Gavin Stoddart - Presentation. Vladivostok january 2013 25 01

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84th meeting of Business-Club "Dialogue"

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  • PPP – kind of project finance – existed since middle agesFirst countries to pioneer modern PPP were Australia (late 80s) and UK. These two and Spain are now among the countries who have used it most extensively
  • Also prisons, military (including mid-air refuelling jets for the Royal Air Force and military barracks), Embassy in Berlin
  • Risk – National Physical Laboratory
  • LACK OF FLEXIBILITYNAO finding - small changes in project specifications can result in fees of between5-10% of the work's value - leading to a £300 charge for changing a plug socket in one case!POOR RISK MANAGEMENTUtility purchasing power risk.Investors in one of the early prison projects made a £14m windfall gain when they used falling interest rates to refinance – taxpayer did not share in thisINEFFICIENT PROCUREMENTCriticism that a hospital scheme in Coventry was reverse-engineered by health chiefs to attract private capital. The city’s two hospitals were to have been renovated by the public sector for £30m. Instead they were demolished and one was rebuilt for £410m M25 widening scheme – if hard shoulders used rather than building new lanes he total cost would have been £478m – not £5bn.
  • Gavin Stoddart - Presentation. Vladivostok january 2013 25 01

    1. 1. Public-Private Partnerships in the United Kingdom Presentation for Dialogi Gavin Stoddart Vladivostok, 30 January 2014 www.moorestephens.ru PRECISE. PROVEN. PERFORMANCE.
    2. 2. History of PPPs in England and Wales • Norman Lamont makes an announcement about "ways to increase the scope for private 1992 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. • Survey by the National Audit Office concludes that, broadly speaking, PFI contracts offer 2003 good value for money. • Following financial crisis mini-bank created within the Treasury to provide loans of up to 2009 £2bn to PFI projects frozen due financing problems • Current Coalition government, formed in May 2010, confirms that it remains committed to 2010 the PFI as a way of delivering investment in infrastructure. 2011 2012 • George Osborne announces a review of PFI is to be carried out • Reform of PFI initiated – reformed version known as Private Finance 2 (PF2)
    3. 3. Some key features of PPPs in the United Kingdom Used by Financed 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 • Private sector debt (bonds, bank loans) • Private sector equity • Public sector debt • Public sector equity • May be underwritten by government Contracts Contractors • Usually 25-30 years (may be less than 20 or more than 40) • Include output specification • Often highly complex • 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. 4. Some key figures regarding UK PPPs £60 billion • Value of capital investment (at 2010 prices) committed by private investors under signed PFI contracts as of March 2011 £267 billion • Total payment obligation for PFI contracts in the UK as at November 2010 £1.5 billion • Value of funding obtained under PFIs during the latest financial year (2012-13)
    5. 5. Typical PFI project types Housing Hospitals Leisure facilities Schools Waste Roads Social Emergency services
    6. 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. • Potential to do things that would be difficult using conventional routes. For example, encouraging the development of a new private sector industry. • 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. Better allocation of risks Wider range of potential projects More projects on time and budget • 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. • Output specifications for design and construction encourage increased productivity and quality in delivery. • Specifying service levels and applying penalties to contractors if they fail to deliver encourages better performance. Encouraging on going maintenance Encouraging innovation and good design Incentivising performance • The banks providing finance conduct checking procedures, known as due diligence, before the contract is signed. This reduces the risk of problems postcontract. Commercial Due Diligence • Using standardised contracts reduces contractual errors. Fewer contractual errors
    7. 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. 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. 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. •The bank loans used to finance construction require a long payback period. This results in long service contracts which may be difficult to change. May lead to less rigorous assessment Reduced contract flexibility •Private finance is inherently complicated which can add to timescales and reliance on advisers. Increased complexity •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 •High termination costs reflecting long service contracts. •Increased commercial risks due to long contract period and the high monetary values of contracts. High termination costs Increased commercial risks
    10. 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. 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 30year 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 cashflows 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 CashFlow 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. 12. Other criticisms of PFI Ineffective use of private sector • Skills of the private sector in innovating not always harnessed Lack of flexibility • PFI projects long term and not responsive to changes in public sector service needs Poor transparency Poor Risk Management Inefficient Procurement Process • True cost of projects not always understood • Accounting rules driving the process - ―off balance sheet‖ • Wrong decisions about who best able to handle risk • Risk not always transferred effectively to Private sector • Criticisms of the way the procurement process has been run both time to make a decision and costs involved
    13. 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. 14. PFI Reform Long term value for money Increasing transparency PFI Reform Improving flexibility More effective use of private sector Reducing costs
    15. 15. PF2 – Reform of PFI - Approach Harness Private Innovation Expand sources of finance • Use private sector innovation to deliver services more cost effectively. • 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 Streamline procurement • Ensure greater flexibility to accommodate changing public service needs. • Deliver an accelerated and cheaper procurement process Greater financial transparency • Ensure that public sector is confident that it is getting what it paid
    16. 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. 17. PF2 – Changes • 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. Transparency • 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 • Proposes changes to ―Value for Money‖ regulations Value for money
    18. 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 Process • 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 • Ensure that there is a clear, understandable and efficient tendering process • Standardise as much as possible • Spend enough time carrying out the necessary assessments

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