Private Finance Initiative – Unravelling PFI

It seems as if it is the fate of the private finance initiative to be reviewed, examined, fiddled with, tweaked and held up for public scrutiny by innumerable interested parties. The present government asked Sir Malcolm Bates to look into PFI within days of taking office. But that was not the end of it. His report was merely a prologue.

Sir Malcolm has recently completed his second review, the results of which are keenly awaited. Soon, the Commons public accounts committee will publish a similar tome on best practice in PFI deals. The Treasury is due to produce its response to the Accounting Standards Board’s revised FRS5 on accounting for PFI. And the Commons Treasury committee has decided to review the initiative’s progress and assess its impact on future spending plans.

But while these studies are being carried out, practitioners in the field must wonder if they will ever reach a steady state so they can get on with making deals work.

Ernst & Young’s corporate finance partner Lindsay Allen says the plethora of reviews only creates confusion. ‘What does appear curious is that on one hand we have Bates II, which will presumably opine about the future of PFI and the extent to which it should be changed, and the separate committee reviews. Then there is the outstanding Treasury guidance on how to account for PFI transactions,’ says Allen. ‘I would have thought they needed to go together. At the same time, there is an independent review of government procurement. I am not sure how that can reach conclusions without understanding fully where Bates is.’

Many of the Bates report recommendations are likely to be mirrored in the PAC’s findings on best practice. A spokesman for the committee says the report, to be published in late May or early June, will be a practical document. ‘We are taking all the lessons learned from individual PFI exercises and tying them together to produce better advice on how to do it in future.

It will be another benchmarking report like in 1983 when we published advice on the proper conduct of public business and followed that up with one on privatisation,’ he says.

The PAC is unlikely to recommend that private finance be scrapped. Generally, the MPs on this Labour-dominated committee are in favour of the scheme.

They see their role as providers of guidance to make the deals better for the taxpayer, and are likely to make recommendations on several areas, including innovation, risk transfer, payment mechanisms, public-sector comparators, audit and the cost of advisers.

The committee chairman David Davis sees innovation as one of the key reasons for using PFI and would like tenders to be written more loosely.

He has pointed out that departments which are awarding contracts do not allow private-sector partners sufficient room for manoeuvre. In last July’s report on the first four PFI road schemes, for example, the committee highlighted the fact that after awarding the contracts, the Highways Agency accepted the operators’ proposals for more than 3,000 innovations. It went on to say: ‘This suggests that the core requirements in the original tender documents were too tightly drawn to encourage novel ideas. However, the exploitation of private-sector innovation is critical to the success of the PFI in delivering improved value for money.’

But the measurement of value for money could remain a thorny problem.

‘In any procurement model the amount paid is not always what people expected at the beginning of the contract,’ Allen says. ‘The important thing is that the basis of the evaluation of whether PFI is an option should be robust and thorough, and proper comfort in the commercial terms and conditions of the contract should give the public sector control.’

Risks involved with risks

The PAC is likely to examine risk and payment mechanisms. While it will reiterate the need to apportion risk to the party best able to shoulder it, the committee may also recommend that public-sector bodies do not create new risks when agreeing payment mechanisms. If payments are based on volumes of activity over which neither the public sector nor the operators have any effective control, the risk will effectively be borne by the operator. Risk costs money, so in this case the public sector has increased its costs needlessly.

The MPs will almost certainly insist that robust public-sector comparators are used when calculating the viability of any PFI deal. In some cases, most notably the £36m Skye Bridge project, public-sector comparators were not used at all. Even if a publicly funded alternative is not being considered, the MPs feel that a comparative costing is an essential element in the PFI process.

The committee is also keen to ensure that the Comptroller and Auditor General is granted access to private bodies providing public services under contract. Last July, it said: ‘The value of contracts awarded or pending award to the private sector (including those under the private finance initiative) is some £13bn. If access is not provided in the contracts, the C&AG may be unable to check that public funds have been used as parliament intended, and with due concern for regularity and value for money.

‘The Treasury could require departments to provide a contractual access clause for the C&AG in all cases, including private finance initiative deals. At present, the guidance on contracted out functions and private finance initiative deals is equivocal on the inclusion of such clauses in contracts. The guidance could be strengthened by establishing a presumption that they will be included in all contracts with providers of public services of this kind.’

The Treasury’s response to the ASB on accounting for PFI will have major repercussions. All the signs are that the Treasury will accept that deals, or at least parts of deals, will be on the balance sheet. This is sure to play a large part in the deliberations of the Commons Treasury committee when it sits down in the autumn to assess PFI’s successes and failures.

Giles Radice, chairman of the Treasury select committee, says he will accept written evidence until the end of June. ‘We shall be looking at PFI’s progress, its successes and failures and asking what should be the guidelines for the future. I would not have thought we will be looking at individual projects, except in so far as they might illustrate a particular trend,’ he says.

The committee’s findings are not expected to be published until the new year.

The inquiry will also examine PFI’s impact on government spending. Radice would not be drawn, however on whether the committee would assess the effect of accounting treatment on the government’s current and capital expenditure, saying that the committee had not yet had a chance to discuss the full extent of the inquiry. But it is difficult to see how this could be avoided. Georgina Ayling, ACCA’s senior technical officer for the public sector, says the adoption of the revised FRS5 standard could have repercussions for public-sector balance books.

‘I believe public-sector bodies would have to go back to PFI deals and retrospectively apply the test to see whether there are liabilities or not. This could have quite a significant effect on their balance sheets. I think that if they are going to get their accounts right, then it will have to apply retrospectively.’

The adoption of the ASB’s new standard would affect both current and capital allocations. ‘If you do the test and find you have got an asset and a liability, it would affect the capital budget,’ she says. ‘In a PFI deal the operating payments will come under current expenditure – the income and expenditure account. But if one of the tests points that the government still has a benefit and a liability, at least part of the deal will go on balance sheet. This will count against the capital allocation.

If there is an ongoing lease, the net value of the leasing payments will count against the capital allocation every year.’

Significant changes lie ahead. The second Bates report, the Treasury guidance on accounting for PFI and the public accounts committee’s report will revise and update best practice. The Treasury Committee’s report could even prove embarrassing for the government. But hopefully, once the current reviews are out of the way, PFI practitioners will be left to get on with the job.


PFI is big business for the Big Five firms and other consultants.

The Scottish Office spent £3m on advisers for the Skye Bridge project, while consultants drew fees totalling £1.55m from the Bridgend and Fazakerley prisons PFI.

Accountants and financial advisers attract the greatest share of advice spending. Price Waterhouse/Hambros received over £1m for their work on the first four major road project PFIs. In contrast, solicitors Denton Hall took around £400,000.

But this income could be in danger. One consultant, who did not want to be named, says the development of model contracts will ‘seriously affect our ability to make money out of PFI’. The Commons public accounts committee is likely to insist that fees for professional advice should be fixed in advance.

But Ernst & Young’s corporate finance partner Lindsay Allen believes this does not mean PFI consultancy is dead. ‘Projects will tend to polarise into two groups. Highly reproducible projects with relatively standard models are emerging for things like hospitals. Clearly, where good practice has been established and the direction tested and accepted, less external advice should be required,’ he says. ‘But in other projects that are very large or unusual, such as with London Underground, rail infrastructure extension or major urban transport developments, external advisers will continue to have an extensive role.’

The consensus seems to be that consultancy work will be curtailed to some extent, though in an effort to keep costs down, government departments will contract with large firms to work on several projects at a time. Seamus Ward is a freelance journalist

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