REFORM OF THE PRIVATE FINANCE INITIATIVE RESPONSE Please send your responses via email, to: PFIevidence@hmtreasury.gsi.gov.uk The deadline for responses is Friday 10 February 2012. Respondent details Your name Mark Redhead Job Title / Level Head of Policy Organisation (Please state whether you are responding on behalf of an organisation or as an individual) Telephone number 020 7074 3273 Email address mark.redhead@foundationtrustnetwork The Foundation Trust Network is the voice of public providers of NHS healthcare. Particular interest in the reform of the Private Finance Initiative (PFI), if helpful in providing context to your answers As a newly independent membership organisation we speak on behalf of over 200 members, who are NHS foundation trusts and NHS trusts seeking to become foundation trusts. Our members span the acute healthcare, mental health, ambulance and community sectors.
Questions outlined in chapter 2 of the Reform of the Private Finance Initiative document Section 1: Role of the Private Sector Question 1 Do respondents think that the private sector has a role to play in the future delivery of public sector assets? Are there specific sectors where the private sector should not have a role? Much of the recent public debate has been critical of PFI contracts (including in the NHS). However, it is important the debate acknowledges that without PFI there would have been few alternative sources of capital funding for large projects. Projects financed through PFI have given the NHS a number of vitally important buildings to replace ones which were often in urgent need of repair (usually delivered in time and to cost). The Foundation Trust Network (FTN) strongly supports an ongoing role for the private sector in the delivery of public sector assets. We wish to see an environment with a plurality of different investment options and models, both public and private and we are working with our members and relevant stakeholders on realising this plurality. Some of these models achieve added efficiency as well as investment. PFI schemes may remain one option for future access to capital for the NHS. However, there should be other alternatives from public capital to additional commercial schemes and joint ventures. For example, consistent with the government s integration agenda around health and social care, it would be appropriate to explore the full potential of FT investment partnerships with local authorities. Historically there has been insufficient support for capital investment and maintenance, PFI was an attempt to correct this but will not be sufficient on its own in the future. We are aware that some members with PFI schemes are looking at the potential to buy out the contracts so that they have more internal control about managing spend. Question 2 Are there other delivery and procurement models used in the delivery of public assets in the UK and internationally that respondents consider work well? What are the key features of these model(s)? There are multiple other models in use in the health service, although not all of them are suited for the larger procurements. Particular existing examples include; Procure 21; LIFT; other Joint Ventures between the public and private sector. Other models may be particularly suitable where the project is not as specialised as an acute hospital, such as primary care premises or a Multi Storey Car Park. ProCure21+ FTN members report that this has worked well, for the following main reasons:
1. partnership approach, especially over a programme of schemes 2. integration of design and construction reduces costs and risk 3. guaranteed maximum price (GMP) transfers cost risk 4. benefit share arrangement where costs come in below GMP 5. publicly financed so lower cost of capital 6. P21+ supply chains are selected from a framework which has already been competed via OJEU, significantly reducing the procurement period compared with other methods 7. client retains full control over design decisions Some FTN members also consider that the LIFT model (Local Improvement Finance Trust) is more inclusive and can establish more collaborative partnership working, learning from mistakes or experience in each tranche of investment or going forward. Whether large hospital projects could have been realised through the LIFT type schemes is a difficult question to answer but if the NHS had looked at all the PFI schemes as a series of investment and project tranches (as per LIFT), a better result may well have occurred. Once the PFI contractor has the contract and builds the building there is less incentive to work with the NHS organisations (as identified in previous National Audit Office reports), whereas the incentive for LIFT providers is that they may not be guaranteed further work in the future. Question 3 How should the use of private finance be evaluated when considering the best procurement route to deliver a public asset? In many cases traditional public procurement methods (i.e. where the public sector funds and organises everything) have been seen as overly bureaucratic, risk averse, time consuming and usually taking longer to complete. The main strength of traditional public procurement is the fact that the Treasury can provide capital or borrowing at far lower costs than the private sector. However, the current state of public finances means that such access to capital is significantly reduced. Accurately assessing the value for money as well as availability of the different options remains the key requirement in deciding whether to use public or private finance. Evidence from the National Audit Office suggests that this has not always been done effectively in the past. Question 4 Are there features of the PFI model that should be retained? The key elements of a PFI contract are about delivery of a project, providing value for money, partnership working, integration of whole life costs, risk sharing and payment mechanism, performance and delivery of contract. The focus is on outputs rather than inputs and helps drive value for money.
