26/11/08

PPP and PFI Value for Money

Peter LiveseySenior Policy Analyst

Corporate and Private Finance

2

PFI Forces Long-term Thinking, Uses Private Sector Risk Management

•Small projects• Performance was good, similar to

larger projects for completion on time or early

• However, procurement times were disproportionately high, as were bid costs

• Overall, these findings suggested it was difficult for small projects to obtain VfM

•PFI for IT projects• Fast changing technology and

needs• Multiple interfaces• Difficulty of specifying risk

transfer and substituting suppliers

There is a major capital investment programme

• Requiring effective management of risks associated with construction and delivery

The private sector has expertise to deliver and PFI represents good VfM

The structure of the service is appropriate

• Public sector can define its needs as service outputs

• Allows optimal and efficient risk allocation to both public and private sectors

Nature of assets and services are capable of being costed on a whole-of-life, long term basis

Others have been deemed less suitable

Some projects are suitable for PFI

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Current Margins on UK PPP Lending

Source: Ernst &Young

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Advantages and disadvantages

Conceptual advantages

• Integrated whole life management

• Risk transfer to private sector Design Risk Construction Risk Financing Risk Technology & Obsolescence Operating and FM Risk

• Focus on output specification

• Opportunities for innovation in service delivery

• Long term certainty

• Private sector capital• Can be off Government Balance

Sheet

Private Sector Capital•Banks capital at risk therefore risk transfer incentivised

•Project finance discipline leading to whole life costing

• Bank step in on contractor defaul

Conceptual disadvantages

•Cost associated with risk transfer

•Price must include profit margin

•Inflexibility

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Improved travel environment - London Underground PPP

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London Underground PPP - Metronet

Metronet in administration July 2007Potentially £2bn (30%) over budget by the end of first period£350m shareholder equity lost

PPP not PFI•not standard form contract•debt underpin 95%•not fixed price•station renewals not clearly specified•tied supply chain•incentive alignment:DfT, TfL, Metronet

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London Underground PPP - Metronet

LUL

TfL

DfT

Metronet S hareholders

x 5

Lenders (existing)

Metronet

Funding letter Funding

Guarantee of PPP ISC Funding

Debt serv ice

Equity - £350m

Put Option – 95% guarantee of debt

PPP contract; ISC

Comf ort letter

Loan - £2,600m

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UK Policy – The Eddington Transport Study

The economic case for targeted new infrastructure is strong and offers very high returns – the best schemes offer returns in the region of £5-10 for each pound invested. Government should therefore continue to deliver, together with the private sector, sustained transport investment.

Getting the prices right means making a comprehensive assessment of the full range of economic, environmental and social impacts of policies, including climate change.

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All Depts. Transport

Number: 650

Value: £53bn

PPP/PFI in Transport

48 7%

£22.5bn42%

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Modal shift - Light Rail

Nottingham Express Transit

BCR 2.0 high

Croydon Tramlink

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UK Policy - PPP/PFI

At investment appraisal value for money must be assessed over the whole lifetime of a project, including disposal, estimating the costs and benefits to society as a whole, not simply those directly relevant to the purchaser - e.g. environmental impact.The decision to use PFI is taken on value for money grounds alone, but not at the expense of employees’ terms and conditions. The accounting treatment of a PFI project is not relevant to this decision.

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Project Delivery

24%70%Projects late

20%73%Projects over budget

PFIConventional

Procurement

PPP/PFI delivers benefits on time and on budget

Source UK National Audit Office

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Strategic Considerations Change During The Procurement Process

Departmental Investment

strategy

Outline Business

CaseOJEU ITN BAFO

Financial Close

Preferred bidder

Main strategic considerations:

•Is there a competitive market interest

•Is the procurement process being properly managed

•Is the commercial and financial deal achieved acceptable

•Is the deal still in accordance with what was desired before?

Main strategic considerations:

•Is the project the right one?

•Is PFI the correct procurement route?

•Is the project affordable?

•Is the project sufficiently developed to be ready to go to market?

•Is there sufficient indication already of market interest?

•Is the project team sufficiently prepared to go to market?

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PPP/PFI VfM Policy

HM Treasury Corporate and Private Finance Team

Private Finance Unit

Mandatory PFI Contract Mandatory VfM guidance

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Value For Money Guidance 3-stage Process

•Predict which procurement routes should apply for projects in overall programme, and if PFI is appropriate

•Increase transparency and improve deal flow•Ensure that investments made using PFI are affordable

•Verify initial decision to use PFI is valid, and if not change procurement route

•Feedback to improve evidence base, market management

•Ensure that project proceeds only if affordable•Test whether the PFI solution is marketable•Ensure an efficient bid process is planned

•Evaluate bids correctly•Feed back market intelligence to planned projects

•Determine if there is market failure or abuse•Ensure proposed risk-sharing is deliverable

Stage 1Investment Programme

Stage 2Project

Assessment

Stage 3Procurement Assessment

Project teams,

monitored by departments

Departments

Project teams,

monitored by departments

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UK Policy - VfM

 Stage 1 Programme Level Assessment

•Applied to the subset of investment identified as potentially suitable for PFI•Central PFU – liasing with team coordinating Spending Review submission•Should be done in time with Spending Review submissions

Ex-ante• Capital strategy considered as part of Spending Review process• Specific investment options identified and appraised using the Green Book• Capital projects prioritised within Department’s capital programme• Those areas which may be suited to procurement through PFI identified

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UK Policy - VfM

Stage 2 Project Level Assessment

•Constitutes part of Outline Business Case for each project•Project team updates analysis from Stage 1 with project specific information and identifies any key VfM issues•If VfM is demonstrated then this assessment is noted in the OBC.•If VfM is not demonstrated, then consider alternative procurement routes. Project should not proceed as PFI.

