Projects under the ‘new PFI’ model could cost more - but the public sector should get its money back in profits, the Treasury has claimed.
The Private Finance 2 model will double the amount of equity compared with old PFI schemes, to 20 per cent. That could see the public sector injecting up to 10 per cent of equity, however, most typically the public sector is likely to contribute around 4 per cent.
This is aimed at addressing concerns over the private sector making a “windfall”, while giving the public sector a share of profits that the asset makes when sold in the secondary market.
It could also be countered by the debt on the scheme becoming cheaper due to the additional capital. And the Treasury is understood to be increasing the equity share to help boost the credit rating of schemes to make them more attractive to investors, such as pension funds.
But as equity is more expensive than debt, there have been concerns it will be worse value for money for the taxpayer.
The PF2 guidance says: “Including a larger proportion of equity in the structure may, at a project company level, make the project more expensive if the price of debt does not decrease proportionately.
“However, as the public sector co-investor will earn a return on its investment, assuming appropriate management of project risk, the overall cost to the public sector will be lower under PF2 than would otherwise be the case if the public sector did not invest.”
It will also mean more risk for the public sector. The documents note that in 2004, the construction costs of several projects involving Jarvis companies “exceeded those anticipated during the bidding process”.
Jarvis plc and other PFI investors bore the costs of a £120m funding gap in projects including Whittington Hospital, Tyne and Wear fire stations, Lancaster University and Wirral Schools.
Graham Robinson, global business consultant at Pinsent Masons, said: “The key issue for PF2 is around equity. This will have the effect of decreasing the value for money for taxpayers. Although the taxpayer could make a return on equity and a higher equity could improve the cost of debt, the tax payer is exposed to more risk. Does this represent value for money?”
Nick Prior, head of infrastructure and capital projects at Deloitte, said: “This is a different model for a different time and different financial markets. It is quite possible that the changes proposed, when compared to the old PFI model, may make some projects more expensive, but this reflects the difficult climate we are operating in.”
Craig MacDougal, P3 (Canadian PPP) advisory associate, Davis Langdon, said: “Equity is more expensive than debt. I do understand why they are trying to bring in as many different funding options as possible if they want equity to be bigger proportion of projects that does cost more. That could be a problem.”
What PF2 says on:
Private sector equity
- the structure of PF2 curbs the ability of primary investors to generate excessive profits and, consequently, the potential for windfall gains on secondary market sales through measures including a mechanism to share unutilised funds in the lifecycle reserve, the removal of soft services where contractors have typically included a risk premium in the pricing and the introduction of public sector equity.
- the introduction of funding competitions for a portion of the private sector equity, to enable long-term equity providers to invest in projects before financial close. This will widen access to different types of investor and is expected increase competitive tension, with downward pressure on equity pricing in the longer term.
Public sector equity
- greater alignment of interests between the public and private sectors, and a more collaborative approach to improving project performance and managing risk;
- better partnership working, with the public sector having greater visibility of project information and more involvement in strategic decision making;
- more transparency, including in relation to the financial performance of the project company, through its project company board membership; and
- value for money to be improved as, subject to the appropriate management of project risk, the public sector will share in the ongoing investment returns, reducing the overall cost of projects to the public sector.