Treasury Select Committee - Report on PFI - Could the UK Learn from the Scottish Model?

Scotland
The Treasury Select Committee's much awaited report on the Private Finance Initiative was published on 19 August 2011 (the Report).  Click here for a link to the Report.

Conclusions and recommendations of the Committee's Report

We would identify the key elements of the Report, as follows:
 1.
Accounting and budgetary incentives. To remove incentives for taking forward PFI schemes which are unrelated to value for money, the Report recommends that a discussion is required in relation to PFI liabilities and that consideration should be given to assessing PFIs in the same way as direct capital expenditure.
 2.
Value for money. The Report recommends that the National Audit Office should perform an independent analysis of the VfM assessment process and model which is used for PFI.
 3.
Future Investment. The Report considers the costs of PFI financing to be “high” and concludes as follows:
Square the cost of PFI finance has not been offset by operational efficiencies and transfer of risk;

Square PFI is unlikely to be suitable where the future demand and usage of an asset is uncertain and where it would be inefficient to transfer the related risks to the private sector;
Square the Treasury should consider using more direct government borrowing to fund new investment;
Square some of the key merits of transferring design, build and operating risks to the private sector are recognised;
Square with respect to the cost of finance of current PFI projects, the government might “buy up the debt”;
Square a voluntary gain-sharing arrangement for sale of private sector equity stakes in PFI should be considered; and
Square consultation is required  on the use of other possible financing methods in competition to PFI.
Analysis of the Report's Conclusions and Recommendations

A number of the conclusions and recommendations of the Committee are matters of policy or of public sector accounting practice, and will ultimately be for the Treasury to reflect upon as appropriate in conjunction with relevant public sector stakeholders.  However, having now been directly involved with the work of this Committee and its equivalent in the Scottish Parliament on the matter of PFI finance, there are some observations we might provide:
 1.
It is clearly appropriate for procuring authorities to take account of the long term financial implications. The Committee's recommendation of recognising PFI finance liabilities in the UK national debt calculations to remove any incentive to use PFI raises wider issues.  PFI finance liabilities are just one of a number of implied government liabilities which would require to be considered in any reappraisal of the fiscal health of the United Kingdom and the Office for Budget Responsibility recognised this point in its Fiscal Sustainability Report, drawing out as examples liabilities surrounding public sector pension schemes and nuclear decommissioning.
 2.
The opportunity cost of PFI schemes, including in the context of financing costs, has long been recognised as a key area of challenge to the PFI model.  However, some of the conclusions drawn by the Report around value for money in light of the private funding costs would require to be forensically examined by the Treasury before firm conclusions can be drawn.
 3.
It is generally recognised that a deceleration in investment in public infrastructure is not an attractive option. However, by suggesting the use of more direct government borrowing to fund this investment, the Committee's challenge to the Treasury is at best aspirational given the current imperatives around debt restraint and deficit reduction.
 4.
Leaving to one side the question of how government might re-structure its fiscal rules to allow greater direct investment in infrastructure, the "cost of finance" argument is a powerful one if divorced from opposing factors such as risk transfer and efficiency benefit.  There are two obvious ways in which government might seek to test the true power of the argument:
Square fund the buy-out of selected operational PFI contracts and monitor future performance on a comparative basis; and
Square within the confines of competition law, provide debt funding support to proposed PFI contracts
 5.
The proposal for a gain-sharing arrangement in respect of the sale of PFI equity stakes is something that, even if deemed meritorious, would likely be complex to enforce and have been better deployed in the context of early PFI schemes (which, broadly speaking, produced a better prospect of high gains to investors).  The majority of those early schemes have already seen the private investment element traded in the secondary market and the gains thereby realised. Whilst the point may be worthy of consideration by the Treasury on future projects, profit-capping or investment sharing models, such as those currently being taken forward in Scotland under “NPD” (Non-Profit Distributing) and “hub” respectively, may afford a more effective means of sharing and capping investor profits.  The NPD model also enshrines the right of the public sector to instigate a refinancing of senior debt.  Such concepts already have general market acceptance in Scotland and, in our view, are likely to be more suitable and effective given the PFI market as it exists today.
 6.
The PFI market in Scotland has recently emerged from several years “in the doldrums” as the Scottish Government (through the Scottish Futures Trust (SFT)) spent time seeking to reconcile the need for infrastructure investment at a time of severely constrained capital budgets with the need to reform the PFI model to address broadly similar issues to those identified by the Committee.  The latest iteration of the NPD and hub models as presented in the standard form documentation recently published by SFT represent an improved PFI model combining profit capping/sharing mechanisms with refined risk transfer allocation designed to improve value for money.  Whilst the evolved model may not provide all the answers, it is certainly a step in the right direction and it is to be hoped that the Treasury, as it considers ongoing reform of PFI, will reflect on the experience and approach of the Scottish Government.