UK Chancellor Hammond signals the end of the most mature PPP/P3 market
In his address to parliament for the 2018 Budget, United Kingdom’s Chancellor Philip Hammond has announced the abolishment of Private Finance Initiative and PF2, pledging to never sign another deal. Does this mean Public-Private-Partnerships and their contract structures are dead in the UK?
WT unpacks the rhetoric and explores how this may affect the future of PFI/PPP/P3
By Adam Shaw, Nick Conte and Jake Witt
The Private Finance Initiative (PFI) is a delivery method of providing funds for major capital investments, such as infrastructure and other mega public projects, where firms from the private sector are contracted to complete and manage these public projects.
Under a PFI structure, the private sector is responsible for the initial costs of the project. After its completion the project is then leased to the public partner, by which they make annual payments, with interest, to the private company to recuperate their investments. These contracts are structured to span over the lifetime of a project and can last 30+ years (National Audit Office, 2018). In 2012, the Chancellor George Osborne’s infrastructure policy essentially rebranded PFI as ‘PF2’ ensuring parliament the “taxpayer would no longer lose out”. However, after six years, 68% of the population of England and 76% of the population of Scotland say PFIs should be banned (Jubilee Debt Campaign, 2017) and costing tax payers an estimated £148m, Hammond has announced that PFI has failed the taxpayer (BBC, 2018). The PFI model’s implementation has been falling since 2008 and reached an all-time low in 2014 (Jubilee Debt Campaign, 2017).
VALUE VERSUS RISK TRANSFER
Hammond alluded a key focus moving forward will revolve around risk transfer from the public to the private sector but failed to touch on value or a balanced approach to holding risk. The Office for Budget Responsibility noted the PFI structure posed significant financial risk to the public sector without adequately reciprocating that risk to the private sector. Given, in order to ensure the private partner operates efficiently and delivers a successful project, it is necessary to transfer risk (The Office for Budget Responsibility, 2018). However, risk is a broad spectrum and should be carried by the contractual party which is best suited to manage it and not blindly offloaded to the private sector.
Typical PFI risks include:
Regulatory and legislative;
Planning, design and construction;
Unexpected project delays;
Insurance and workforce risks
Ultimate responsibility and costs associated with operating and maintaining the asset;
Direct exposure to financial risk;
Unexpected interest rate fluctuations; and
Debt structure and demand risk.
Failure to fully understand the risks the public sector is transferring to private companies is a key reason for PFI and PF2’s failure. This was primarily driven by a failure to understand the differences in quality provided by rival bidders because procurement decisions were driven by price, subsequently resulting in lower quality end-products. The UK’s National Audit Office has identified a need for more than £300bn in social and economic infrastructure by 2020/21 (National Audit Office, 2018). With these mammoth demands, it’s financially infeasible of the public sector to exclude the private sector.
FAILING TO DELIVER VALUE FOR MONEY
PFI and PF2 critics have noted since the introduction of PFI in 1992, and the re-introduction as PF2 in 2012, the Treasury is unable to produce evidence to support its claims the PFI is worthwhile – apart from the fact it removes debt from the balance sheet. Hammond said the existing 700 active PFI and PF2 contracts will be honored, but there will be no new deals under the PFI and PF2 structure (Guardian, 2018). However, Public Private Partnerships (P3) projects include both qualitative and quantitative aspects, which is something that appeared to be overlooked in the PFI procurement strategy. Typically, P3 projects work towards an optimal combination of quantity, quality, features and price across the entire life of the project. As such, P3 projects should not be focused solely on price and should strive to comprehensively encapsulate the interests of the users (i.e. the public) as both taxpayers and beneficiaries of the project’s services. Therefore, in order to deliver value for money, quality versus cost should be a principle driving force, rather than excluding quality and focusing solely on the price.
INFLEXIBLE AND OVERLY COMPLEX
The Treasury has claimed the existing P3 models were “inflexible and overly complex.” With rigidness and obscurity, primarily driven by cost cutting, private partners to were forced to spend exorbitant amounts of money and to convalesce costs they increased interest payments, which exacerbated budget pressures. Hammond noted the public sector would cease to be a “pushover” as a client and continued to say a new division would be set up to manage existing PFI deals. This specialized governmental body will see out the end of the near 700 PFI and PF2 contracts, which are expected to conclude in 2040 (Guardian, 2018).
P3 projects are incredibly complex in nature and require careful consideration. P3 projects serve the public interest as the need to repair and continually develop infrastructure is an issue that cannot be overlooked. The public sector benefits with P3 projects through their innovation, risk sharing and value to the taxpayer and cannot achieve this without the involvement of the private sector. The PFI and PF2 models may have been overly inflexible and complex in their nature, however the overarching P3 model requires collaboration and risk sharing, not risk offloading.
