Crunch Time for PFI
On 27 July 2010, the National Audit Office (NAO) issued its report on the implications of the credit crisis for both existing and future PFI projects. “Financing PFI Projects in the credit crisis and the Treasury’s response” highlights the challenges the Treasury faced as the crisis took hold in the autumn of 2008, explains the Treasury’s response and outlines the Treasury’s proposals for the financing of future projects.
Response to Lower Availability of Finance
To set the scene, the report explains that as the UK entered recession in 2008 “the Government had a significant pipeline of infrastructure projects, with an investment value exceeding £13 billion.” With debt finance becoming increasingly difficult to secure and bond finance no longer a viable option, the Treasury feared that delays in finalising PFI contracts would result in the loss of the opportunity to boost growth through new infrastructure. Consequently, the Treasury’s policy became one of endeavouring to close PFI deals promptly to stimulate the economy.
To this end, the Treasury requested that the European Investment Bank (EIB) increase its lending to infrastructure projects. Whilst support was received from EIB, the commercial banks’ collective reluctance to resume lending to the extent that had been hoped at the start of 2009 meant that the amount of funding available remained insufficient for larger projects.
The Treasury’s response to this in March 2009 was to establish its own financing unit. The perceived role of the newly established Infrastructure Finance Unit (IFU) was to be available to provide loans to infrastructure projects on commercial terms in order to meet shortfalls in available bank finance.
Although the IFU only provided funding for one project (a waste treatment and power generation project in Greater Manchester), the report claims that the availability of funding in itself contributed to market confidence and helped reactivate the lending market for infrastructure projects. Some thirty-five government projects have been agreed since the establishment of the IFU without public funding.
The cost of Finance and the Treasury’s Response
Unsurprisingly, the report notes that interest costs increased as a result of the credit crisis, with the annual charge of typical PFI projects going up by between 6% and 7%. Despite this, the Treasury continued to prioritise closing deals in line with stated policy. Whilst the increased costs inevitably affected the value for money previously attributed to PFI, the Treasury and, perhaps more importantly, the NAO remain confident that the contracts entered into in 2009 still represent good value. Although not supported by a case-by-case evaluation, the report defends the Treasury’s position on the grounds that the drive to continue the economic stimulus (which required new projects) severely limited the scope for a thorough review as projects rolled forward.
Going forward
Notwithstanding the foregoing, the report emphasises that there should be no presumption that PFI will continue to represent value for money in the future. Indeed the report suggests that, going forward, other financing options for infrastructure projects merit further consideration.
These include the French government’s approach of guaranteeing 80% of debt once a project is operating successfully. This has the benefit of reducing the use of bank risk capital and therefore financing costs. The drawback however is that intervention would neither be temporary nor reversible and the public sector would therefore retain some project operating risk. A second option would be to seek more funding from the European Investment Bank (which is generally available on more favourable terms than commercial funding), but it goes without saying that this is not a limitless resource. Another interesting option touched on by the report would be to repay funders from public sector payments for services or from payments by users or consumers directly, which is a departure from accepted PFI ideology. The new government’s response to such proposals is keenly awaited.
In light of recent experiences, the Treasury has set up Infrastructure UK to oversee investment in infrastructure. It faces the unenviable task of prioritising projects and procurement in a climate of cutbacks and limited availability of finance. Nevertheless, and in response to the challenges faced, the report outlines the following recommendations to be taken into consideration:
Conclusions
Whilst the report points to a more cautious approach by the Government to PFI deals in the future, the door certainly hasn’t been closed on PFI and indeed confidence remains high that this route can offer value for money. That said, and given that the economic climate remains a challenging one, it seems that alternative financing options will increasingly be explored for future infrastructure projects.
For further information, please contact Stephen Colliston.