The scene is set for an epic battle. The gallant Sir David Tweedie has thrown down the gauntlet. Together with his small but dedicated band of followers he has dared to challenge the practice of off-balance sheet accounting for PFI, and in doing so he has threatened the future of the initiative itself. He must now arm himself against the champions of UK industry, who are rallying rapidly behind the massed ranks of the Treasury.
Sir David has picked a fight with a formidable enemy.
On the face of it, Sir David’s challenge looks innocuous. All he has done is to issue, in his role as chairman of the Accounting Standards Board, a 27-page amendment to FRS 5: Reporting the substance of transactions.
He has tried to create, in his words, ‘an unequivocal rule book for PFI which clarifies where the risks lie with these schemes’.
But the new rule book is a contentious document. It proposes that all PFI schemes be forced onto the balance sheet, either under the application of leasing standard SSAP 21, or under FRS 5. In the past, they have often ended up falling ‘between stools’ as Sir David puts it, conveniently missed off the accounts of either government or the private-sector company involved in the scheme.
The amendment also insists on a dissection of the majority of contracts and the application of rigorous ownership tests that identify the asset as belonging to either the government or the private sector.
In practice, when these ownership tests are applied the vast majority of assets will end up on the government’s balance sheet. Sir David explains: ‘If the government takes the residual risk value, if it determines the nature of the property, if it bears variations in costs, all these things indicate that it is its asset.’
Tim Stone, head of PFI at KPMG, cannot see loopholes for the government: ‘This is a puritanical standard,’ he says. ‘Under the ASB’s proposals, every deal dreamt up from now on in, would end up on the public sector balance sheet.’ Such an addition to the debts of UK plc would be bound to upset Chancellor Gordon Brown.
But, regardless of Brown’s wishes, the logic behind a move to on-balance-sheet accounting is strong. Sir David reasons that PFI, currently off-balance sheet in the majority of cases, has become something of a time bomb threatening to explode into a financial crisis. ‘Confusion over the accounting treatment of PFI has made it difficult to see who is taking the risks,’ he says. ‘We’ve seen what happened to private companies with too much off balance sheet – they go bust. We believe that, for its part, the government should be letting future generations know what they’re in for.’
In this respect, the timing of the proposed amendment could not be more pertinent. There are a host of schemes that have been kept waiting in the wings since the end of 1996 and many are now ready to take the stage.
The Department of Health has at least a dozen outline plans for PFI hospitals.
Accountancy Age has discovered in-the-pipeline schemes for 11 schools, 15 new or improved roads and as many as 35 new court buildings. The amendment to FRS 5 is unlikely to be applied retrospectively – certainly that is not the ASB’s intention – but if it is finalised in March, as planned, as the definitive accounting standard for PFI, it would be applied to all of these new schemes.
‘PFI has never moved quicker than it is now,’ says Stone. ‘The government has turned up the Bunsen burner and it’s going like a train. At KPMG we have 140 people working on these schemes around the country, and I’ve spoken to big private-sector companies who see PFI as a major plank in their future business strategies. The number of schemes will just keep rising.’ Officially, the Treasury is taking the ASB’s proposals in its stride, ‘discussing its response’ and not appearing the least bit rattled.
But behind closed doors there is a feeling that Sir David’s hardcore accounting could spoil the PFI party, just when things were starting to go with a swing.
The Treasury has made no secret of the fact that one of the major attractions of PFI is its off-balance sheet status. In Partnerships for prosperity, published recently by the Treasury taskforce for PFI, this view is clearly defined: ‘Where the accounting analysis requires a PFI transaction to be treated in substance as borrowing, the procurer (the public sector) will almost certainly want to look at the deal again. The public body should examine the scope for reworking the deal so that it is clearly for the provision of services.’
The document continues: ‘There may on occasion be good, value-for-money projects that the auditors may wish to capitalise under FRS 5. Such projects may be acceptable but treatment in the relevant expenditure total would need to be discussed further with the Treasury.’
It doesn’t take a team of accountants to read between the lines. The message is clear: the Treasury does not want these schemes inflating the public-sector borrowing requirement.
But government officials are playing down the importance of any changes.
Terence Jagger, head of PFI at the Ministry of Defence, insists: ‘There aren’t any new instructions, I don’t know why we’re even discussing it.’ But several of Jagger’s counterparts at other departments admitted they were concerned about the proposed amendment, and that they were expecting the Treasury to put the ASB in its place.
Away from the corridors of Whitehall, the big dealmakers are prepared to admit that Sir David’s crew has stabbed at the heart of PFI.
‘The ASB proposals could be an utter catastrophe,’ says KPMG’s Stone.
‘They have the potential to scupper PFI as we know it.’