However, Hammond mentioned that half of the UK’s £600bn infrastructure pipeline will be funded and constructed by the private sector and then went on to discuss the importance of technology and enterprise as drivers of growth. As such, these infrastructure and social demands necessitate a continuation of financing and involvement from the private sector to fund public projects. Social infrastructure apparently has been deprioritized as roads, railways, research and digital infrastructure were highlighted as industries “that will power this country in the 21st Century” (IJGlobal, 2018). Nonetheless, there will be a new model involving public projects with private financing. The new model may be adjusted to factor in a targeted focus or incentives to incorporate technology and enterprise.
I have never signed off a PFI contract as Chancellor…and I can confirm today that I never will.
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 but there is compelling evidence that the private finance initiative does, I can announce that the government will abolish the use of PFI and PF2.
We will establish a center of excellence to actively manage these contracts in the taxpayers’ interest starting in the health sector.
PFI and PF2 models have dealt with critics both inside and outside the construction industry before.
The proposed annulment makes room for a new model to replace it. However, this harkens back to a very similar issue which took place during the Global Financial Crisis of 2008. The Scottish National Party developed the Scottish Futures Trust to effectively replace the PFI model in Scotland. The newly rolled out model, Non-Profit-Distributing (NPD), which capped private sector earnings, sending surplus profits back into the public sector, supposedly shattered the illusion of “excessive private profits.” This was later shut down by the EU in 2014 (IJGlobal, 2018). The NPD was widely regarded as identical to its predecessor and critics have ranked the measure as an expensive political rebranding operation. Wales subsequently tweaked the NDP so private sectors were not capped however, 20% of the total equity will be shared with the public sector as shareholdings are mixed – fostering collaboration and keeping 80% off the balance sheets (IJGlobal, 2018).
We can expect the P3 model will endure as England will restructure and rebrand, presumably with a similar three-letter acronym. It is important to note that the development of the private sector and the public sector should not be mutually exclusive. As evidenced in the US, Canadian and Australian models, P3 projects are divisive and complex in their nature, but with flexibility and an emphasis on partnership, P3s can take on many forms to suit the infrastructure and the means of financing it – delivering monumental projects that are on time and on budget.
Hammond’s comments were (seemingly) intended to create shock and awe, and that’s what he got. Scratch below the surface, and all he is saying is that there needs to be more rigor around the contract structures, value for money and on-going management. It’s exactly what every other market has been doing for some years. I think the market is safe from anything other than a very temporary blip which will recover as quick as the news cycle changes.
Adam Shaw, Executive Vice-President of WT Partnership
WT Partnership is one of the fastest growing advisory firms in North America. WT was founded in Australia back in 1949, WT is known as the oldest start-up in the industry and has been a force in North America since 2015. Ranked in the Top Two Global P3/PPP Technical Advisory Firms by Inframation in 2017/18 and WT currently manages $6.5 billion dollars of active mega projects across North America.
BBC, 2018. PFI deals ‘costing taxpayers billions’. British Broadcasting Corporation News, [Online]. 1, 1. Available at: https://www.bbc.com/news/business-42724939 [Accessed 1 November 2018].
Davies, R., 2018. Hammond abolishes PFI contracts for new infrastructure projects. The Guardian, [Online]. 1, 1. Available at: https://www.theguardian.com/uk-news/2018/oct/29/hammond-abolishes-pfi-contracts-for-new-infrastructure-projects [Accessed 1 November 2018].
HM Treasury, 2018. Private Finance Initiative (PFI) and Private Finance 2 (PF2). HM Treasury, [Online]. 1, 1. Available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/752173/PF2_web_.pdf [Accessed 1 November 2018].
Jubilee Debt Campaign, 2017. The UK’s PPPs Disaster Lessons on private finance for the rest of the world. Jubilee Debt Campaign, [Online]. 1, 10. Available at: https://jubileedebt.org.uk/wp-content/uploads/2017/02/The-UKs-PPPs-disaster_Final-version_02.17.pdf [Accessed 1 November 2018].
National Audit Office, 2018. PFI and PF2. National Audit Office, [Online]. 1, 54. Available at: https://www.nao.org.uk/wp-content/uploads/2018/01/PFI-and-PF2.pdf [Accessed 1 November 2018].
‘Private Finance Initiatives’, Public Accounts Committee, June 2018; ‘Fiscal Risks Report’, Office for Budget Responsibility, July 2017.
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