Practical Law

Nick Maltby, Consultant and PLC Public Sector consultation board member:

On 5 December 2012, PF2 finally arrived with the publication of “A new approach to public private partnerships” and a replacement of SoPC4, Standardisation of PF2 Contracts (December 2012).  It follows a detailed consultation a year ago and 12 months of guessing and delay.  So was it worth the wait? 

Before looking at what PF2 consists of and how it differs from PFI, it is worth revisiting the objectives of the PFI Review.  These were that there was to be a new approach to the delivery of public facilities that:

• Was less expensive and used private sector innovation to deliver services more cost-effectively.
• Could access a wider range of financing sources, including encouraging a stronger role to be played by pension fund investment.
• Struck a better balance between risk and reward to the private sector.
• Had greater flexibility to accommodate changing public service needs over time.
• Maintained the incentive on the private sector to deliver capital projects to time and to budget and to take performance risk on the delivery of services.
• Delivered an accelerated and cheaper procurement process.
• Gave greater financial transparency at all levels of the project so that the public sector is confident that it is getting what it paid for and the taxpayer is sure it is getting a fair deal now and over the longer term.

Before looking at the detail PF2, the dissatisfaction with PFI evinced by all political parties should be recalled, as embodied by reports of the Public Accounts Committee and Treasury Select Committee and the anti-PFI campaign by Jesse Norman MP and the Daily Telegraph. A key test for PF2 will be whether the government has done enough to address these concerns.

So what of the features of PF2? 

First, some good news for the PPP industry: the government believes that private sector investment, innovation and skills should continue to play a significant role in the delivery of public infrastructure and services.It is to be hoped that this will signal an end to PPP-bashing in all its forms and the introduction of a PF2 pipeline.  Moreover, the fundamental shape of PF2 resembles PFI in many respects.  There will continue to be long-term contracts between public and private sectors for construction and building maintenance financed by a mix of debt and equity.  The Education Funding Agency has published a Project Agreement for the Priority Schools Building Programme (PSBP) and those familiar with PFI will see that PF2 resembles PFI in many respects.  The reforms also build on some of the government’s other reforms since coming into office such as the publication of Whole of Government Accounts, the Operational PFI Savings Programme and the creation of the Major Projects Authority. 

The main changes under PF2 are as follows:

• Equity finance: the government will look to take a minority equity stake in future projects and will put in place arrangements to minimise the conflict of interest. While this is welcome it should be noted that this was a key part of LIFT and BSF and equity is likely to be more expensive than debt so this will not reduce the cost, particularly if projects try for a80/20 debt/equity ratio rather than 90/10. Funding competitions for private sector equity may also have unintended consequences.
• Debt finance: one of the drivers for the Review was the shortage of competitively priced debt finance (although it is interesting to note that the £4.5bn Inter City Express Project was nevertheless financed in the debt market) and the Government has made considerable efforts to bring in pension funds and other providers. PF2 will therefore be structured to facilitate access to the capital markets by transferring less risk to investors. However, it is clear that this sort of finance remains a work in progress and it is a shame that the European bond market has not recovered like the US market. The government’s efforts are, however, very much welcome.
• Appropriate risk allocation: The report notes that risk allocation has not always offered value for money and the hope is that under PF2 it will be improved (particularly in relation to general change of law and insurance reserves). This was a point made by many in the consultation and it is encouraging to see it taken on board.
• Flexible service provision: soft services will not be included in projects (as had already largely become the case) and some additional flexibility will be provided around the margins. However, PF2 will remain a long-term contract which cannot be broken without significant financial penalties.
• Transparency: a number of welcome measures will be taken to address this including requiring the private sector to provide actual and forecast equity return information for publication.
• More efficient delivery: like all governments since the advent of PFI, it seems that central delivery will be enhanced. Whether this will be achieved depends to a degree on what the pipeline looks like although the central approach of the Education Funding Agency is very much welcome. It is unclear why the government continues to shy away from the creation of a centralised procurement unit but it appears we are moving in the right direction. More controversial, is the commitment to close all projects in 18 months from advert. The travails of waste projects suggests that this may be difficult and it must be queried whether this is a risk that the private sector should be exposed to as delay arises from all sorts of sources. While it is good to have a standard suite of documents, this has been a hallmark of PFI for as much as a decade and to the extent that there are changes it would be desirable to bed them down before setting them in concrete.

So how has the government fared against its set objectives? 

While it is questionable whether the new model will be cheaper or much more flexible and it is doubtful that all projects can be procured in an arbitrary 18 months, the government has avoided reinventing the wheel entirely and provided a much needed overhaul of the basic PFI model.  PF2 is therefore to be welcomed.  However, setting aside the PSBP and one defence project, the industry will be wondering where the pipeline of projects is once the legacy Labour projects reach financial close and it will be interesting to see when this emerges.  At a time when money is tight, in PF2 we have a model that can deliver much-needed facilities during a time of austerity and it deserves to fare well.  It is to be hoped that the politicians think the same.