behnam sarani - msc dissertation - risk management in ppp pfi projects - 2010

Risk management and sharing in PPP/PFI projects

A dissertation submitted to the University of Manchester for the degree of MSc in Engineering Project Management in the Faculty

of Engineering and Physical Sciences

2010

Behnam Sarani

School of Mechanical, Aerospace and Civil Engineering

Behnam Sarani, University of Manchester Risk Sharing and Management in PPP/PFI projects

2010 of 129

COPYRIGHT STATEMENT

The following three notes on copyright and the ownership of intellectual

property rights:

i. Copyright in text of this dissertation rests with the author. Copies (by

any process) either in full, or of extracts, may be made only in

accordance with instructions given by the author. Details may be

obtained from the appropriate Graduate Office. This page must form

part of any such copies made. Further copies (by any process) of

copies made in accordance with such instructions may not be made

without the permission (in writing) of the author.

ii. The ownership of any intellectual property rights which may be

described in this dissertation is vested in the University of

Manchester, subject to any prior agreement to the contrary, and may

not be made available for use by third parties without the written

permission of the University, which will prescribe the terms and

conditions of any such agreement.

iii. Further information on the conditions under which disclosures and

exploitation may take place is available from the Head of the School

of [insert name of your School here] (or the Vice-President and Dean

of the Faculty of Life Sciences for Faculty of Life Sciences’

candidates.)


2010 of 129

Table of Contents 1.0 Introduction ...................................................................................................................... 7

1.1 Background .................................................................................................................. 7

1.2 Aims ............................................................................................................................. 8

1.3 Objectives ..................................................................................................................... 8

1.4 Research questions ....................................................................................................... 9

1.5 Scope and limitations ................................................................................................. 10

2.0 Research methodology ................................................................................................... 11

2.1 Introduction ................................................................................................................ 11

2.2 Approach to Research ................................................................................................ 11

2.3 Report structure .......................................................................................................... 12

2.4 Data Collection ........................................................................................................... 13

2.5 Research Strategy ....................................................................................................... 14

2.6 Summary .................................................................................................................... 16

3.0 Overview of PPP/PFI procurement systems .................................................................. 16

3.1 Introduction ................................................................................................................ 16

3.2 PPP/PFI Procurement origins ..................................................................................... 16

3.3 Government commitment to PFI procurement ........................................................... 19

3.4 PFI Project structure ................................................................................................... 21

3.5 PFI tendering process ................................................................................................. 25

3.6 VfM determinants ...................................................................................................... 29

3.7 Financing PFI projects................................................................................................ 33

3.8 Payment mechanisms in PFI projects ......................................................................... 36

3.9 Summary .................................................................................................................... 38

4.0 Critical review of PPP/PFI procurement ........................................................................ 39

4.1 Introduction ................................................................................................................ 39

4.2 Utilising the efficiencies of the private sector ............................................................ 39


2010 of 129

4.3 Risk allocation strategies ............................................................................................ 42

4.4 New Risks being introduced to the public sector ....................................................... 47

4.5 Is the transfer of risk feasible ..................................................................................... 50

4.6 Evaluating the robustness of the Public Sector Comparator ...................................... 53

4.7 Determining the value of risks transferred ................................................................. 55

4.8 Refinancing of PFI projects and the secondary equity market ................................... 61

4.9 The impact of the recession and change in government ............................................. 67

4.10 Summary .................................................................................................................. 72

5.0 Case Studies ................................................................................................................... 73

5.1 Introduction ................................................................................................................ 73

5.2 Norfolk and Norwich University Hospital care Trust ................................................ 73

5.2.1 Background to project ......................................................................................... 73

5.2.2 The Project structure ........................................................................................... 74

