84th meeting of Business-Club "Dialogue"

1. PRECISE. PROVEN. PERFORMANCE.
Public-Private Partnerships in the
United Kingdom
Presentation for Dialogi
Gavin Stoddart
Vladivostok, 30 January 2014
www.moorestephens.ru

2. History of PPPs in England and Wales
1992
• Norman Lamont makes an announcement about "ways to increase the scope for private
financing of capital projects” that launches the Private Finance Initiative (PFI)
1997
• PFI is expanded under the Labour government, which comes to power in 1997.
2003
• Survey by the National Audit Office concludes that, broadly speaking, PFI contracts offer
good value for money.
2009
• Following financial crisis mini-bank created within the Treasury to provide loans of up to
£2bn to PFI projects frozen due financing problems
2010
• Current Coalition government, formed in May 2010, confirms that it remains committed to
the PFI as a way of delivering investment in infrastructure.
2011
• George Osborne announces a review of PFI is to be carried out
2012
• Reform of PFI initiated – reformed version known as Private Finance 2 (PF2)

3. Some key features of PPPs
in the United Kingdom
Used by
• PFI is used in both central and local
government.
• For local government capital
element funded by central
government
• The local authority selects a private
company to perform the work
Financed by
• Private sector debt (bonds, bank
loans)
• Private sector equity
• Public sector debt
• Public sector equity
• May be underwritten by government
Contracts
• Usually 25-30 years (may be less
than 20 or more than 40)
• Include output specification
• Often highly complex
Contractors
• Usually a private sector consortium
• Consortium usually includes a
construction company and a service
provider, may also include a bank
• SPV created for purpose
• Many employees transferred from
public to private employment

4. Some key figures regarding UK PPPs
• Value of capital investment (at 2010
prices) committed by private investors
under signed PFI contracts as of March
2011
£60
billion
• Total payment obligation for PFI contracts
in the UK as at November 2010
£267
billion
• Value of funding obtained under PFIs
during the latest financial year (2012-13)
£1.5
billion

5. Typical PFI project types
Hospitals
Housing
Leisure
facilities
Waste
Roads
Schools
Social
Emergency
services

6. Potential advantages of PPPs
•Encouraging the allocation of
risks to those most able to
manage them and thus
achieving overall cost
efficiencies and greater
certainty of success.
Better
allocation of
risks
•Potential to do things that
would be difficult using
conventional routes. For
example, encouraging the
development of a new private
sector industry.
Wider range of
potential
projects
•The private sector is not paid
until the asset has been
delivered which encourages
timely delivery. PFI
construction contracts are
fixed price contracts with
financial consequences for
contractors if delivered late.
More projects
on time and
budget
•The banks providing finance
conduct checking
procedures, known as due
diligence, before the contract
is signed. This reduces the
risk of problems post-
contract.
Commercial
Due Diligence
•Many conventionally
(government) funded projects
fail to consider whole-life
costs. Involving private
companies encourages the
construction of more efficient
assets with transparent
whole-life costs.
Encouraging
on going
maintenance
•Output specifications for
design and construction
encourage increased
productivity and quality in
delivery.
Encouraging
innovation and
good design
•Specifying service levels and
applying penalties to
contractors if they fail to
deliver encourages better
performance.
Incentivising
performance
• Using standardised contracts
reduces contractual errors.
Fewer
contractual
errors

7. Overall evidence of success
• July 2003 survey showed that the only deals that were over budget
were those where the public sector changed their minds after
deciding what they wanted and from whom they wanted to buy it
• National Audit Office report inn 2009 found that 69% of PFI
construction projects between 2003 and 2008 were delivered on
time and 65% were delivered at the contracted price
• Salaries for guards lower in PFI prisons than in public prisons but
still attract staff

8. Successful project - Prisons
Building
time
• Under PFI as little as 2 years compared to 7
years when constructed by government
Design
• Consider to be better in PFI prisons than in
public sector ones (although this may just be to
do with age)
Running
costs
• Running costs lower in PFI - mainly because
staff are paid a 25% less than in the public
sector (though senior managers are paid more)

9. Potential disadvantages of PPPs
•Higher cost of finance as
bank lending to private
sector more expensive
than lending to
government. Has
increased since the Credit
Crisis.
Higher finance
costs
•The prospect of delivering
the asset using private
finance may discourage a
challenging approach to
evaluating whether this
route is value for money.
May lead to
less rigorous
assessment
•The bank loans used to
finance construction
require a long payback
period. This results in long
service contracts which
may be difficult to change.
Reduced
contract
flexibility
•The Public pays for the
risk inherent in private
finance contracts but
ultimate risk lies with the
public sector.
Paying for Risk
that is retained
•Private finance is
inherently complicated
which can add to
timescales and reliance on
advisers.
Increased
complexity
•High termination costs
reflecting long service
contracts.
High
termination
costs
•Increased commercial
risks due to long contract
period and the high
monetary values of
contracts.
Increased
commercial
risks