The key feature - that the private sector provider has to have constructed the asset and services commencing before payment - has helped ensure that most projects have been delivered to time and cost. Developing Standard Project Agreement and associated schedules is particularly useful. There are lessons to be learnt from previous PFI schemes and this can only help improve PFI contract. Due to the complex nature of a PFI project it takes a considerable length of time to get through the procurement process and shortening the time period would be beneficial. Once the outline specification/brief has been established, it would be of benefit for the design to be fully developed for all phases of the project, much sooner in the process, so there is a much clearer understanding of what the output will be. Section 2: Institutional investment Question 5 What changes to the current approach to the allocation of risk and the procurement and delivery of public facilities and services would increase institutional fund investment appetite, either directly or through intermediary investment vehicles? Question 6 Would alternative approaches to the current typical capital structure of projects be favoured by institutional investors? What constraints currently exist to adopting these approaches, and how could these be addressed? Question 7 Are there other actions that could be taken, by the public or private sectors, to increase institutional investment in public assets and services, and what are these? What would be the expected implications for cost, risk transfer and value for money? The FTN is aware of the work currently being undertaken by the Cabinet Office to provide industry with greater visibility of future public sector demand (future procurement pipelines) over the medium term, together with a confidence rating to give industry greater confidence to invest for future business. We consider this to be a worthwhile aim which would encourage institutional investors, although the difficulties in doing so for the health sector are considerable. In the NHS procurement remains fragmented to individual organisations and there is no standard collection of information on long term capital plans. This is in part due to uncertainties around ongoing revenue funding and the wider requirements around necessary changes in service delivery across the NHS. Certainty around operating environments, structures and revenue streams would clearly help increase institutional investment appetite.
Section 3: Government s role in project funding Question 8 What if any role should public sector capital play in the financing of the construction or operational phase of public assets and services? How and when might public sector capital be best used to improve investor/lender appetite and pricing without adversely affecting risk transfer and performance incentives? What constraints should apply to the quantum of public sector capital grants? It may be the case that public sector capital could best be directed at any refurbishment elements of a development. The provision of public capital in the construction phase should be provided to whatever level provides best value for money, without artificial constraint. Question 9 What if any role should public sector risk underpinning or guarantees play in partially de-risking the construction or operational phase of public assets and services? In which areas could underpinning or guarantees have a beneficial impact on investor and/or lender appetite and pricing? What are the constraints to this approach, with particular regard to risk transfer and performance incentives? Although anything that reduces the overall risk (capital or operational) of the project would benefit the scheme and investors view, this would have to considered in the context of offering value for money and be affordable. The FTN feels that until the market is more developed and investors are able to have a better picture of risk and confidence in individual organisations, then retaining the option for a Secretary of State guarantee to be used in some situations is sensible. Question 10 If public sector capital grants are made to part-finance the construction phase of projects, what constraints should apply and what impact would a level of capital contributions in excess of the current 30% be expected to have on equity and debt investors investment appraisal and pricing, and on risk transfer and performance incentives? Question 11 If public sector loans are made to part-finance the construction or operational phase of projects, what impact would this have on equity and debt investors investment appraisal and pricing, assuming pari-passu ranking with senior debt? What approach should be taken to lender voting rights and what other constraints or procedures would be relevant?
