Whitehall officials are gossiping that the Treasury wants to kill off the PFI, some major contractors are losing interest, the National Audit Office is on the war path and the flow of deals has dried up. The Treasury is dithering over whether to take more control, contractors and banks are raging over having to take on more risk and there are murmurs about dubious handling of major projects.
And with strong opposition to the PFI during the Scottish and Welsh elections, the initiative has, for the first time, become a political hot potato.
The whole market is in a state of flux, with civil servants awaiting guidelines that have been in draft form for a year and contractors mulling over their future involvement.
One senior contractor says: “The private sector is thinking very seriously about the PFI. Some organisations are thinking, do I need to do this when I can do a partnering project for a 5% margin and not spend £1m getting it?” The chairman of another top 10 firm says civil servants resentful of change, professionals harking back to traditional procurement, unions and the media are all hampering the PFI. He says the savings being made on prisons and roads are not being repeated on hospitals and schools because first-time trust and council clients are constantly reinventing the wheel. “The result is an extremely long, drawn-out and expensive bidding process that can easily cost the participants from 5% to as much as 8% of the capital cost of a project.” He even says the cost of lengthy discussions with dozens of advisers often cancels out the planned savings. “The PFI is a very competitive market and has not proved nearly as attractive as was originally thought for the contractors and service providers involved,” he continues.
Trusts should maximise the extent of competitive tension in the bidding process for PFI projects
National Audit Office Report on Dartford PFI Hospital
The root of the problem goes back to the early days of the PFI, when the Conservatives, and then Labour, were under severe pressure to get deals signed on almost any basis possible. The first PFI hospital deal, a £177m undertaking by Tarmac at Dartford, was attacked on several fronts by the NAO last week, leaving a question mark over its whole raison d’être. It is quite possible, the NAO said, that it would have been cheaper to build the hospital traditionally.
Knowing that this broadside was on its way – drafts of NAO reports do the rounds within Whitehall for at least a year before publication – officials have been busy preparing their defence. The result is a set of new Treasury and Department of Health contract guidelines designed to derail any PFI gravy train, and possibly a complete overhaul of the sector.
The guidelines are causing problems in two areas. The first is their exact clauses, with one that insists that consortia get paid a “market rate” for their hospital if, for example, the hospital trust terminates its contract.
Contractors argue that the market rate for a hospital on which the trust client has cancelled the contract would be very low, putting their whole investment at risk.
The NAO report, however, makes the Treasury’s position clear. After criticising the Dartford deal’s provision to give Tarmac a “fair” rate of compensation, it explains that the Treasury thinks this “artificial” compensation system is not appropriate.
Commitments cannot come any stronger than delivering 12 major new hospitals since May 1997. We would not be signing contracts today if we did not believe there was a long-term future for PFI
Health Minister John Denham
The NAO report also explains that the risk to Tarmac of future changes in the law is capped at £2m – the new contract will see trusts and contractors fully sharing this risk.
Setting up a two-horse race
These changes are particularly galling to bankers, but for contractors, the more pressing issue is the new guidelines’ bid to prolong competition on projects. The NAO criticises the Dartford trust for quickly moving to two shortlisted contractors – Tarmac and Taylor Woodrow – because competition effectively ended after Taywood withdrew. This led to a situation where Tarmac increased its bid by 33%, which was later reduced to 17%, before signing the deal. The NAO says: “Trusts should maximise the extent of competitive tension in the bidding process for PFI projects.” As a result, a new system is being piloted on a second wave of PFI hospitals at Dudley, West Middlesex and Reading, whereby a shortlist of six is reduced to three and then two. The idea is that these two consortia are then taken “to the wire”, assembling all their design and financing before a winner is picked. But contractors see this as a ludicrous waste of money for the losing bidder. Laing deputy finance director Adrian Ewer says: “We don’t think it is necessary. The private sector doesn’t do this – why does the public sector have to? “There is still a paranoia – the need to get the audit to work – which is forcing this on them. But in the longer term, it will create a bigger issue because we will have to load the cost of projects we don’t win on to the bids for those we do.”
Who pays for wasted bid costs?
Barry Francis, a partner at law firm Beachcroft Wansbroughs, speaking at a conference organised by The PFI Report this month, said: “The issue will be, when these bids are priced, will they be affordable to the trusts?” It is this issue more than any other that threatens the future of PFI hospitals. Contractors have already met health minister John Denham to lobby for a change.
Our concern is that Labour is using the PFI to bring about vast quantities of borrowing and conceal it from the public sector balance sheet
Nick Gibb, shadow Treasury PFI spokesman
The attempt to push more risk back on to the private sector is also behind Treasury adviser Sir Malcolm Bates’ plan to create UK Capital, a new body to help regulate the PFI. Recommended in a report commissioned by chancellor Gordon Brown and sent to ministers in March, UK Capital would advise departments and invest public cash in PFI projects. The Treasury would thus have more control over the deals, and particularly over the financing arrangements struck with banks, which officials are concerned have led to poor-value deals.
But bankers argue that, by bidding to work for contractors, they give competitive rates of lending. David Metter, chief executive of top PFI equity funder Innisfree, also cites the creation of its new £150m investment fund as evidence that no extra public cash is needed to finance PFI projects.
WS Atkins’ head of PFI, David Clements, says: “I’m sorry the government isn’t allowing the market to develop incrementally and is trying to force the pace by intervening. It’s the spending departments that actually sign up and are accountable for the contracts, so I don’t see why a new central body taking over that authority makes sense.”
Increasing public sector involvement
Bates’ stalled report is expected to be published in the next month. If the UK Capital idea is accepted, a total overhaul of the PFI could take place. Industry leaders are expecting more public sector involvement in projects, with parties possibly sharing profits, more along the lines of local authority public-private deals.
We need more standardisation of terms, an acceptance that best value for money does not result from a high-risk tender process The public sector does not understand the principle of whole-life costing. It reverts to capital all the time. Also, the
There are other issues linked to specific projects that are causing the private sector real concern about the PFI. The £7bn public-private partnership to upgrade the London Underground, which contains £500m-750m of building work, is hopelessly stalled. And Whitehall cynics say the Treasury engineered a débâcle over the Home Office HQ redevelopment to help it escape the deal.
In this instance, a competition started in 1996 was cancelled in April because officials decided they did not want to move out of and then back into their existing base. But this was specified in early bid documents, and developers are livid that the project is now to be rebid to allow officials to make a single move to a new building.
Some senior industry figures believe the situation highlights another PFI headache – the difficulties officials used to picking the lowest price have in weighing up complex, 25-year deals. One says: “Some of the evaluation processes are strange. You need some nous to understand the importance of the answers given in the bids, which a lot of civil servants don’t seem to have.” Kier Project Investments director Les Mitchell says: “When you get into the grey areas of risk adjustment – which bidder is offering which benefit to the public – I don’t know how some clients make a judgement. Prisons and roads were much better – at least there are central agencies there with experience of assessing bids.” The Home Office deal highlights another gripe for contractors. Developer Godfrey Bradman put in an innovative bid that would have allowed the department a single move. This idea will now form the brief for the rebid.
Conversely, there is also real resentment that ideas outside the brief are sometimes rejected out of hand, even if they are quite clearly better than the original plan.