PFI - Making it Work! : 1

Development of the PFI Approach

PMI's Martin Mustard reflects on the background to the Private Finance Initiative and the growing sense of disillusionment generated initially.

It is something of an understatement to say that the Government's flagship Private Finance Initiative (PFI) steamed into stormy waters following its launch in November 1992. Four years on and its veracity as a procurement instrument is still under fire but Insight reports on the discernible groundswell of calculated optimism and a will in both the Private and Public Sectors to make it work.

Use your imagination; this might have been a real dialogue around 1993 or 1994: ?Breaking new ground! Breaking new ground! Codswollop!? (or words to that effect), moaned the consultant in mild disgust. She was in fact defaming the Treasury publication of the same title which her client had just slipped across the desk.

The client looked coolly into the eyes of his prize adviser and shrugged his shoulders. "I can understand what you're saying, Lynn", said the client sympathetically, "but my instructions are to test PFI as a procurement option within the project business case. I've been told that unless I do so, the case will be rejected by our resource people. And you know what that means!"

"No funding for the project", sighed the Consultant. "But, you know, the whole thing doesn't stack up: the risks are too high to the Private Sector, the process is too complicated and where is the return? Just trying to avoid public investment if you ask me. Before long, we'll be asking if hot dog vans can be hooked onto the backs of ambulances!"

"Listen for a minute, Lynn. All we've been asked to do is test PFI as an option. I'm pretty sure no-one in the Private Sector will be interested anyway. We'll include a mini-test of the market in the business case."

"Okay, I get your drift. It s never going to catch on anyway."

Perhaps that imaginary scene is a simplistic exaggeration but, nonetheless, it somehow epitomises the apathy surrounding PFI in both sectors during the early days. To be fair, in the intervening period, both sides of the public/private divide gave the initiative a hefty shove concomitant with burgeoning political pressures. By the time the Treasury published its second bi-annual review Progressing the Private Finance Initiative in 1995, we were heading towards a target of £5 billion capital value of new projects in 1995/96.

But, even then, the storm clouds were gathering. There were symptoms of disillusionment. Suppliers seemed to become increasingly selective, occasionally to the point of withdrawal, and clients more confused. A barrage of criticism ensued, some of it from powerful sources, particularly in the Construction Industry. Criticism spilled into the public consciousness with adverse publicity surrounding bigger, emotive civil projects such as the Channel Tunnel and the Skye Road Bridge.

Moreover, there was growing unrest amongst public sector workers as the impact of PFI as an 'outsourcer' of non-core activities began to be fully appreciated. In short, PFI as a procurement device had suddenly become controversial and politicised.

Private Sector concerns centre mainly upon the cost and time involved in the tender process, confusion and delays over value for money testing and apparent overly demanding risk transfer. Will we clear our investment? A few words from John Watt of the British Linen Bank Ltd.

Funders' attitudes to PFI Healthcare: procrastination, frustration, irritation

One of the principal difficulties which has arisen over the last 12 months has been the question of the position if an NHS Trust fails to discharge its obligations. In order to address this, the Government has produced the Residual Liabilities Act which i imposed an obligation upon the Secretary of State to discharge the financial responsibilities of a Trust. The legislation, however, did not go as far as many banks would have wished and a variety of comfort letters have been circulating in the financial community over the past months. It would appear that a comfort letter, acceptable to both the NHS and the banks, is reaching a state of agreement. However, it seems to be recognised that this comfort letter is only a stage on the way to resolving some of the many problems surrounding NHS Trusts.

The other key issue which will be of concern to funders as well as bidders is that of affordability. This is a problem in virtually every project in the health sector at the present time and is proving very difficult to resolve. If the private sector?s costs are forced down to a level where there is little margin for error the funders will be concerned about the deliverability of the facility and the services and the risks that the funders accordingly take on in funding the project. What day-to-day risks do funders face once they actually sign up for a PFI healthcare transaction? We can see that a number of the risks, while capable of being described as normal operating risks, do have significant connotations in the healthcare sector. If the special purpose company which the banks are supporting fails to deliver the services properly and ends up being in default, will the banks step in and exercise the rights under the contract to replace the service provider? What liabilities does this impose on the banks and what risks do they run in stepping in and putting their deep pockets behind a poorly performing service provider? The banks, therefore, will need to be very sure that the consortia they support are capable of delivering the services not just in the short-term but throughout the period during which debt is being serviced. They will also require to see a level of equity in the special purpose company which ensures that the risks to the banks are minimised by having adequate protection from the equity providers who ultimately take the real risks during the operating phase.

The banks are also funding the construction phase and will need to be sure that the commitment from the contractor to build the hospital on time and to budget is one which is capable of being delivered. Past history of NHS procurement suggests that this is a major risk as cost over-runs in traditional NHS procurement are substantial, averaging around 20% of initial project cost. PFI is seen as a way of resolving this, but we have to question whether or not the industry is well enough developed at the present time to enable the contractors to price accurately in order to allow the banks to absorb this risk. If the banks do not then the contractors will be putting their own balance sheets on the line to ensure they deliver the project on time and to specification. There are not many contractors capable of taking on this risk.

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