This week, as part of the Autumn Statement, the Chancellor, George Osborne, released details of the outcome of the Government's review of the Private Finance Initiative and announced its successor, PF2. This article will highlight some of the key changes and compare PF2 to the approach taken in Scotland under the Non-Profit Distributing Model ("NPD").
PF2 – the future of Private Finance in England and Wales
The documentation issued by HM Treasury on 5 December to support the Chancellor's Autumn Statement included "A new approach to public private partnerships" which set out central Government's approach to PPP Projects going forward. HM Treasury also produced "Standardisation of PF2 Contracts" which will ultimately replace Standardisation of PFI Contracts Version 4 as the standard text for preparing contracts that utilise revenue based finance in England and Wales.
Some of the most notable changes to the model are as follows:
Investment of public sector equity in the project company – this is one of the key changes to the model. Under PF2, the public sector will invest equity in a project as a minority shareholder on the same terms as the private sector. PF2 envisages that the level of equity will be 30 to 49% and that it will be invested by a central government unit (the "CGU") within HM Treasury rather than the sponsoring authority itself.
This is designed to ensure that the public sector receive a share of the upside in any project and is designed to combat public perception that the private sector make windfall gains in PPP Projects. Equity participation does of course also mean that the public sector will share in the project risks as well as any potential upside.
Incentivisation to include long term equity participation in a Project from the outset. PF2 identifies that equity funding competitions are likely to be introduced to widen access to those types of entity that are likely to be interested in long term equity. The report suggests that this is likely to be done at preferred bidder stage, prior to financial close, when documentation is advanced to minimise cost.
Inclusion of mechanisms to limit the ability of the private sector to generate excessive profits on secondary market equity sales through inclusion of the current refinancing gain share provisions, as well as other mechanisms to reduce excessive profits such as the sharing of unutilised sums in the lifecycle fund which seeks to ensure that surpluses are aggregated and shared equally between the public and private sector at the end of the contract term.
A commitment to reducing the tendering phase of proposed PF2 projects to 18 months or less. This is likely to be welcomed by the private sector, who often criticise the competitive dialogue model due to long procurement timescales that lead to excessive costs.
Removal of soft services such as catering and cleaning from the scope of services for the private sector and flexible service provision. PF2 envisages that soft services will be retained by the public sector which is designed to achieve better value for money. In terms of flexible scope, PF2 envisages that the public sector will be able to review a catalogue of minor works at the outset of the project and again on an annual basis to elect whether or not to carry out those works itself. Traditional PPP was criticised for a lack of flexibility and this is likely to be viewed positively within the public sector.
A number of reporting tools have been introduced such as disclosure of equity return information in order to tackle the public perception that PPP Projects have in the past lacked transparency.
Retention of risks that are better placed to sit with the public sector such as general changes in law, utilities costs, off site contamination and insurance. This is intended to drive better value for money for the public sector.
NPD – the current Scottish model
The first wave of projects to be procured under Scotland's NPD model, are approaching financial close and the model shares many of the ideas and characteristics of PF2.
NPD project companies include a public interest director, who can trigger a refinancing. With PF2, the public sector would also have Board representation as it has an equity stake in the project company. NPD takes a very similar line to PF2 on the risks retained by the public sector such as utilities costs, insurance, and general changes in law requiring capital expenditure. Under NPD, soft services are also retained by the public sector.
The models do; however, take a different line in terms of equity returns. Whilst PF2 envisages public sector equity at project company level, NPD does not. The Scottish Government's hub model does include the possibility of equity participation from the public sector, but it is not mandatory for the public sector participants involved.
In addition, and perhaps the most notable difference, is that PF2 has not opted to cap the return to the private sector which the NPD and hub models do. Under NPD, distributions are prohibited and all surplus funds are returned to the public sector. Under PF2 distributions are allowed, and the public sector (at CGU level) would share in those distributions by virtue of its equity participation in the project.
The primary challenge for infrastructure projects across the whole of the UK remains securing the requisite funding. For those projects already in procurement in England and Wales, where the focus has typically been bank funding, there are some incentives available such as the UK Guarantee Scheme announced this summer. The focus of PF2 funding seems to have shifted, moving towards attracting and retaining long term funding from the capital markets.
What the English and Welsh market really needs now is a pipeline of projects. Only once that pipeline of projects emerges will we know which model the market, and funders, prefer. Scotland is slightly ahead of the game in terms of procurement timescales at the moment, but will the English and Welsh model ultimately prove more attractive – time will tell.
A copy of the HM Treasury documentation on PF2 is available at http://www.hm-treasury.gov.uk/as2012_documents.htm