Out-Law News | 15 Feb 2012 | 11:10 am | 2 min. read
In a new report (40-page / 561KB PDF), the National Audit Office (NAO) said that public bodies should receive clearer evidence that they are paying a fair price for funding "considering the stable environment that PFI generally provides".
The current Treasury review should "give closer scrutiny to the returns investors are getting from PFI projects and take account of the areas we have identified where there is scope for savings," said NAO head Amyas Morse.
Investors selling shares in PFI schemes early in order to fund future projects are typically receiving high returns of "between 15 and 30%" – well above an expected return of 12-15% at the point the contracts are signed, he added.
The PFI model was introduced in the 1990s as a way of using private funding to pay for major public infrastructure projects such as roads, prisons and schools. In a PFI agreement, the private sector obtains finance to design, build and operate a facility for the benefit of the public. In return the public sector will grant its private sector partner a long-term contract to run the facility and will pay a monthly fee over the life of the project to repay the loan.
The NAO has previously reported on the increasing cost of debt in financing PFI projects. Critics of the funding method have suggested that higher borrowing costs due to the recent economic downturn have resulted in its long-term costs becoming much higher than for other, more conventional, forms of borrowing.
The Government announced that it intended to reform the system in November last year. A 'call for evidence' on a replacement funding method that would "draw on private sector innovation but at a lower cost to the taxpayer" closed on 10 February.
Infrastructure law expert Kate Orviss with Pinsent Masons, the law firm behind Out-Law.com, said it was "interesting" that the NAO had chosen to publish its findings so close to the end of the Treasury's call for evidence. The department had specifically asked for responses on "a range of issues", including its approach to equity participation.
"The Treasury has firmly stated that improving value for money in equity investment needs to be taken into consideration as part of a wider ranging review. In a time when the whole PFI model is under scrutiny this must be the correct approach," she said.
"At the moment, what the new model will look like is the biggest question for any participant in the PFI industry whether equity investor, funder or contractor. Recent speculation that restricting equity from PFI projects would risk pushing investment abroad to more receptive markets such as Canada and Australia remains a concern more generally, and we look forward to the Government clarifying its approach to the new model and getting investment in infrastructure in this country back on track," she said.
The NAO said that PFI investors usually have to commit to providing around 10% of a project's costs up front as "risk capital or equity" before a bank will agree to lend the rest of the finance. The investor's stake is then the first money lost if a project runs into difficulty.
PFI projects are traditionally split into the 'construction' and 'operation' phases, with the construction phase being the most risky. Although investors theoretically bear these risks, which can include contractors failing to deliver or project costs being higher than anticipated, such risks are generally passed on to contractors in the project subcontracts, the NAO said. Additionally, the Government is a "very safe credit risk".
The Treasury and other contracting authorities usually relied on competition during the procurement process to ensure they received the best price but had not "gathered systemic information" around the time and costs of bidding, bank requirements and minimum rates set by investors which do not take into account the actual risks that a specific project will face, the NAO said.
It said that annual service payments in three projects it had analysed were 1.5-2.2% higher than expected "in terms of the main risks investors said they were bearing".