5.2.3 Value for money analysis .................................................................................... 76

5.2.4 Financial restructuring of the PFI Project ........................................................... 78

5.3 HMP Altcourse (Fazakerley) ...................................................................................... 82



5.3.3 Financial restructuring of the PFI Project ........................................................... 86

5.3.4 The Secondary Equity market ............................................................................. 89

5.3.5 Risk Transfer ....................................................................................................... 91

5.4 Queen Elizabeth II Bridge, Dartford crossing ............................................................ 93



5.4.3 Risk transfer to the private sector ....................................................................... 98

5.5 Summary .................................................................................................................. 101

6.0 Conclusion ................................................................................................................... 102

6.1 Introduction .............................................................................................................. 102

6.2 Discussion ................................................................................................................ 102


2010 of 129

6.2.1 Research Question 1 ......................................................................................... 103





6.3 Ensuring PFI project success .................................................................................... 113

6.4 Final Conclusion ...................................................................................................... 116

6.4.1 Aims .................................................................................................................. 116

6.4.2 Objective One ................................................................................................... 117

6.4.2. Objective Two .................................................................................................. 118

6.4.4 Objective Three ................................................................................................. 119

6.4.5 Objective Four .................................................................................................. 120

6.4.6 Objective Five ................................................................................................... 121

6.5 Limitations ............................................................................................................... 122

6.6 Recommendations .................................................................................................... 122

7.0 References .................................................................................................................... 123

Appendix A ........................................................................................................................ 127

Appendix B ........................................................................................................................ 128

List of figures

Figure 1 - Research Structure ............................................................................................... 13

Figure 2 - Number and value of PFI projects (HM-Treasury, 2006a) ................................. 20

Figure 3 - Proportion of Projects by capital value (HM-Treasury, 2006a) .......................... 21

Figure 4 - Adapted from Fox 1999 ...................................................................................... 22

Figure 5 - Features of SPV (Saunders, 2010a) ..................................................................... 23

Figure 6 - Timing of payments under the PFI and conventional procurement adapted

from(PAC, 2003a) ................................................................................................................ 29

Figure 7 - PSC comparison with the PFI option (Canadian-Council-for-PPP, 2003) .......... 31

Figure 8 - Typical sources of Finance for PFI projects, Adapted from (Fox, 1999) ............ 34

Figure 9 - Unitary payment components (Hogg, 1996) ....................................................... 37


2010 of 129

Figure 10 - Metronet Consortium, adapted from (Kellaway and Shanks, 2007) ................. 51

Figure 11 - Cost elements in public sector comparators and PFI (Broadbent et al., 2008) .. 56

Figure 12 - Project risks, financial costs and return based on phase of project (Finlay, 2003)

............................................................................................................................................. 62

Figure 13 - Real quarterly GDP growth (ONS, 2010a) ....................................................... 68

Figure 14 - Public spending and taxation % GDP (HM-Treasury, 2010b) .......................... 71

Figure 15 - NNUH trust aerial photo and Hospital main entrance (NNHU, 2010) ............. 73

Figure 16 - NNUH Trust PFI project structure (Partnerships-UK, 2010b) .......................... 75

Figure 17 - NNUH Trust termination liabilities post and pre refinancing (PAC, 2006) ...... 81

Figure 18 - HMP Altcourse Prison aerial photo and main entrance (Google Images) ........ 82

Figure 19 - FPSL project structure (Partnerships-UK, 2010a) ............................................ 85

Figure 20 - How the HMP Altcourse refinancing increases, and brings forward, the returns

to the shareholders of the consortium (NAO, 2000) ............................................................ 87

Figure 21 - Changing shareholder profile of HMP Altcourse PFI project (Partnerships-UK,

2010a) .................................................................................................................................. 89

Figure 22 - Queen Elizabeth II Bridge - Dartford crossing ................................................. 94

Figure 23 - Queen Elizabeth II Bridge PFI Project Structure. Adapted from (Saunders,

2010b, Highways-Agency, 2010) ........................................................................................ 97

Figure 24 - One of FSD’s buses during the Dartford Crossing installation (FSD, 2010) .. 100

Total Word count inclusive of references of Appendix: 27,900


2010 of 129

1.0 Introduction

This chapter will cover the background of the project and the

relevance and importance of the topic investigated. The aims of the

research project are outlined and defined through a set of research

questions.

