PPP and PFI Value for Money

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PPP and PFI Value for Money

• Peter Livesey
• Senior Policy Analyst
• Corporate and Private Finance

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PFI Forces Long-term Thinking, Uses Private
Sector Risk Management
Others have been deemed less suitable
Some projects are suitable for PFI

• Small projects
• Performance was good, similar to larger projects
  for completion on time or early
• However, procurement times were
  disproportionately high, as were bid costs
• Overall, these findings suggested it was
  difficult for small projects to obtain VfM
• PFI for IT projects
• Fast changing technology and needs
• Multiple interfaces
• Difficulty of specifying risk transfer and
  substituting suppliers

• There is a major capital investment programme
• Requiring effective management of risks
  associated with construction and delivery
• The private sector has expertise to deliver and
  PFI represents good VfM
• The structure of the service is appropriate
• Public sector can define its needs as service
  outputs
• Allows optimal and efficient risk allocation to
  both public and private sectors
• Nature of assets and services are capable of
  being costed on a whole-of-life, long term basis

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Current Margins on UK PPP Lending

Source Ernst Young
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Advantages and disadvantages

• Conceptual advantages
• Integrated whole life management
• Risk transfer to private sector
• Design Risk
• Construction Risk
• Financing Risk
• Technology Obsolescence
• Operating and FM Risk
• Focus on output specification
• Opportunities for innovation in service delivery
• Long term certainty
• Private sector capital
• Can be off Government Balance Sheet

• Private Sector Capital
• Banks capital at risk therefore risk transfer
  incentivised
• Project finance discipline leading to whole life
  costing
• Bank step in on contractor defaul
• Conceptual disadvantages
• Cost associated with risk transfer
• Price must include profit margin
• Inflexibility

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Improved travel environment - London Underground
PPP
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London Underground PPP - Metronet

• Metronet in administration July 2007
• Potentially 2bn (30) over budget by the end of
  first period
• 350m shareholder equity lost
• PPP not PFI
• not standard form contract
• debt underpin 95
• not fixed price
• station renewals not clearly specified
• tied supply chain
• incentive alignmentDfT, TfL, Metronet

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London Underground PPP - Metronet
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UK Policy The Eddington Transport Study
The economic case for targeted new infrastructure
is strong and offers very high returns the best
schemes offer returns in the region of 5-10 for
each pound invested. Government should therefore
continue to deliver, together with the private
sector, sustained transport investment. Getting
the prices right means making a comprehensive
assessment of the full range of economic,
environmental and social impacts of policies,
including climate change.
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PPP/PFI in Transport
All Depts. Transport Number 650 Value
53bn
48 7
22.5bn 42
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Modal shift - Light Rail
Croydon Tramlink
Nottingham Express Transit BCR 2.0 high
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UK Policy - PPP/PFI
At investment appraisal value for money must be
assessed over the whole lifetime of a project,
including disposal, estimating the costs and
benefits to society as a whole, not simply those
directly relevant to the purchaser - e.g.
environmental impact.
The decision to use PFI is taken on value for
money grounds alone, but not at the expense of
employees terms and conditions. The accounting
treatment of a PFI project is not relevant to
this decision.
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Project Delivery
PPP/PFI delivers benefits on time and on budget
Source UK National Audit Office
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Strategic Considerations Change During The
Procurement Process
Departmental Investment strategy
Outline Business Case
OJEU
ITN
BAFO
Financial Close
Preferred bidder

• Main strategic considerations
• Is there a competitive market interest
• Is the procurement process being properly managed
• Is the commercial and financial deal achieved
  acceptable
• Is the deal still in accordance with what was
  desired before?

• Main strategic considerations
• Is the project the right one?
• Is PFI the correct procurement route?
• Is the project affordable?
• Is the project sufficiently developed to be ready
  to go to market?
• Is there sufficient indication already of market
  interest?
• Is the project team sufficiently prepared to go
  to market?

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PPP/PFI VfM Policy
HM Treasury Corporate and Private Finance
Team Private Finance Unit
Mandatory PFI Contract
Mandatory VfM guidance
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Value For Money Guidance 3-stage Process

• Predict which procurement routes should apply for
  projects in overall programme, and if PFI is
  appropriate
• Increase transparency and improve deal flow
• Ensure that investments made using PFI are
  affordable
• Verify initial decision to use PFI is valid, and
  if not change procurement route
• Feedback to improve evidence base, market
  management
• Ensure that project proceeds only if affordable
• Test whether the PFI solution is marketable
• Ensure an efficient bid process is planned
• Evaluate bids correctly
• Feed back market intelligence to planned projects
• Determine if there is market failure or abuse
• Ensure proposed risk-sharing is deliverable