Section 4: Debt finance Question 12 What alternative approaches to the debt finance of projects should be considered that would address regulatory pressures on the market, while maintaining current benefits of lender due diligence and risk monitoring - thinking about both bank finance and capital markets solutions? Question 13 What is the view of respondents to an approach which financed the construction period of projects separately from the operational phase? We are not clear as to what impact the separation of capital from operational phase may have on investor s appetite to a project. Providing there was sufficient interest on a PFI scheme that had these characteristics and, risk, pricing and value for money were not adversely affected then it could be something to be considered. With existing PFI contracts, the potential benefits are around looking at (amongst other things), the whole life benefits (and costs) of a project and a PFI contract may lose out on this, if a scheme is no longer bundled. Question 14 What impact would a shorter term debt finance approach be expected to have on financing costs? What if any implications would there be for the lenders due diligence approach and for the transfer of asset design, construction and maintenance risk? What factors would enable the transition from bank debt funded projects to capital markets refinancing? Question 15 What factors are relevant to consideration of the appropriate allocation of refinancing risk between the public sector authority and the contractor? Is it possible for project performance and credit factors to be separated from market factors when allocating refinancing risk? Question 16 What are the views of respondents on the effectiveness of preferred bidder debt funding competitions? Could a wider application of debt funding competitions enable
more effective access to the debt markets and what role should the public sector play in this, at a local or central level? We would expect that the PFI markets are familiar with funding competitions and involving the public sector (locally or centrally) in this may be a risk, in terms of lack of experience and time to reach a successful conclusion. Question 17 What alternative approaches could be considered to inflation risk and interest rate risk management, taking into consideration trade offs between budgetary certainty and operational flexibility? Section 5: Equity return Question 18 Would a regulated asset model be more economically efficient than the PFI concession model? Question 19 What are respondents views on an approach that capped equity returns or that provided for public sector sharing in returns achieved above a specified level? What impact would this be expected to have on investor appetite and pricing and on project performance? At what level should any cap or sharing threshold be set? This is a question for investors particularly. Whilst it sounds initially attractive to public sector organisations we do not feel in a position to make a recommendation on levels or thresholds that would prove acceptable. A sharing threshold with the individual organisation would be preferable to a cap as it would encourage both parties to work together to drive performance improvements. Question 20 Should the public sector limit the transferability of PFI equity? What nature and quantum of limit would not adversely impact on investment appetite and pricing, and on project performance? Members have expressed concern about the scope for, and past behaviour of PFI providers in, transferring equity holdings offshore to avoid UK tax, which affects the overall value for money of the PFI projects concerned.
Question 21 Should the public sector share in gains on sale of PFI equity, and what impact would this have on investment appetite and pricing? There is a balance to be drawn between the obvious attractiveness of sharing a gain on sale of equity and the impact this might have on the cost attached to the original equity investment. Question 22 What views do stakeholders have on public sector co-investment or joint venturing alongside private sector equity? What quantum or terms of public sector equity stake would not adversely impact investment appetite and pricing, and on project performance? As outlined in earlier questions, the FTN is keen to explore the potential for a range of new investment models, in partnership with other parts of the public sector for example local authorities. We are keen to support an environment where joint ventures are made increasingly possible so that FTs can make the most of opportunities to improve patient care in new and innovative ways. Section 6: Risk allocation Question 23 In what areas do respondents consider that a change to the conventional PFI risk allocation as between the public sector authority, sponsors, funders and suppliers could reduce costs and/or improve the flexibility while still offering value for money? In general we are sceptical about the degree that risk can be transferred from the public sector to the private sector. Risk is only transferred at a price and the private sector has responsibilities to future dividends and profits that mean they are likely to accurately demand higher premiums for higher risk. The aim should be to seek to risk share with the private sector in future in a way that mitigates the cost of capital rather than to transfer all risk, which will inevitably come at a high a price and not provide value for money. Question 24 Are there other ways in which the conventional contractual framework could be simplified in a way that would enable the private sector to price more cost effectively?