1.1 Background

Until the late 1980s the provision of public service infrastructure was

funded by a strong tradition of public sector procurement. All associated

costs were placed on the government balance sheet due to strict rules in

involvement of the private sector, meaning works were placed to

competitive tendering. However increasing pressure on the government

budget and an ever growing population led to a lack of available funding for

the development of critical public infrastructure (Fox, 1999, Mackie and

Smith, 2005, Dixon, 2005).

The Conservative government of the time introduced new guidelines

such as the Ryrie rules to encourage funding from the private sector to fund

major road infrastructure projects (Carlile, 1994). This led to initiatives such

as PFI (a type of PPP) which would allow private funding to design, finance,

build and operate public infrastructure projects in return for a regular

payment from the government, also known as the unitary charge.

This allowed for major infrastructure spending to be taken off the

government balance sheet with private sector expertise and innovation

being utilised to deliver projects on time, on budget and to a higher standard

(Mackie and Smith, 2005, Dixon, 2005). The private sector also gave


2010 of 129

projects further credibility as their involvement would ensure commercial

viability and remove the possibility of projects being sanctioned for political

reasons. It was stated that these arrangements could be used to transfer

risk away from the public sector and provide Value for Money (VfM) for the

taxpayer (Akintoye et al., 1998).

The PPP/PFI market has evolved, with the private sector participants

introducing innovation to maximise profits. Initiatives such as refinancing of

PFI Projects to take advantage of lower interest rates and the emergence of

thriving secondary and tertiary markets, trading in equity, have raised

concerns about the risk management process in PFI projects. It is the aim of

this research to investigate the critical issues that need consideration in

PPP/PFI projects.

1.2 Aims

To complete qualitative research into the academic and government

literature on PPP/PFI procurement methodology.

To review the risk management and transfer process in PFI projects

to critically review the wider VfM objective of PFI projects.

1.3 Objectives

1. Determine the extent to which risk transfer is central to the

development of PPP initiatives and whether the government’s

justification of such initiatives has changed.

2. Critically review government guidelines on the successful

implementation of PFI procurement


2010 of 129

3. Examine the extent by which government objectives of risk transfer

are realised in operational PFI projects

4. Critically review the VfM appraisal process and the method by which

valuation of risks transferred is carried out

5. Determine the future implications for PFI procurement methodology

1.4 Research questions

From the objectives above, a number of research questions have

been created to provide a focus for the research study. Upon completion of

the literature survey, these questions will be used to analyse and evaluate

the information gathered.

1. To what extent do government regulations stipulate risk transfer and

management as a requirement of PPP/PFI procurement and whether

implementation of PFI project shows evidence of this occurring?

2. Is the transfer of risk to the private sector feasible?

3. How accurate is the VfM appraisal process and does the transfer of

risk to the public sector represent VfM for the taxpayer?

4. What have been the major developments in the PFI procurement

method and how have government guidelines adapted accommodate

these?

5. What has been the positive impact of transferring risks to the private

sector and the benefits realised through their involvement?


2010 of 129

1.5 Scope and limitations

With PPP/PFI initiatives being used more widely to provide

infrastructure and services in the health, prisons, education and transport

sectors, it is important to gauge whether the transfer of risk is being realised

and whether these initiatives offer VfM for the tax payer in comparison to

those procured through traditional methods.

The debate for and against using private funding to provide public

service infrastructure has been ongoing ever since its inception. This debate

provides valuable literature (reports and journal publications), that can be

used to complete a qualitative literature-based research project to take into

account arguments for (Forshaw, 1999, Partnerships-UK, 2008, HM-

Treasury) and against (Pollock et al., 1999, Froud, 2003) the use of

PPP/PFI procurement.