Stage 1 Investment Programme
Departments
Project teams, monitored by departments
Stage 2 Project Assessment
Project teams, monitored by departments
Stage 3 Procurement Assessment
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UK Policy - VfM

• Ex-ante
• Capital strategy considered as part of
  Spending Review process
• Specific investment options identified and
  appraised using the Green Book
• Capital projects prioritised within
  Departments capital programme
• Those areas which may be suited to procurement
  through PFI identified

•  Stage 1 Programme Level Assessment
• Applied to the subset of investment identified as
  potentially suitable for PFI
• Central PFU liasing with team coordinating
  Spending Review submission
• Should be done in time with Spending Review
  submissions

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UK Policy - VfM

• Stage 2 Project Level Assessment
• Constitutes part of Outline Business Case for
  each project
• Project team updates analysis from Stage 1 with
  project specific information and identifies any
  key VfM issues
• If VfM is demonstrated then this assessment is
  noted in the OBC.
• If VfM is not demonstrated, then consider
  alternative procurement routes. Project should
  not proceed as PFI.

• Stage 3 Procurement Level Assessment
• Continuous assessment of whether drivers of value
  for money are maintained until financial close.
• Proceed with procurement ensuring there are no
  material changes such as market failure.

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Qualitative Assessment Makes Reasons For
Undertaking PPP Explicit
Example question
Categories
Programme level objectives and outputs Operationa
l flexibility Equity, efficiency,
accountability Risk management Innovation Servi
ce provision Incentive and monitoring Lifecycle
costs, residual value Transaction costs, client
capacity Competition
Is the procuring authority satisfied that
operable contracts could be constructed for
projects falling in this area? Does the
project involve the purchase of a significant
capital asset, where the risks of cost and time
over-runs are likely to be significant? Is
there sufficient client-side capability to manage
the procurement process?
Viability Desirability Achievabilit
y
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Standardised Financial Model - Used in
Conjunction with Qualitative Analysis
Only one part of the assessment qualitative
factors could be more important
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Where does value for money arise

• Whole life integrated service - design, build,
  finance, maintenance, service
• Innovative design
• cheaper construction cost
• cheaper whole - life maintenance
• Output specification
• services provided in different ways
• Possible third party income
• catering, nursery facilities, tolls
• Risk transfer
• More efficient utilisation of assets

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Whole life benefits - Street Lighting and
Highways Maintenance
BCR 3.5 high
BCR 2.3 high
Picture courtesy of PriceWaterhouseCoopers
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PPP/PFI delivers Whole Life Benefits

• Strong evidence of innovation in street lighting
  PFI projects
• White light lanterns saving 25-30 of energy
  consumption
• LED illumination for signs and bollards
• Lower wattage control equipment
• Induction lighting (100,000 hours burning time
  rather than 20,000)?
• Better directed light projects supported by the
  Dark Skies campaign.
• The significant investment in street lighting is
  leading to greater expenditure on research and
  development by manufacturers which is resulting
  in technological innovation.
• Source 4Ps review of operation PFI projects