Section 7: Procurement and contract management Question 25 What further improvements could Government consider to the standard approach to PFI procurement in order to streamline the process and reduce costs, while meeting wider objectives for effective competition, accessing bidder innovation and maintaining a robust contractual framework? FTN members have found that entering into a PFI procurement process is complicated as there are contractual obligations running throughout the course of the contract (20 40 years) and is by its nature, lengthy. There have been improvements in the process such as developing Standard Form Project Agreements, learning lessons from previous waves of PFI contracts, reducing bid costs. Another improvement has been reducing the number of stages and bidders in the bid process to a more manageable level, whilst maintaining competition. Considerable experience has been gained through the Private Finance Unit that has been applied to the next wave of PFI schemes. As experience in the public sector increases this will continue to improve the procurement process. The approval process is overly-long and it is considered that the recent MPA requirements may only exacerbate this problem. The more bodies involved and the more drawn out the approvals process, the greater the procurement costs and the greater the inflation risk eventually borne by the public sector. The lengthier approval process now has led to the irony of guidance aimed at improving value for money in major projects may actually be compromising it. It is suggested that if the key parameters from the outline business case stage remain unaltered, then a streamlined approval should be possible - and desirable - for the appointment and full business cases. The government can also continue to work with industry to develop a range of standard designs that could be used, as bespoke buildings will inevitably cost more money. This would not be the same as having a standard design but more a range of options that could be drawn upon if needed. Government also needs to look at the appropriate processes, for example the use of Competitive Dialogue can be valuable but companies will inevitably account for the risk of losing such competitions in their prices. For simpler or more standard projects it may not be the most appropriate process. Question 26 Are there particular ways in which the private and/or public sector approach to contract management can be improved in order to manage contracts more cost effectively? The Foundation Trust policy was intended to bring greater commercial skills and awareness into the NHS. However, at the time PFI was introduced several years before, there was insufficient skill and experience at a local level in dealing with both contract negotiation and management. Although the foundation trust movement is addressing this there is still a way to go in terms of NHS experience in working with such contracts. FTs would appreciate being able to access support from a range of sources, including DH and Treasury to improve capability across the sector.
Section 8: Balancing innovation and standardisation Question 27 What is the right balance of output based versus standardised specification, when considering the twin objectives of accessing greater contractor innovation and reducing costs? The government can continue to work with industry to develop a range of standard designs that could be used, as bespoke buildings will inevitably cost more money. This would not be the same as having a standard design but more a range of options that could be drawn upon if needed. There is also a key role for providers to understand the outputs that they need, for example by engaging clinicians in the design and specifications in a way that they understand the quality and costs relationship and secure best value rather than simply aiming for either the cheapest standard or the highest possible quality. Question 28 Could a different approach to the engagement of contractors in the procurement process access greater private sector innovation? Section 9: Soft facilities service management Question 29 Should soft services continue to be included within the contractual model alongside the delivery and finance of the public facility? Soft FM should be considered as part of the overall value for money exercise for individual projects and if found not to offer value, then it should be excluded. We have examples both from members who have done this and from potential investors who would rather focus on construction and hard facilities management than be drawn into soft services. Question 30 Are there alternative approaches to the contractual framework for soft service delivery for a long life facility that could result in a better balance of risk transfer, flexibility and competitive pricing? The existing contracts allow for regular re-tendering of soft services and competitive tenders for new service elements that arrive. This needs to be supported by greater transparency and benchmarking of the cost and quality of such service elements. It may be the case that the contracts need to allow for easier transfer to a new FM provider if the existing provider is found to