This research however has limitations that affect the extent of works

carried out. PPP/PFI projects are typified by contracts over a lengthy period

of time (30 to 60 years). This means that only a few projects have

completed the operational phase and been handed back to public

ownership. Therefore an analysis of long-term effects of new developments,

such as equity markets and refinancing, cannot be fully investigated.

Also the model of PFI procurement has been exported with an

overwhelming number of projects worldwide and copious volumes of

information relating to these projects available. For the purposes of this

research, UK projects will be the primary focus, as PPP/PFI procurement

was pioneered in the UK along with Australia and the USA.


2010 of 129

2.0 Research methodology

2.1 Introduction

This section will outline the structure of the dissertation and the approaches

implemented in collecting the required information. Also the method by

which analysis of the information gathered is carried out and its relevance to

the objectives of the report are discussed. Furthermore the justification of

the research methods utilised will be established.

2.2 Approach to Research

The relatively short history of PFI projects coupled with long-term

concession agreements has resulted in the majority of projects not

completing the operation phase. This however has not deterred extensive

research and analysis of the PFI procurement methodology by both

regulatory bodies and academia. There are also increased levels of

transparency in the PFI market as this type of procurement is carried out in

the public domain, with extensive data from PFI projects being made

available from government sources. This transparency has led to multiple

books and journal publications in support of and against the government’s

ever increasing reliance on procuring major public infrastructure projects

using PFI methodology.


2010 of 129

Qualitative desktop research was carried out to gather the required

information for the purposes of this postgraduate dissertation. A qualitative

research methodology as defined by Naoum (1998) is the subjective

assessment of a situation or problem and takes the form of an opinion,

perception, view or attitude towards objects (Naoum and Coles, 1998). The

use of qualitative research methodology will allow for exploratory research

with an emphasis on description and discovery rather than on hypothesis

testing and verification (Harake, 2006). This research approach is

implemented to subjectively evaluate the situation, evaluate different

perspectives and discover new ideas with regards to the workings of PFI

projects.

2.3 Report structure

The section of this report have been categorised, as per guidance of

Maxwell (2005), into four main section (Maxwell, 2005). Initially the purpose

of this research is outlined by stipulating the aims and objectives. the

methods applied for the collection of data and its relevance are explained in

the second section. The final two sections relate to identifying the relevant

literature to research project and critically reviewing these findings to

present a discussion in the effectiveness of risk management and transfer

within PFI projects. The structure of the research project can be seen

overleaf in figure 1.


2010 of 129

Figure 1 - Research Structure

2.4 Data Collection

The two main methods of data collection are fieldwork and desktop

study approaches. Fieldwork is regarded as the collation of primary data for

the purposes of research, whilst desktop research is the analysis of data

from a secondary source such as government reports, journal publications

and text books. Findings from the literature review can be reinforced or

proven using case study information highlighting practical evidence of the

theory highlighted (Naoum and Coles, 1998).

Galliers (1992) defined case studies as “an attempt at describing the

relationships which exist in reality, usually within a single organisation or

organisational grouping” (Galliers, 1992). The use of case study information


2010 of 129

is beneficial as it captures in detail the specifics of PFI projects and

analyses the various aspects of an often complicated process. Both Galliers

(1992) and Bell (2005) point out a weakness in case studies being

susceptible to generalisation as they tend to be restricted to a single event

(Bell, 2005, Galliers, 1992). Furthermore case studies are susceptible to the

interpretations of events by various stakeholders and researchers, who may

derive dissimilar conclusions from the same set of data (Galliers, 1992). To

minimise these obstacles, case study information from various sources

(such as government commissioned reports from various sectors) will be

used to support findings (PAC, 2006). These will in turn be compared to

findings of independent case study reports done by academic research

(Edwards, 2009).

