"PFI projects benefit from secure cash flow from
the public sector. Public sector authorities should have clear
evidence they are paying a fair price for private sector funding,
and risk equity in particular, considering the stable environment
that PFI generally provides.
"The Chancellor plans to reform the PFI model.
The Treasury review should give closer scrutiny to the returns
investors are getting from PFI projects and take account of the
areas we have identified where there is scope for
savings."
Amyas Morse, head of the National Audit Office, 10
February 2012
Equity investors have helped to deliver many
public sector infrastructure projects via the Private Finance
Initiative and have managed them in ways from which the public
sector can learn. Against a background of limited information,
evidence gathered by the National Audit Office raises concern that
the public sector is paying more than it should for equity
investment.
Banks or bondholders provide around 90 per
cent of the project funding for a PFI project on the condition that
the remaining money is provided by the investors as risk capital or
equity, which will be lost first if the project runs into
difficulty.
Investors are rewarded for taking risks. The
risks the investors bear are mainly the costs of bidding; that
their contractors may fail to perform; or that other project costs
the investors bear the risk for will be higher than envisaged.
However, the investors limit their risk by passing it to their
contractors. In addition, the government is a very safe credit risk
and many projects such as hospitals and schools are repeat
projects.
The Treasury and departments to date have
relied on competition to secure efficient pricing of the contract
but have not gathered systematic information to prove the pricing
of equity is optimal. The NAO report identifies three potential
inefficiencies in the pricing of equity. These are the time and
costs of bidding; minimum rates set by investors, which sometimes
do not reflect the actual risks the project will face; and bank
requirements.
Today’s report concludes that, generally,
public sector authorities have not been equipped with the skills
and information required to challenge investors’ proposed returns
rigorously. The NAO shows how further analysis during the bidding
process would help authorities to assess the reasonableness of the
investor returns. As an illustration, the NAO estimates that around
1.5 per cent to 2.2 per cent of the annual service payments in
three projects it analysed were difficult to explain in terms of
the main risks investors said they were bearing.
Some investors in successful projects have
gone on to sell shares in their equity to release capital and fund
new projects. This has also resulted in accelerating the receipt of
their returns. Analysis by the NAO has shown that investors selling
shares early have typically earned annual returns of between 15 per
cent and 30 per cent. The NAO recommends that the Treasury should
use its current review of PFI to consider alternative investment
models that limit the potential for very high investor returns in
relation to risk.
Publication details:
HC: 1792, 2010-2012
ISBN: 9780102975406