be of lower value; for example the public sector organisation may find through benchmarking that there are better value for money options available but the cost of removing themselves from existing arrangements mean they are tied in to their current provider. Question 31 What impact would the separate contracting of soft services be expected to have on equity and debt investors view of the project s risks and rewards? Section 10: Hard facilities management Question 32 Under the current PFI model, how effectively has the party who holds hard facilities management and lifecycle risk been able to price those risks? Question 33 Reflecting on the long term nature of the contracts and changing approaches in maintenance contracts, for example improvements in technology that drive greater efficiency, how could the public sector have better confidence in the ongoing value for money achieved from hard facilities management and lifecycle risk transfer? Through the bid process there could be more transparency in respect of the lifecycle costs anticipated by the private sector and openness about the pricing of this. There is an understanding that the risk of this lies with the private sector but this has been priced. If the costs exceed the model, this falls to the private sector and if there is a windfall this goes to the private sector. Also a regular value testing process could be established in the contract, in a similar form to for soft facilities managements. Even if the public sector does not then actually change provider it will provide pressure for efficiency improvements and gain share. Section 11: Insurance Question 34 Are the insurable risks of PFI projects most appropriately dealt with (a) by the private sector with a fixed cost passed through to the unitary charge, (b) by a premium risk sharing mechanism or (c) by the public sector? Please specify reasons for your choice. There should be a mechanism that recognises this as a pass through and is managed over the construction and operational phases of the contract, where risks are likely to change over a period of time. Most models probably have some risk sharing whereby each party takes a part of the pain
or gain. Again, transparency is the key and openness of the pricing strategy. Both parties should be trying to achieve an affordable price and obtaining best value for money. Question 35 Are changes in insurance costs that are attributable to project-specific factors (eg claims-history, poor security, quality of build material, installation of sprinklers, security arrangements, etc) most appropriately borne by (a) the private sector, (b) the public sector, or (c) borne on a shared basis? Please specify how. Question 36 Are there (a) certain types of project (eg housing, office accommodation, specialist accommodation, highways, street lighting, equipment etc) and (b) certain types of risk (eg negligence of the contactor/supply chain, business interruption cover for banks, officer s liability, statutory cover, third party liability, vandalism, construction phase cover, property damage all risks), which are more/less suited to coverage by the public sector. If so, which are they and why? What are the concerns, constraints or procedures that would be relevant or required for any such public sector selfinsurance? Question 37 If the public sector provided cover for insurable risks for any future PFI projects, what incentives or penalties would be needed to promote a private sector interest in managing risks effectively to reduce/avoid claims? Question 38 Would you favour the establishment of a framework of insurers for PFI contractors to use (with the use of mini-competitions)? If so (a) should the use of the framework be mandatory and (b) would it lead to better value for money for the public sector compared with contractor led portfolios? Question 39
Do you consider that the ratio of premium income to claims paid for PFI projects indicates that (a) commercial insurance does or does not represent good value for money and (b) the commercial insurance market is or is not operating efficiently in this area? Please specify reasons for your view. Section 12: Flexibility Question 40 Should there be more and/or earlier break points in contracts and what would be the expected pricing impact for the public sector? Are there specific points that break points should be linked to? Future PFI and non-pfi funded capital projects need to consider whether contracts can be designed to more easily permit organisations to change the way they operate and adapt to a more competitive market. For example high termination costs and a lack of flexibility in being able to adapt buildings for long term service need are a barrier to necessary changes in healthcare delivery e.g. increasingly moving services into the community and closer to the patient. Question 41 What are respondents views on the current approach to determining voluntary termination compensation, are there alternative approaches that should be considered, in particular should there be differentiation in compensation amounts reflecting the point at which the termination arises? Section 13: Transparency Question 42 What degree of financial transparency should be adopted for future privately financed and delivered assets and services? There should be more transparency throughout the whole process, procurement through to financial close, construction completion and operations. The pricing of life cycle replacement, could be based on evidence of other similar PFI schemes or construction projects. This would help on the pricing of contracts, with both parties understanding what is being priced and whether this offers an affordable, VFM scheme.
Question 43 What are respondents views on the potential extension of project information requirements to periodic financial reporting and disclosure from project subcontractors and shareholders, including sub-contractor out-turn costs, project equity transfers and achieved project and equity returns? FTN members that this could be useful from a procuring authority perspective, as it would give reassurance that excessive profit are not being made. Question 44 Would a different approach to project governance improve transparency? What if any role should be played by the public sector in the governance of privately delivered and operated projects? Public sector representation on SPV Board may be a possible option to improve transparency. Section 14 Other Please use this box to include views on other issues that you consider are important that are not covered by the questions in chapter 2 of the Reform of the Private Finance Initiative. You can also use this box to capture alternative proposals or you may want to submit these in a separate attachment.
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