2.5 Research Strategy

For the purposes of this dissertation, the literature review is centred

on existing work on risk management methods used within PFI and PPP

projects and how the process has developed in line with evolution of the PFI

procurement methodology. This will include:

• Investigating the critical role risk management plays in PFI

projects,

• Reviewing how risks are identified, quantified and allocated to the

various parties involved in typical PFI projects,

• Identifying and critiquing the contractual mechanisms that

facilitate the transfer and sharing of risk and


2010 of 129

• Completing a review of the risk transfer process and any

identifiable shortfalls in this process.

The main source of secondary data will be government

commissioned review reports sourced from respective websites of the

departments and public bodies involved. These include:

• National Audit Office (NAO)

• The Office of Government Commerce] (OGC)

• HM Treasury Taskforce – PPP Projects (up to 2000) (HM-

Treasury)(HM-Treasury)

• Partnerships UK (Partnerships-UK, 2008).

Non-governmental sources include literary publications on the subject

with prominent publications by Fox, Pollock and Boussabaine. (Fox, 1999,

Pollock, 2005, Boussabaine, 2006), in addition to journal publications and

web publications. E-journal databases will be used to collate journal articles

on the subject. Initial searches will utilise Science Direct and Compendex

databases.

The argument for and against PPP/PFI projects has led to the

publication of many sources of literature that are related to the subject. It is

the aim of the search strategy outlined above to ensure that all viewpoints

are considered in the final dissertation report.


2010 of 129

2.6 Summary

In this section the proposed research methodology was outlined and the

qualitative desk top research methodology justified against the aims and

objectives of the research project.

3.0 Overview of PPP/PFI procurement systems

3.1 Introduction

In this chapter the theoretical background to PFI procurement methodology

will be investigated. This will include a brief history of PFI projects and the

analysis of the reasons behind the government’s decision to involve private

sector participants in the provision of major infrastructure projects. An

analysis of government guidelines of what is required for effective PFI

procurement is also carried out.

3.2 PPP/PFI Procurement origins

Until the 1980s major infrastructure projects were completed using

traditional public procurement with all funding placed on the public sector

balance sheet. There was a strong tradition of public sector procurement

with works being placed to competitive tendering and strict rules with

regards to the involvement of the private sector. The lack of available

funding led to neglect of many of the UK’s essential infrastructure such as

hospitals, schools, prisons and the road network. This coupled with growth


2010 of 129

in the economy and population increases led to increased demand for

provision of new infrastructure (Heald, 1999).

The need for major investment meant that the Conservative

Government introduced new guidelines such as the Ryrie rules to promote

funding from the private sector (US-DoT, 2007). The Ryrie rules meant that

private sector investment could be utilised to fund major infrastructure

projects. These privately sourced funds were to be used in place of, rather

than an addition to, public funds whilst all risks had to be genuinely

transferred to the private sector (Mackie and Smith, 2005).

In the UK the involvement of the private sector was implemented

through Public Private Partnerships (PPP). PPP can be defined as a long-

term contract between public and private sector parties for the design,

construction, financing and operation of public structure by the private

sector party (Yescombe, 2007). Payments are made over the life of the PPP

contract to the private party for use of facilities by the public sector parties or

the general public. The facility remains in public sector ownership or reverts

to public ownership at the end of the PPP contract (Yescombe, 2007).

The PPP option of procurement is distinctive from traditional public

sector procurement. The traditional procurement method involves the public

authority taking full responsibility for operations and maintenance of the

facility. Payment is made using funds from taxation or public borrowing

(Fox, 1999).

In a PPP project, the public authority stipulates its requirements in

terms of output, but does not specify how these are to be achieved. It is left

to the private body to design, finance, build and operate the facility. The


2010 of 129

private party receives regular payments known as “unitary charge” aimed at

repaying the borrowed finances for the project and give a return to the

investors (Yescombe, 2007).

