Weighing up the case for PFI

A&L Goodbody Partner Mark Thompson examines the success factors for PFI projects and the lessons learned to date.

It has been widely reported that the ability of Northern Ireland to drive and sustain economic growth over the next decade will be dependent on various factors, and that a key factor will be investment in infrastructure improvements. To support local business and attract increased foreign direct investment (FDI), investment will be required to deliver affordable and sustainable energy and water supply, waste management improvements, upgrade the transportation network to move people and goods in and out of the province and to continue development of the ICT network.

The current fetters on public finance for procurement of this number of investments by traditional means has led to renewed discussion as to the merits of the Private Finance Initiative (PFI) and the use of public private partnerships as a means of supporting the public purse. The PFI was first introduced by the Conservative Government in 1992 and since then has been widely used in the United Kingdom. Latest figures from HM Treasury show that 728 PFI schemes have been entered into throughout the UK with a value of £56.6 billion.

In Northern Ireland, there are currently 39 ongoing PFI projects which include the Belfast Metropolitan College in the Titanic Quarter, Belfast City Hospital Cancer Centre, and a range of education and health projects in the South West, South East and Belfast City. The Northern Ireland Audit Office has stated that the total value of the PPP contracts in Northern Ireland is in excess of £7 billion and that the costs to the Northern Ireland Executive are approximately £245 million each year. Advocates of PFI argue that it provides:

• Value for Money (VFM) – delivering value for money compared to conventional procurement, assessed by reference to properly constructed Public Sector Comparators (PSC) which is appropriate and necessary;

• Affordability – being sustainable in the longer term (i.e. over the life of the contract) and is compatible with the effective management of public expenditure; and

• Best Practice – PPPs bring new technology and know-how from the private to public sector in an open and transparent manner consistent with social partnership arrangements.

However, not all PFIs have been successful. What is becoming increasingly useful is the body of data that is now emerging from the significant number of projects which are now live in the UK and globally (many for more than 10 or 15 years), which offers the opportunity to assess where PFI can work most effectively, and where it has less efficacy. This is highlighting the sectors in which the model works well, key factors in successful PFIs, areas where PFI should be avoided and what might have been done differently when those early projects were procured. The ability to recognise this data is also useful in determining where PFI may be selected as the best funding route for a particular project when there are a number seeking finance.

The data indicates that PFIs have worked best where:

• projects have a strong rationale, are essential and enjoy broad political or public support;

• the outputs for the project have been clearly defined and are expressly specified in the contract;

• the project is in a mature and/or stable sector where development occurs at a gradual pace and delivery requirements and usage are more predictable;

• competitive bidding can be generated and maintained during procurement;

• transaction structures avoid overt complexity and allow for financial and contractual flexibility;

• when it is used for straightforward assets of a modest size;

• when risk allocation reflects stakeholder capabilities and capacity;

• when private money is really at risk;

• where delivery of VFM and efficiency benefits is achieved;

• the transaction is planned over the longer term and is a commercially driven partnership between the stakeholders;

• the private sector partner is financially robust and sustainable;

• a strong partnership emerges between shareholders exhibiting; and

• the project is a separate, standalone one with limited interface risks.

Those projects which, in the early development stages, do not make sense from a commercial perspective or cannot be let to the market on a sensible basis under a traditional procurement model, will not be improved, or have their issues mitigated by procuring it as a PFI. The model does not operate well where a difficult issue is being passed to the private sector.

Best fit

Experience from active projects tells us that, in relation to schools and highways, the PFI model works best. On the schools side, private sector developers bring good construction experience with innovation and emerging best practice at no extra cost. This leads to design and build synergies for contracting authorities.

Largely, the data highlights that schools’ projects are generally successful, although market perception of the correct allocation of risks and responsibilities is still evolving and that a common theme with the most successful schools projects is the buy-in of the head teacher, early in the procurement. That being said, schools PFIs can go wrong, as was seen with a well-known local project (which adopted a commercial approach, strong negotiation processes and a responsive decision making process) which was built using a PPP scheme – only for the school to close in 2007 due to falling student numbers and leaving a commitment for the education and library board to pay £7.4 million annually over the next 20 years. This was despite the school being closed. A good example of an issue is a project that was not mitigated or removed during the procurement process.

In respect of roads, these have also built a strong evidence base of a good fit with PFI, with fixed price asset delivery, locked in maintenance and value for money. As a relatively straightforward asset unaffected by technological change, highways have been at the forefront of PFI across Europe. Part of the appeal to using PFI for roads has been the ability to lock in future maintenance obligations as part of the contract but this has led to various projects being revisited were operators have struggled in the current economic climate.

Road projects that have been less successful having been troubled by issues such as unexpected land conditions (which has led to increased emphasis on construction risk with funders), complex interfaces with utilities during the build, and demand risk being poorly evaluated.

Projects in other sectors such as health have a less comfortable fit with the PFI methodology. History has shown that the delivery on VFM can be challenging given the varied nature of health-related project. Whilst such assets tend to be delivered quickly, concern is becoming more common on affordability, responsiveness to future health care policy and lifecycle costs compared with the cost of building them through conventional procurement.

Given the range of projects that are likely to be procured in Northern Ireland, it seems that some of these will undoubtedly be delivered through PFI funding. To that extent, it is important for those procuring infrastructure projects to determine at an early stage whether they will procure conventionally or, for those which are suitable through PFI.

A&L Goodbody
42-46 Fountain Street, Belfast, BT1 5EF
Tel: +44 (0)28 9031 4466
Email: mthompson@algoodbody.com
Web: www.algoodbody.com