PFI projects: future in jeopardy

Any casual observer of PFI in the UK could be forgiven for coming to the
rapid conclusion that private finance initiatives (PFI) in the UK are in
terminal decline.

The high profile collapse of Metronet is perhaps the most graphic
illustration of an industry in crisis and other sectors have also had their
problems facing strong criticism.

While the £45bn Building Schools for the Future (BSF) programme almost came
to a complete halt last year; the health sector remains in considerable turmoil
as policy changes and money runs out; with the exception of the M25, there is
little current activity in the roads sector; and in defence, although some large
Ð and very over due Ð projects were signed last year, there are few new PFI
projects coming to market.


In the light of this experience, it is perhaps not surprising that mixed
messages have been emerging from the public sector about the long-term
sustainability of the PFI/PPP but is PFI finished as a procurement tool?

The simple truth is that there are no good new ideas as to what might replace
PFI as a financing tool for major infrastructure projects. While PFI is no
longer seen as the panacea, it still has a future even if it is now to be used a
little more judiciously.

To support this view the 2007 Budget allocated, for the first time, a
spending envelope of credits of £3.6bn a year for three years in a move ‘to
provide greater certainty to local authorities on the level of capital

In waste, the lack of alternative models to PFI and legal imperatives such as
the 2010 deadline to comply with the EU Landfill Directive have forced local
councils and the government to see common sense.

PFI will be used in waste, but only for the big recycling and incineration
plants and not for the collection and disposal services where its use is

In defence, PFI will not be the default procurement option that it once was
and, importantly, no project will receive the go-ahead unless it is able to
demonstrate that it can afford both an off and on balance sheet solution. But,
at least there are a couple of new PFIs that have come to market this year.

The £45bn BSF schools scheme appears to have recovered and a dozen new BSF
schools will open in 2007 with a similar number in 2008. The government has also
promised to act on social housing and transport and the most obvious route
remains PFI or a quasi-PFI model.

But while it would be safe to say that the government has not given up on
PFI, what about sponsors?

The administration of Metronet, with the loss of an estimated £300m for its
shareholders, and TfL will have been a very sobering experience for many but it
is unlikely in itself to have a significant impact on investors in PFI.

The tube PPP was a one off. The structure and risks associated with the deal
are without doubt unique to that project and while lessons have been learned,
there is far less read across into other PFI sectors than a casual observer
might assume.

However, there do remain some blockages in the market. Bid costs continue to
be of considerable concern to sponsors. The recent introduction of the
competitive dialogue with its emphasis on front ended effort before the
preferred bidder appointment, combined with the requirement for a post-preferred
bidder funding competition, has increased this concern.

Traditional viewpoint

The traditional position has been for government and local authorities to
strongly resist any requests from bidders to contribute towards bid costs but
there are signs that this resolve is now weakening and this has some support
from within the Treasury.

In May this year, the North Bristol NHS Trust admitted that its £374m
hospital scheme would reimburse bid costs as part of a drive to boost
competition in the health partnerships market. This is the first project where
losing consortiums will be officially reimbursed for a portion of their bidding
costs. Other countries have been paying back bid costs for some time.

However, there has been one significant change in the UK over the last year
or so. Prior to the introduction in 2006 of the competitive dialogue, the
practice under the negotiated procedure was for much of the detailed negotiation
on PFI projects to take place after preferred bidder selection.

This meant that even if the negotiations were protracted the consortium would
be able to recover its costs through the unitary charge. However, under the
competitive dialogue, there is a renewed emphasis on fully developing
documentation prior to preferred bidder selection as only clarification and fine
tuning is permitted once the dialogue is closed.

This will inevitably increase bidding costs. Those who defended the decision
to pay bid costs in North Bristol NHS Trust claim, this may not necessarily be
bad news, as awarding construction contracts without competition – according to
the research from Deloitte – can cost as much as 13% higher than the industry
average, so paying bid costs actually saves £33m.

Facts of business life

Nine out of ten senior executives with personal experience of establishing
and/or managing long term PFI/PPP deals believe that collaborative partnerships
are critical to business success and will become increasingly so, according to
an Ipsos Mori survey commissioned by Socio.

But the survey also reveals a disconnect between the importance of business
partnerships and the capabilities within UK organisations to make them work.

Public private partnerships are not only a fact of business life but an
increasingly significant part of the UK economy – HM Treasury reports £46bn
already spend with a further £26bn earmarked for investment by 2010.

Despite some fairly negative press, the study found that there is a lot less
cynicism out there than might be expected – in fact, nine out of ten UK senior
executives across both the public and private sectors said they thought the
benefits of business partnerships outweigh the cost.

Although much of the ground work has been done to establish and measure
governance and operational processes for partnerships, senior executives now
believe that the greatest value would come from developing better partnering

Respondents consistently identified mutual understanding and cultural fit as
being the most important factor to success – yet these are precisely the areas
in which they would like more capability.

Mark Paterson is a partner at law firm Burges Salmon
specialising in commercial contracts and PFI and PPP projects

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