10. Assessing value for money
• The benefits and disadvantages of PPPs each have differing impacts
on the overall value for money of a project
• Some may not materialise on any given project
• Some of (both positive and negative) may also apply to other forms of
procurement
• The key question to consider is whether or not the actual benefits
unique to PPPs outweigh the disadvantages unique to them

11. Example to illustrate
Relative cost of capital - Government vs PPP
• This example is
from real life and
relates to a
hospital project
which required
£244 million in
capital
expenditure.
• The contract is
expected to run
for 34 years,
including a 4-
year
construction
period and a 30-
year
management
phase in which
the private
partner will
deliver
maintenance
services
• During the
management
phase, the Trust
will pay to the
private partner a
periodic unitary
charge. This
provides the
private partner
with a revenue
stream from
which to meet
operational
costs (primarily
maintenance
and lifecycle
costs, along with
the costs of
running an office
and paying
insurance), and
financial costs.
• The additional
financial cost of
PFI can be
derived by
discounting the
stream of cash-
flows at the
relevant
discount rate—
which is taken to
be the "gross
redemption
yield" on
government
"gilts" of the
approximately
the same
maturity as the
PFI loans (i.e.
30 year gilts).
This is 4.2%.
• Discounting the
Project Cash-
Flow stream at
4.2% produces
an NPV of £175
million. This
figure
represents the
additional
financial cost of
using private,
rather than
public finance,
to deliver that
amount of
capital
expenditure.

12. Other criticisms of PFI
• Skills of the private sector in innovating not always
harnessed
Ineffective use of
private sector
• PFI projects long term and not responsive to changes in
public sector service needs
Lack of flexibility
• True cost of projects not always understood
• Accounting rules driving the process - “off balance sheet”
Poor transparency
• Wrong decisions about who best able to handle risk
• Risk not always transferred effectively to Private sector
Poor Risk
Management
• Criticisms of the way the procurement process has been run
both time to make a decision and costs involved
Inefficient
Procurement Process

13. Failed project – London Underground
• In 2003 London Underground lines and rolling stock were effectively
privatised and passed to two companies – Metronet and Tube Lines
• The cost of writing the £15.7 billion contracts to upgrade the
underground was around £400m
• When Metronet, collapsed in 2007, it emerged that 95% of its bank
loans had been underwritten by the government, which had to come
up with £1.7 billion as a result.
• Government Transport Committee conclusion that it should not be
taken for granted that private sector involvement will bring efficiency

14. PFI Reform
PFI
Reform
Long term
value for
money
More
effective use
of private
sector
Reducing
costs
Improving
flexibility
Increasing
transparency

15. PF2 – Reform of PFI - Approach
Harness
Private
Innovation
• Use private
sector
innovation to
deliver
services more
cost
effectively.
Expand
sources of
finance
• To reduce cost
• To include
pension fund
investment
Balance Risk
• Strike a better
balance
between risk
and reward to
the private
sector.
• Maintain the
incentive on
the private
sector to
deliver
projects per
contract
Improve
flexibility
• Ensure greater
flexibility to
accommodate
changing
public service
needs.
Streamline
procurement
• Deliver an
accelerated
and cheaper
procurement
process
Greater
financial
transparency
• Ensure that
public sector is
confident that
it is getting
what it paid

16. PF2 – Changes
Equity
• Minority public equity stake (typical level 20%.)managed by a unit separate from the
procuring authority.
• Introduce funding competitions for a proportion of equity in order to attract long-term
investors into projects
Delivery
• Ensure that the tendering phase of PF2 projects to take longer than 18 months.
• Introduce a standardised and approach to PF2 procurement and publish a
comprehensive suite of standard documents.
• Introduce additional HM Treasury checks at the pre-procurement stage ensure that
projects do not go to market before they are fully prepared.
Flexibility
• "Soft" services such as cleaning and catering will removed from projects.
• Discretion on minor maintenance activities at the outset. Flexibility to add or remove.
• Mechanism to share any surplus lifecycle funding.
• Periodic reviews of service provision will be introduced.

17. PF2 – Changes
Transparency
• Control total for all commitments arising from off-balance sheet PF2 contracts signed.
• Information on private sector to be published.
• Publish an annual report on all projects in which the government an equity stake.
• More information on HM Treasury's website,
Risk
Allocation
• New internal rules within government for the management of the risk of additional
capital expenditure arising from issues such as an unforeseen general change in law;
utilities costs; site contamination; insurance
Value for
money
• Proposes changes to “Value for Money” regulations

18. Lessons to be learnt
Assess every project
individually
• Decisions should not be made based
on dogma or laziness
• Full financial and non-financial
analysis of the benefits of all potential
forms of funding
Risk Allocation
• Look carefully at who really bears the
risk
• Ensure the risk premium paid is
appropriate to the transfer of risk
Value for money
• Ensure that contracts are designed to
ensure value for money
• Ensure contracts include the right
incentives / penalties for performance
• Ensure that contracts can be
cancelled easily if value for money is
not obtained
Process
• Ensure that there is a clear,
understandable and efficient
tendering process
• Standardise as much as possible
• Spend enough time carrying out the
necessary assessments