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Son of PFI

13 December 2012

The government remains committed to Plan A, and there is no suggestion that the UK is about to "spend its way to growth". Indeed, Infrastructure UKs Geoffrey Spence has recently said that PF2 would not "suddenly improve" prospects for the construction industry.

But recently glimmers of hope for a beleaguered infrastructure sector, such as the £1.75 billion Priority School Building Programme (PSBP), have perhaps been heightened by further information, released in the Chancellors in the Autumn Statement, about this much-trailed "son of PFI" in the Treasurys document "A New Approach to Public Private Partnerships".

Describing the previous PFI model as "discredited", the government announced a model which builds on the existing position but introduces a number of innovations.

What are the key features that local authorities, which may have experienced procurements under the old regime, will look to when considering PF2 as a source of infrastructure investment?

The procurement Guillotine

The days of PFI lengthy procurements, with competitive or negotiated procedures taking perhaps several years, are to be a thing of the past. The length of the PFI process, and its associated costs, has been one of its most criticised aspects.

This will be enforced by the Treasury withdrawing funding for any procurement that takes over 18 months unless special consent has been obtained, and compensation of bidders costs to any who fall victim to this procurement guillotine.

But in reality 18 months may not be an overly-long time for a high value infrastructure procurement. Indeed, the average time for procurement of a PFI project was around three years and had remained so for some time - despite the multiple waves of standardisation that were attempted. It will be interesting to see how many projects ultimately have to seek dispensation from the 18 month limit, and what approach Treasury will take to any such requests.

The commercial pressure exerted by a definite timescale, with bid costs payable if it is not met and the project pulled, may also have a profound effect on the negotiating positions of the parties as the deadline approaches.

At the very least, all parties will certainly be incentivised to do as much preparation as they can at the outset. This will be buttressed by more in-depth pre-procurement engagement and scrutiny from central government, with the procuring body expected to produce a full "bidders pack" (including contract, specification and intended timetable) at the time of OJEU. There is to be no central government encouragement to local authorities to use PFI in the form of "PFI Credits" or similar subsidies.

Indeed, it does appear that the current direction of travel is towards centralised procurement units (rather than procurements through individual agencies, health bodies and local authorities etc). This is reflected in the governments centralised approach to the PBSP.

Much may depend on the extent to which the new, standardised procurement documents (which include not only contractual guidance and procurement pro-formas, but a standardised payment mechanism and output specification) really do achieve full buy-in from both procuring authorities and contractors. As noted above, procurement timescales had not really reduced for "PF1" despite over a decade of standardisation. The government will be determined to ensure that the PF2 documentation does not see a similar fate.

Risk and reward

Under the original PFI, and indeed many other forms of public private partnership, there was a great deal of discussion about effective risk transfer. Indeed, through its various incarnations since the original "Treasury Task Force" in the late 1990s, the standard form project contract negotiated its way towards a risk sharing position deemed to be optimum.

Many contractors would disagree, as evidenced by often long negotiations about the allocation of risk.

PF2 seeks to row back from this, mitigating the drive towards risk transfer and focussing in addition on "reward share". As with the procurement process, the final detail will have to be agreeable to both public and private sectors in order to achieve the governments aim of quicker, better value for money procurements based on a more appropriate allocation.

Some particular risks, which will be familiar to those who bear the scars of lengthy PFI negotiations, and which the private sector will retain under PF2 are:

- capital expenditure arising from unforeseeable changes in law. Previously, much time, and lengthy drafting, was spent allocating risk to the private sector for capital expenditure unless it was "specific" or "discriminatory". The Treasury believes that such risk rarely, if ever, occur, and that a high risk premium has been built into the costs of PFI to deal with this unlikely event. This will change under PF2;

- utilities consumption. Under PFI and a wide range of accommodation PPPs, complex risk sharing mechanisms were built into the payment mechanisms to ensure that the private sector assumed some risk for the volume of utilities consumed. The public sector, meanwhile, retained tariff risk. PF2 sees this distinction as artificial, complex, difficult to manage and, as a result, poor value. However, consumption risk will only be taken on by the public sector subject to an initial "testing period". Should this period indicate that the asset results in the use of more energy than that suggested during the procurement period, the contractor will have to rectify this or compensate the procuring body for its loss. Of course the complexity of this regime, and how subject to more nuanced negotiation it will become, remains to be seen;

- off-site contamination and site risks. According to the Treasury, these are also risks which it is bad value to transfer, and often led to lengthy discussions. In future, external contamination will be retained by the public sector. Also, gone will be protracted debates over site surveys, the cost of undertaking them, and related categories of land risk. The public sector will obtain site condition surveys at its costs, and make the appropriate warranties available to the winning bidder; and

- insurance premium risk. The public sector will be given greater flexibility to accept more risk for changes in insurance premiums, reducing the need for contractors to build up reserves (perceived by Treasury as poor value) against these contingencies.

Allied to this, central government will play a role as an equity investor, seeking to achieve the genuine "partnership", and share in success and reward, the review sees as so fundamentally lacking in the old style PFIs.

Moreover, a central plank of PF2 is encouragement into the market of a wider range of investors, including (as well as the government itself, either directly or as guarantor) institutional and other investors.

Flexible service provision

It was part of the mantra of PFI that, by harnessing the commercial expertise of the private sector and by "bundling" service provision with provision of capital assets, the public sector would drive efficiencies.

According to the government this rarely, if ever, actually happened. Instead, the inclusion of "soft" facilities management services, and "hard" lifecycle maintenance costs, with long-term debt funded capital projects led to inflexibility, a lack of transparency, and poor value.

PF2 will take a different approach. Soft services will not normally be bundled with the capital project, and instead be delivered through a series of sub-contracts (perhaps relatively short term) and, as mentioned above, the specification of these services will be more standardised. Hard FM will be delivered on a more flexible, "open book" approach, with more discretion for the procuring authority on how things are managed, and a sharing of any surplus lifecycle fund.

It remains to be seen whether the market and its funders will accept this level of flexibility without accounting for any "integration risk" that might occur from the divorce of capital build from ongoing services.

The fact that the PF2 document is detailed, and appears to have a plan for a mode of funding, must be a welcome boost to the infrastructure industry. A PF1 style capital funding bonanza is certainly not in sight and, starting with the forthcoming PSBP, public sector bodies with infrastructure needs and contractors alike will be watching the new model keenly.

This article was first published by www.localgovernmentlawyer.co.uk


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