PFI on trial – a juryman’s view

The fate of PFI hangs in the balance with a Treasury announcement expected next month.

Having heard all the evidence presented, it is not clear to me that either the prosecution or defence has made out a sufficiently compelling case. Independent enquiry suggests that either side could have weighed in evidence the fact that PFI, just like any other business, has been affected by market forces which have shaped its evolution. Early-wave pre-standardisation contracts were negotiated on the basis of risk assumptions which were cautious to averse. Competition and experience coupled with the introduction of standard forms of contract have relentlessly driven down the premium attached to risk and the cost of capital.  The defence should have made more of the impact of inflation – over which neither procuring authority or project company has any control – which has accounted (and will continue to account) for much of the cost escalation presented by the prosecution.  Anyone can see that linking costs to RPI is in reality inevitable and given the intrinsic unpredictability of retail prices, anyone can see that predictions of the through-life cost of PFI projects are at best guesswork and may be seriously misleading. Claims made by prominent parliamentarians and trumpeted by the media tend to be based upon such guesswork. Another issue which has not been adequately illuminated by the defence is the extent to which private companies have sustained losses (in the case of the National Physical Laboratory project, terminal for John Laing Construction). Jarvis is widely known to have lost large amounts on a number of service contracts and other companies of high standing have found that conflicting interpretation of service specifications and ensuing dispute resolution has left them out of pocket. The reality is that some PFI investors have definitely not been laughing all the way to the bank.

Thus whereas both prosecution and defence have presented a black and white picture, from where I’m sitting there appear to be several shades of grey. I’m also conscious that HMG’s record on direct procurement over the years has contributed its fair share of shocks to the taxpayer in terms of time/cost overruns and cancellations. At least with PFI these risks sit squarely with the private investors.

So, after an inconclusive debate, what does the future hold for PFI/PPP and where should this method of procurement sit within the limited range of options available to HMG for continuing its much-needed programme of infrastructure development?

Subject to some general – oft repeated and seemingly ever forgotten – observations about the urgent need for greater professionalism and competence in the specification and management of capital projects by the public sector, the overriding principle for public procurement should be to ensure that the taxpayer receives best value and is put in a fair position to judge that this will be delivered before being presented with the bill as a fait accompli.

Talk of abandoning PFI is akin to advocating throwing the baby out with the bathwater. As a procurement method it has a number of things going for it – it is well understood by the capital markets, contract documentation is well developed, it reliably and predictably delivers projects where alternative methods (if available) have proved unreliable and unpredictable and the PFI industry contains a reservoir of competitively priced, widely sought-after expertise which needs to be harnessed for future growth rather than be relegated to the out-tray.

Is PFI perfect? Absolutely not! It’s imperfections start with the byzantine complexity of EU public procurement rules (enshrined in UK law) which absorb huge amounts of time and money on both sides of the public/private sector divide, most of which is a hostage to fortune and is thrown away if for whatever reason the procurement is cancelled. So-called ‘deal specific variants’ over-complicate standard form documents already too complex after years of professional tinkering. The obsession with inviting tenders against an ‘output specification’ – basically a loose concept of outcomes the procurer is expecting – demands an ‘apples and pears’ assessment of the merits of widely different approaches which is inefficient and can lead to a triumph of aesthetics over functionality. As the lawyers would say, “this is not an exhaustive list”, however, taken in the round the faults with PFI/PPP – most of which are relatively easily curable – add significantly to the overall cost of the projects which make it to the winning post.

Inevitably in this economic climate it is the headline £p numbers which excite attention. Anyone who is told that payment of £4 million over 25 years for something costing £1 million to build will be easily persuaded that the deal is a rip-off – particularly if excited by non-specific references to refinancing gains and big returns to investors. A mixture of truth and disingenuity can be very misleading. The whole story is rather different. Leaving aside inflation mentioned above, much of the £3 million difference in the example used will pay for maintenance and other services ensuring that at the end of the 25 years the public assets are in good condition capable of delivering the underlying business functionality to the public with no backlog investment needed. Contrast this situation with publicly maintained assets showing disastrous levels of deterioration resulting from accumulated under-provision and a bill for restitution that can never be afforded.

Some advocates have extolled the virtues of the Scottish ‘No-Profit Distribution’ model as a nirvana approach to the future ‘acceptable’ shape of PFI/PPP. The NPD system has lenders but not investors and whilst seeking contractually to extract ‘super-performance’ from PFI companies to create surpluses exponentially returnable to the procuring authority, it offers little incentive, or realistic opportunity, for returns to be realised. The market will of course be judge and jury on NPD, but arguably there are simpler and more effective ways to achieve gains for the taxpayer from properly incentivised evolutionary improvements in working practices, energy savings and service developments. There may also be merit in looking at the French ‘cession de creances’ (assignment of receivable), which aims to achieve an equable sharing of risk and debt in PPP contracts and may offer bankable variants to the existing UK models which could yield a demonstrably better deal to the taxpayer.

As the Lord Chancellor said of the ending of his nightmare in Gilbert & Sullivan’s Iolanthe – “the night has been long, ditto ditto my song and thank goodness they’re both of them over” – I end my juryman’s review with a prediction that PFI/PPP will continue to evolve and subject to much-needed revision of process and practice must be harnessed to deliver excellent projects more quickly, more cheaply and with less wriggle room.