26/11/08 PPP and PFI Value for Money Peter Livesey Senior Policy Analyst Corporate and Private Finance

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

3 Current Margins on UK PPP Lending Source: Ernst &Young

4 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

5 Improved travel environment - London Underground PPP

6 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 alignment:DfT, TfL, Metronet

7 London Underground PPP - Metronet

8 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.

9 All Depts.Transport Number: 650 Value: £53bn PPP/PFI in Transport 48 7% £22.5bn42%

10 Modal shift - Light Rail Nottingham Express Transit BCR 2.0 high Croydon Tramlink

11 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.

12 Project Delivery 24%70%Projects late 20%73%Projects over budget PFIConventional Procurement PPP/PFI delivers benefits on time and on budget Source UK National Audit Office

13 Strategic Considerations Change During The Procurement Process Departmental Investment strategy Outli ne Busi ness Case OJEUITNBAFO Fina ncia l Clo se Pref erre d bidd er 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?

14 PPP/PFI VfM Policy HM Treasury Corporate and Private Finance Team Private Finance Unit Mandatory PFI ContractMandatory VfM guidance

15 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 Stage 2 Project Assessment Stage 3 Procurement Assessment Project teams, monitored by departments Departments Project teams, monitored by departments

16 UK Policy - VfM 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 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 Department’s capital programme Those areas which may be suited to procurement through PFI identified

17 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.

18 Programme level objectives and outputs Operational flexibility Equity, efficiency, accountability Risk management Innovation Service 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 Achievability Qualitative Assessment Makes Reasons For Undertaking PPP Explicit Example questionCategories

19 Standardised Financial Model - Used in Conjunction with Qualitative Analysis The quantitative assessment is a simple tool Tool kept simple – even non-Excel literate users should understand Only looks at the PFI decision – does not consider affordability Needs a sound evidence base Can use information from past PFI projects, from various depts Only one part of the assessment – qualitative factors could be more important

20 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

21 Whole life benefits - Street Lighting and Highways Maintenance Picture courtesy of PriceWaterhouseCoopers BCR 3.5 high BCR 2.3 high

22 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

23 Main Considerations - Approving a Business Case Before Going to Market Assessments required 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? Main question

24 Programme level objectives and outputs Operational flexibilIty Equity, efficiency and accountability Transaction costs and client capacity Competition Qualitative Assessment: Viability, Desirability And Achieveability Questions to be answered – VIABILITY AND ACHIEVABILITY 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?

25 Risk management Innovation Service provision Incentive and monitoring Lifecycle costs and residual value Overall Qualitative Assessment: Viability, Desirability And Achieveability Questions to be answered - DESIRABILITY 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 Minister’s 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?

26 PFI accounting under IFRS PFI rules – from 2009/10 (IFRS) PFI now (UK GAAP)‏ Overall framework Follow accounting treatment ? Follow accounting treatment ESA 95 – EU statistical framework ONS decide classification National Accounts (basis for fiscal rules)‏ Balance sheet decision depends on control Balance sheet decision depends on who has “risks and rewards” UK GAAP adapted for public sector International Financial Reporting Standards (IFRS) from 2008/9 Financial Reporting Advisory Board (FRAB) advise on adaptations NAO/Audit Commission audit accounts Resource Accounts Autumn 2007 Consult on draft PFI guidance Spring 2008 Final PFI guidance Autumn 2008 departments re-state accounts Summer 2009 departments produce accounts 2010 PFI may be in net debt

27 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

28 Mersey Gateway Shorter journeys - Mersey Gateway Bridge

29 Motorway PFI

30 Databank HM Treasury policy guidance: Transforming Government Procurement Green Book treasury.gov.uk/economic_data_and_tools/greenbook/data_greenbook_index.cfm PFI Policy VfM, standardised PFI contracts, project list (all financial data) Budget

31 Databank Department for Transport policy guidance: NATA Eddington Transport Study Department for Transport - The Eddington Transport Study Review of Highways Agency’s Major Roads Programme Highways Agency

32 Databank Other sources: Office of Government Commerce Consolidated UK procurement regulations Partnerships UK 4ps Green Public Private Partnerships National Audit Office

33 Databank Other sources: Transport for London Home | Transport for London Thames Gateway Bridge way/2203.aspx TGB Public Enquiry Mersey Gateway Bridge