone wishing to further explore these topics can do so by reading my book: Infrastructure Finance: An Inside View.

Infrastructure Finance: An Inside View by Martin Blaiklock is published by Globe Law and Business Ltd.