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Main Considerations - Approving a Business Case
Before Going to Market
Assessments required
Main question
Long term needs assessment Scope of
project Value for Money Guidance (financing
decision)? Affordability assessment
budgeting Design quality assessment Output
specification Risk allocation Market interest
assessment contractors Market interest
assessment funders Documentation and
process Suitability of advisers Indicative
timetable Project team Commitment of sponsors,
users Statuatory process
Is the project the right one? Is PFI the
correct procurement route? Is the project
affordable? Is the project sufficiently
developed to be ready to go to market? Is there
sufficient indication already of market
interest? Is the project team sufficiently
prepared to go to market?
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2
3
4
5
6
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Qualitative Assessment Viability, Desirability
And Achieveability
Questions to be answered VIABILITY AND
ACHIEVABILITY
Programme level objectives and outputs Operat
ional flexibilIty Equity, efficiency and
accountability Transaction costs and client
capacity Competition
Is the procuring authority satisfied that
operable contracts could be constructed for
projects falling in this area? Can these
contractual outputs/requirements be robustly
assessed? Could the contracts describe service
requirements in clear, objective, output-based
terms? Could they support assessments of whether
the service has been delivered to an agreed
standard? Is the fit between needs and outcome
sufficient to proceed? In the event of staff
transfer, can the contracts be drafted to avoid
perverse incentives and deliver quality
services? Is the procuring authority satisfied
that operational flexibility is likely to be
maintained over the lifetime of the contract, at
an acceptable cost? Have the long term tradeoffs
between operational flexibility and cost been
identified? Are there public equity, efficiency
or accountability reasons for providing the
service directly, rather than through a PFI
contract? Are there regulatory or legal
restrictions that require services to be provided
directly? Have the expected staff terms and
conditions at stage 2 been considered and what
are the impacts on the contract, equity,
efficiency and accountability? Is there
sufficient client-side capability to manage the
procurement process and appraise ongoing
performance against agreed outputs? Can
appropriately skilled procurement teams be
assembled in good time? Is there evidence that
the private sector is capable of delivering the
required outcome? Is there likely to be
sufficient market appetite for the project? How
is it expected that the market will receive the
proposed risk profile?
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Qualitative Assessment Viability, Desirability
And Achieveability
Questions to be answered - DESIRABILITY
Risk management Innovation Service
provision Incentive and monitoring Lifecycl
e costs and residual value Overall
Does the project involve the purchase of a
significant capital asset, where the risks of
cost and time over-runs are likely to be
significant? Does a preliminary assessment
indicate that there is likely to be scope for
innovation? To what extent are the projects
scope, specification and operation pre-set or
open to negotiation with the private sector? Are
there good strategic reasons to retain soft
service provision in house? What are the
implications in the longer term for the
organisation in losing these skills are all the
expertise transferring or is there some
retention? Is soft service transfer essential for
achieving the overall benefits of improved
standards of service delivery? Where soft
services are not transferred, is this consistent
with the Prime Ministers commitment to
flexibility of public service provision? Can the
outcomes or outputs of the investment programme
be described in contractual terms which would be
unambiguous and measurable?Can the service be
assessed against an agreed standard?Would
incentives on service levels be enhanced through
a PFI payment mechanism? Is it possible to
integrate the design, build and operation of the
project?Is a lengthy contract envisaged? Will al
long-term contractual relationship be suitable
(or advantageous) for the service?Are there
significant ongoing operating costs and
maintenance requirement? Are these likely to be
sensitive to the type of construction? Overall,
is the accounting officer satisfied that PFI
would bring sufficient benefits that would
outweigh the expected higher cost of capital?
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PFI accounting under IFRS

2010 PFI may be in net debt
Autumn 2007 Consult on draft PFI guidance
Spring 2008 Final PFI guidance
Summer 2009 departments produce 2008-09 accounts
Autumn 2008 departments re-state 2007-08 accounts
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Issues arising from accounting change

• Stock
• - need to manage the impact on existing projects
  (although 45 on balance sheet, mainly due to 3
  tube deals)?
• PFI Pipeline
• - rigorous scrutiny of proposed PFI programmes
  for CSR07
• - future procurement of complex project

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Shorter journeys - Mersey Gateway Bridge
Mersey Gateway
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Motorway PFI
http//www.hm-treasury.gov.uk/documents/public_pri
vate_partnerships/ppp_pfi_stats.cfm
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Databank

• HM Treasury policy guidance
• Transforming Government Procurement
• http//www.hm-treasury.gov.uk./media/4EA/89/govern
  ment_procurement_pu147.pdf
• Green Book
• http//www.hm-treasury.gov.uk/economic_data_and_to
  ols/greenbook/data_greenbook_index.cfm
• PFI Policy
• VfM, standardised PFI contracts, project list
  (all financial data)
• http//www.hm-treasury.gov.uk/documents/public_pri
  vate_partnerships/ppp_index.cfm
• Budget 2007
• http//www.hm-treasury.gov.uk/index.cfm

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Databank

• Department for Transport policy guidance
• NATA
• http//www.webtag.org.uk/index.htm
• Eddington Transport Study
• Department for Transport - The Eddington
  Transport Study
• http//www.dft.gov.uk/about/strategy/eddingtonstud
  y/pubeddingbase?page2
• Review of Highways Agencys Major Roads Programme
• http//www.dft.gov.uk/pgr/roads/nicholsreport/?vi
  ewStandard
• Highways Agency
• http//www.highways.gov.uk/default.aspx

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Databank

• Other sources
• Office of Government Commerce
• http//www.ogc.gov.uk
• Consolidated UK procurement regulations
• http//www.opsi.gov.uk/si/si2006/uksi_20060005_en.
  pdf
• Partnerships UK
• http//www.partnershipsuk.org.uk/index.asp
• 4ps
• http//www.4ps.gov.uk/
• Green Public Private Partnerships
• http//www.ogc.gov.uk/documents/Green_Public_Priva
  te_Partnerships.pdf
• National Audit Office
• http//www.nao.org.uk/

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Databank

• Other sources
• Transport for London
• Home Transport for London
• Thames Gateway Bridge
• http//www.tfl.gov.uk/corporate/projectsandschemes
  /networkandservices/thamesgateway/2203.aspx
• TGB Public Enquiry
• http//www.persona.uk.com/thamesgateway/
• Mersey Gateway Bridge
• http//www.merseygateway.co.uk/