Summary and implications
The Treasury has issued a draft guidance note, as part of a wider pilot programme, aimed at encouraging PFI contract managers to implement cost saving measures within their contracts. The guidance forms part of a wider strategy under the Government’s deficit reduction plan to reduce costs within the public sector while maintaining frontline services. The guidance note focuses on:
- Cost saving actions to consider before making the decision to amend a contract;
- Amendments which authorities should explore when considering varying a PFI contract; and
- The development of supporting initiatives at a central level which will support the focus on cost savings.
The guidance is addressed primarily to contract managers within central and local government, but will inevitably have an impact on private sector contractors as the public sector begins to follow the recommendations and examine its contractual arrangements. It is currently in draft format and will be tested later this year via a pilot PFI project. It will then be updated to reflect lessons learnt from that pilot.
Of course, the guidance is expressed in rather less trenchant terms than those heard from the Cabinet Office minister, Francis Maude – describing many PFI deals as “ghastly” and putting a “millstone” round the neck of schools and hospitals.
Treasury Guidance: “Making savings in operational PFI contracts”
To view the guidance in full, click here
1. Pre-amendment considerations
Before authorities decide to seek amendments to their PFI contracts in a bid to reduce costs, the guidance suggests taking a step back and considering the following issues:
- Are current contracts being managed and are existing assets under those contracts being used as efficiently as possible?
- There may be scope to reduce costs without making any contractual amendments by monitoring and improving the practical performance of the contracts (e.g. use of properly trained staff; keeping accurate records of a contract’s progress; monitoring the use of project assets; etc.).
- Have the potential benefits of any amendments been weighed up against the potential fees that will be incurred in implementing those changes?
- Are there any procurement law issues to consider (see text box, above right)?
- Cost transparency is paramount: SoPC4 contracts should contain robust provisions aimed at ensuring public sector visibility over real project costs, but contracts entered into before SoPC4 became effective may not be as robust. Public authorities should seek to “upgrade” their contracts to reflect SoPC4 best practice.
- Taking the time to agree a formal variations protocol reflecting Treasury-issued guidance will save time and protect the public sector from hidden costs.
The private sector should also be aware that Infrastructure UK (IUK) is pursuing the introduction of a voluntary Code of Conduct with investors, subcontractors and lenders at a national level. This will address operational savings actions that are generic across all projects. At a minimum, signatories will need to:
- Engage positively and proactively with public authorities in the cost savings agenda;
- Agree to the inclusion of SoCP4 cost transparency provisions in contracts which do not have them; and
- Implement the SoCP4 Variations Protocol where it is not already included.
The above is not an exhaustive list. It is clear that IUK will expect a significant amount of “buy-in” from the private sector in seeking to pursue the costs savings agenda.
Procurement law considerations
Contract managers need to have regard to the Public Contracts Regulations 2006 when considering changes to PFI contracts. It is advisable to check that the variations proposed do not risk a new tender procedure being required. This point was underlined in the 2008 case of Pressetext (C-454/06), in which the European Court of Justice held that material variations to an existing contract may amount to the award of a “new” contract that will need to be re-tendered.
Operational Taskforce Note 3 regarding variations protocols
To read guidance designed to assist in drawing up a variations protocol where a pre-SoCP4 contract is being used, click here
2. Potential cost saving measures
The guidance goes on to set out a number of amendments that authorities could make to PFI contracts in an attempt to reduce costs:
Review service standards
This entails the review of service specifications where authorities feel they are incurring costs for unnecessary services, (e.g. too frequent decoration; overspending on utilities such as electricity due to overnight maintenance of infrastructure; etc). Authorities should always be mindful of undermining a project’s main objectives when agreeing to changes.
Remove/re-scope soft or ancillary services
The removal or re-definition of soft or ancillary services from a contract may represent Value for Money (VfM) in certain circumstances, such as where a particular service is no longer required by an authority or where it could be provided by an alternative provider for better VfM.
Align the timing of value testing exercises
The careful scheduling of often costly and time consuming value testing exercises could save authorities considerable costs. For example, authorities who have more than one PFI contract could save money by undertaking the exercises for each contract simultaneously or as one. Again, however, the specific terms of, and circumstances surrounding, particular projects will need to be considered to ensure the cost savings of alignment are not outweighed by any extra costs of deferring the exercise and changing the contract.
Take back the provider’s share of change in law risk
The financial structure of a particular project may be such that an authority will achieve better VfM by taking back into the public sector the risk of capital costs incurred by changes in law taking effect during the operational phase of a project, rather than sticking with the more common method of sharing the risk with the PFI provider. The effects of doing so and the ramifications for other parts of the contract will need to be considered carefully.
Maximise volumes for purchasing energy
Cost savings may be made by authorities retaining the power to purchase energy supplies directly rather than allowing a PFI provider to purchase energy on their behalf where the authority has greater buying and negotiation power than the provider.
One further option, discouraged by the Treasury, is to consider the scope for stripping out lifecycle costs in a PFI deal – in effect reversing the entire premise of PFI.
The guidance concludes these suggestions by urging authorities who have their own actions in mind to consult their relevant departmental PFU for further advice.
3. Centrally developed support initiatives
Whilst fervent in its encouragement of the use of cost saving measures by authorities entering into PFI contracts, the guidance recognises that such contracts can be extremely varied, particularly at an operational level, and so advises that specialist support is sought before an authority pursues a proposed action point, as “failure to do so could result in short term savings at the expense of long term VfM”. Examples suggested by the guidance of bodies providing such support include IUK’s Operational Taskforce, departmental PFUs and other governmental projects bodies.
While the Treasury’s guidance is written for the benefit of, and clearly intended for, a public sector audience, private sector entities would be advised to take note. In an economic climate where the reduction of costs is a key concern for public and private sector organisations alike, existing PFI deals have become a target. In this context, private sector contractors will need to be able to demonstrate ever more clearly that they can run PFI deals in as cost efficient a way as possible and in line with the public sector’s cost saving objectives. Having an understanding of those objectives, and the considerations behind cost saving suggestions mooted by contracting authorities, can only assist private sector entities as they engage with their public sector clients going forward.