Stage 3 Procurement Level Assessment

•Continuous assessment of whether drivers of value for money are maintained until financial close.•Proceed with procurement ensuring there are no material changes such as market failure.

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Programme level objectives and outputs

Operational flexibility

Equity, efficiency, accountability

Risk management

Innovation

Service provision

Incentive and monitoring

Lifecycle costs, residual value

Transaction costs, client capacity

Competition

Is the procuring authority satisfied that operable contracts could be constructed for projects falling in this area?

Does the project involve the purchase of a significant capital asset, where the risks of cost and time over-runs are likely to be significant?

Is there sufficient client-side capability to manage the procurement process?

Viability

Desirability

Achievability

Qualitative Assessment Makes Reasons For Undertaking PPP Explicit

Example questionCategories

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Standardised Financial Model - Used in Conjunction with Qualitative Analysis

The quantitative assessment is a simple tool

Tool kept simple – even non-Excel literate users should understand

Only looks at the PFI decision – does not consider affordability

Needs a sound evidence base• Can use information from past PFI

projects, from various depts

Only one part of the assessment – qualitative factors could be more important

Only one part of the assessment – qualitative factors could be more important

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Where does value for money arise

• Whole life integrated service - design, build, finance, maintenance, service

• Innovative design cheaper construction cost cheaper whole - life maintenance

• Output specification services provided in different ways

• Possible third party income catering, nursery facilities, tolls

• Risk transfer• More efficient utilisation of assets

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Whole life benefits - Street Lighting and Highways Maintenance

Picture courtesy of PriceWaterhouseCoopers

BCR 3.5 high

BCR 2.3 high

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PPP/PFI delivers Whole Life Benefits

Strong evidence of innovation in street lighting PFI projects:

White light lanterns saving 25-30% of energy consumption;

LED illumination for signs and bollards; Lower wattage control equipment; Induction lighting (100,000 hours burning time

rather than 20,000) Better directed light – projects supported by the

Dark Skies campaign.“The significant investment in street lighting is leading

to greater expenditure on research and development by manufacturers which is resulting in technological innovation.”

Source – 4Ps review of operation PFI projects

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Main Considerations - Approving a Business Case Before Going to Market

Assessments required

Long term needs assessmentScope of project

Value for Money Guidance (financing decision)

Affordability assessment – budgeting

Design quality assessmentOutput specificationRisk allocation

Market interest assessment – contractorsMarket interest assessment – funders

Documentation and processSuitability of advisersIndicative timetableProject teamCommitment of sponsors, usersStatuatory process

Is the project the right one?

Is PFI the correct procurement route?

Is the project affordable?

Is the project sufficiently developed to be ready to go to market?

Is there sufficient indication already of market interest?

Is the project team sufficiently prepared to go to market?

Main question

2

3

4

6

1

5

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Programme level objectives and outputs

Operational flexibilIty

Equity, efficiency and accountability

Transaction costs and client capacity

Competition

Qualitative Assessment: Viability, Desirability And Achieveability

Questions to be answered – VIABILITY AND ACHIEVABILITY

Is the procuring authority satisfied that operable contracts could be constructed for projects falling in this area? Can these contractual outputs/requirements be robustly assessed?Could the contracts describe service requirements in clear, objective, output-based terms?Could they support assessments of whether the service has been delivered to an agreed standard?Is the fit between needs and outcome sufficient to proceed?In the event of staff transfer, can the contracts be drafted to avoid perverse incentives and deliver quality services?

Is the procuring authority satisfied that operational flexibility is likely to be maintained over the lifetime of the contract, at an acceptable cost?Have the long term tradeoffs between operational flexibility and cost been identified?

Are there public equity, efficiency or accountability reasons for providing the service directly, rather than through a PFI contract?Are there regulatory or legal restrictions that require services to be provided directly?Have the expected staff terms and conditions at stage 2 been considered and what are the impacts on the contract, equity, efficiency and accountability?

Is there sufficient client-side capability to manage the procurement process and appraise ongoing performance against agreed outputs? Can appropriately skilled procurement teams be assembled in good time?

Is there evidence that the private sector is capable of delivering the required outcome? Is there likely to be sufficient market appetite for the project? How is it expected that the market will receive the proposed risk profile?