Keith Stein, head of PFI at Ernst & Young says: ‘We understand the sentiments behind the ASB’s proposals. But the practice is very different. The government is going to turn around and say “I’m sorry, we don’t want this on our balance sheet. To fund these developments we have to shift the risk.” But if they shift the risk to get it off the balance sheet, the private sector could be completely put off PFI. Either that, or the private sector will say that it will accept the risk, but only at a higher cost – jeopardising value for money.’
The other problem, as Stein points out, is that by changing the allocation of risk the project will have to have more equity finance – which is riskier and more expensive – and less debt. The likely consequence is that the cost of capital will rise and deter the participation of many private partners. The higher costs of capital could be balanced by increased payments to the ‘operator’ (the private-sector party) but this would have a negative effect on value for money, making it less attractive to the public sector.
Fighting on common ground
The dealmakers are convinced that PFI is already a commercial success, so they are not sure the ASB should have taken a knife to it. ‘From what I can see the ASB is being far too puritanical,’ says Stone. ‘The ASB seems determined to carve each of the contracts into separable and non-separable services and assets, when really what they should be looking at is the underlying commercial deal.’
Stone admits he is no accountant and his colleague Stephen Smith, whom Stone describes as ‘a technical wizard when it comes to PFI,’ says he has no qualms about the ASB’s methodology.
Hedy Richards, PFI specialist at Ernst & Young, says the ASB got it right with regards to disaggregation. ‘Most schemes seem to naturally separate themselves into different elements,’ she says. But she still feels there is a danger of getting ‘too bogged down in the accounting issues’. She adds: ‘All we are talking about here is simple double-entry bookkeeping.
It would be a shame if either the public or private sector let simple accounting get in the way of an initiative that is starting to work well.’
Jagger agrees: ‘The balance-sheet treatment doesn’t affect the commercial reality,’ he says. ‘The important thing is that PFI is proving its worth’.
No-one seems to disagree on this point. Sir David, for all his rigorous tests, is adamant that ‘the ASB is not trying to ban PFI per se.’ So it seems the two sides in this battle do have some common ground. ‘Too much uncertainty over the accounting rules for PFI would not benefit the sector,’ adds Sir David. ‘We hope PFI will become more efficient and that everyone will benefit, not just in the short term but in the future as well.’
Stein, who is worried about the effect of the ASB’s amendment, concedes that someone had to come up with some rules and regulations.
‘There’s no question that the issue of asset ownership and residual risk value has caused problems with particular projects. There have, for example, been disagreements between advisers on the schemes. There have been problems with people threatening to back out of projects unless they are financially restructured and some of these projects have taken an incredibly long time to negotiate, because there is no definitive structure in place.
It would help if we knew what standard we are working to, even at the tendering stage.’
Prior to the publication of the ASB’s proposals, the Treasury itself had admitted that someone had to clarify the accounting procedures for PFI. So the issue is not whether something should be done, but what should be done. Sir David still believes it is possible that the ASB will emerge victorious. He points to the precedent of the mid-80s, when a number of deals were constructed between banks and property companies to take assets off-balance sheet until the price was right for a sale. Some of the property companies went bust because their liabilities grew out of all proportion.
Sir David is hoping that such examples will serve to make his case stronger.
Refusal to raise the white flag
He is also hoping for the accountancy profession’s support. ‘Much will depend on the Big Six,’ he says. ‘The early signs are that they have mixed feelings. Accountants in PFI departments seem to have some sympathy with the ASB, but commercial concerns will weigh heavily on their minds, as they have all invested time and money in this growth sector.’ According to a Treasury spokesman, several of the banks have already given their backing to the government.
Sir David knows this, but is not about to wave the white flag. ‘There are a lot of vested interests in this debate,’ he says. ‘And that means we’ve got a battle on our hands. We will have to go before the select committee and hear their arguments. But unless they prove we are actually wrong and that we’ve missed a key point, we will not simply bow to the pressure.’
The problem for the ASB is that the Treasury has the power to overrule its decision, at least where the public sector is concerned. In typically candid fashion, Stone says: ‘The Treasury holds the cards, it has the ultimate sanction of saying “Look, we make the rules guv, and that’s the end of it”.’
An option the Treasury could exercise, according to one government official, would be to accept that the amendment to FRS 5 will be applied to the private sector, but to dictate that it has no bearing on the public sector, meaning no extra borrowing on the sacred PSBR.
Either way, it is unlikely that the ASB’s rule book will become a definitive accounting guideline for both the public and private sectors. The opposition to on-the-balance sheet PFI is too powerful. There is too much riding on this particular accounting standard. It would seriously jeopardise the government’s tight spending restrictions. As a consequence, Sir David is likely to be cut down to size by the Treasury’s iron chancellor.
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