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Risk management

Innovation

Service provision

Incentive and monitoring

Lifecycle costs and residual value

Overall

Qualitative Assessment: Viability, Desirability And Achieveability

Questions to be answered - DESIRABILITY

Does the project involve the purchase of a significant capital asset, where the risks of cost and time over-runs are likely to be significant?

Does a preliminary assessment indicate that there is likely to be scope for innovation? To what extent are the projects’ scope, specification and operation pre-set or open to negotiation with the private sector?

Are there good strategic reasons to retain soft service provision in house? What are the implications in the longer term for the organisation in losing these skills – are all the expertise transferring or is there some retention?Is soft service transfer essential for achieving the overall benefits of improved standards of service delivery?Where soft services are not transferred, is this consistent with the Prime Minister’s commitment to flexibility of public service provision?

Can the outcomes or outputs of the investment programme be described in contractual terms which would be unambiguous and measurable?Can the service be assessed against an agreed standard?Would incentives on service levels be enhanced through a PFI payment mechanism?

Is it possible to integrate the design, build and operation of the project?Is a lengthy contract envisaged? Will al long-term contractual relationship be suitable (or advantageous) for the service?Are there significant ongoing operating costs and maintenance requirement? Are these likely to be sensitive to the type of construction?

Overall, is the accounting officer satisfied that PFI would bring sufficient benefits that would outweigh the expected higher cost of capital?

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PFI accounting under IFRS

PFI rules – from 2009/10 (IFRS)

PFI now (UK GAAP)

Overall framework

• Follow accounting treatment ?

• Follow accounting treatment

•ESA 95 – EU statistical framework•ONS decide classification

National Accounts

(basis for fiscal rules)

•Balance sheet decision depends on control

•Balance sheet decision depends on who has “risks and rewards”

•UK GAAP adapted for public sector•International Financial Reporting Standards (IFRS) from 2008/9•Financial Reporting Advisory Board (FRAB) advise on adaptations• NAO/Audit Commission audit accounts

Resource Accounts

Autumn 2007Consult on draft PFI guidance

Spring 2008Final PFI guidance

Autumn 2008departments re-state2007-08 accounts

Summer 2009departments produce2008-09 accounts

2010PFI may be in net debt

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Issues arising from accounting change

Stock - need to manage the impact on existing projects (although 45%

on balance sheet, mainly due to 3 tube deals)PFI Pipeline- rigorous scrutiny of proposed PFI programmes for CSR07- future procurement of complex project

Proportion of PFI projects on and off the balance sheet by sector

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

DfES DEFRA CLG Health HO MOD DfT

% ON% OFF

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Mersey Gateway

Shorter journeys - Mersey Gateway Bridge

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Motorway PFI

http://www.hm-treasury.gov.uk/documents/public_private_partnerships/ppp_pfi_stats.cfm

Project Financial Close Capital Value £m

Balance Sheet treatment

Dartford Crossing Apr-87 180 On Severn Crossing Oct-90 331 On M6 Toll Feb-92 485 Off A69 Jan-96 9 On A1(M) Feb-96 128 On A417/419 Feb-96 49 On M1/A1 Mar-96 214 On A50 May-96 21 On A30/35 Jul-96 75 On M40 Sep-96 65 On A19 Oct-96 29 On A1 DtoD Yorkshire Feb-03 245 On A249 Feb-04 73 On Total 1904

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Databank

HM Treasury policy guidance: Transforming Government Procurement

http://www.hm-treasury.gov.uk./media/4EA/89/government_procurement_pu147.pdf

Green Book http://www.hm-treasury.gov.uk/economic_data_and_tools/greenbook

/data_greenbook_index.cfm

PFI Policy VfM, standardised PFI contracts, project list (all financial

data) http://www.hm-treasury.gov.uk/documents/public_private_partnerships/

ppp_index.cfm

Budget 2007http://www.hm-treasury.gov.uk/index.cfm

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Databank

Department for Transport policy guidance: NATA

http://www.webtag.org.uk/index.htm Eddington Transport Study

Department for Transport - The Eddington Transport Studyhttp://www.dft.gov.uk/about/strategy/eddingtonstudy/

pubeddingbase?page=2 Review of Highways Agency’s Major Roads

Programmehttp://www.dft.gov.uk/pgr/roads/nicholsreport/?view=Standard

Highways Agencyhttp://www.highways.gov.uk/default.aspx

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DatabankOther sources: Office of Government Commercehttp://www.ogc.gov.uk Consolidated UK procurement regulationshttp://www.opsi.gov.uk/si/si2006/uksi_20060005_en.pdf Partnerships UKhttp://www.partnershipsuk.org.uk/index.asp 4pshttp://www.4ps.gov.uk/ Green Public Private Partnershipshttp://www.ogc.gov.uk/documents/Green_Public_Private_Partnerships.

pdf National Audit Officehttp://www.nao.org.uk/

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Databank

Other sources: Transport for LondonHome | Transport for London Thames Gateway Bridgehttp://www.tfl.gov.uk/corporate/projectsandschemes/

networkandservices/thamesgateway/2203.aspx TGB Public Enquiryhttp://www.persona.uk.com/thamesgateway/ Mersey Gateway Bridgehttp://www.merseygateway.co.uk/