The PPP procurement approach did not require increased taxes and

meant that infrastructure spending was taken off the government’s balance

sheet. The use of PPP procurement is not exclusive to the United Kingdom

with similar schemes in North America (P3) and Australia (Privately

Financed Projects (PFP)). In the UK, PPP procurement is done primarily

through Private Finance Initiatives (PFI) a type of PPP (Yescombe, 2007).

For the purposes of this research project, the focus will be on PFI projects to

reflect the government’s preference in using the PFI procurement model.

Another feature of PPP/PFI projects is that by allowing the private

sector to determine how to deliver the service, the awarding authority is able

to transfer some risks to the private sector. This risk transfer is integral to

the contracting of any PFI project (Fox, 1999). This includes the transfer of

design, construction, finance and operational risks to the private sector,

which would otherwise be borne by the public sector under typical capital

asset procurement (Hogg, 1996). If a traditional procurement process was

used, all risks from the project and consequent effects on project costs and

schedules in case of failure, would be accountable to the public sector

(Perez, 2006).

The use of PPP/PFI method of procurement also allowed the

government to bring forward capital expenditure and enable major projects

to be completed in the healthcare, education, corrections and transportation

sectors. Furthermore with a lack of sufficient public funding being available,


2010 of 129

some argue that without the introduction of initiatives such as PPP/PPP,

many essential infrastructure projects would have not been financed (Heald,

1999).

Unlike government projects which were susceptible to late

completion and above budget, the involvement of the private sector

introduced much needed technical expertise and project management

capabilities to ensure that projects were delivered on time, on cost and to

the desired quality (US-DoT, 2007). Furthermore in traditional procurement,

there is no incentive for the contractor to choose the best construction

materials or ensure optimal performance during the operation phase due to

financial restraints and need to maximise profit. This is not an issue in PFI

procurement where it is in the interests of the private consortium to

complete the construction, operations and maintenance of the facilities to a

good standard for the entirety of the project (Mackie and Smith, 2005).

3.3 Government commitment to PFI procurement

Government guidance and statistics in PPP/PFI projects show that it

plays an increasingly pivotal role in delivering much needed public

infrastructure in the health, education, defence, transport and prison

sectors. There are currently 920 PPP/PFI projects in the United Kingdom

that have achieved financial close (Partnerships-UK, 2008), of these

projects 668 are PFI projects with a total estimated capital value of £56.5

Billion (HM-Treasury, 2010d). The increasing trend in total number and

value of PFI deals since their inception in the early 1990s can be seen in

figure 2.


2010 of 129

Figure 2 - Number and value of PFI projects (HM-Treasury, 2006a)

PFI procurement has been used in twenty different government

departments with the Department of Health (DoH) and Department for

Education and Skills (DfES) being the largest of PFI users. Figure 3

represents the breakdown of these projects according to the various

departments.


2010 of 129

Figure 3 - Proportion of Projects by capital value (HM-Treasury, 2006a)

The increasing trend in number of PFI projects was set to continue

with the outgoing Labour government supporting PFI procurement. A further

116 PFI projects with a total capital value of £14.4 Billion are currently in the

tendering stage (HM-Treasury, 2010c). The effect of the new Coalition

government on the future of PFI projects will be discussed in detail in

section 4.9.

3.4 PFI Project structure

PFI projects involve numerous parties whose relationships are

governed by various contracting agreements. Central to the structure of a

PFI project is the Special Purpose Vehicle (SPV). The SPV, also known as

the project company is a central feature of PFI projects and an essential risk

transfer mechanism. The SPV lies in the centre of the PFI project structure

in between the main parties involved. These are the awarding public


2010 of 129

authority, the private parties chosen to design, build and operate the project

and the debt funders financing the project (Fox, 1999).

The typical structure of a PFI project and the parties involved can be

seen in figure 1.

Figure 4 - Adapted from Fox 1999

The SPV lies at the centre of all contractual and financial

relationships within a PFI project as a separate legal entity with sole

responsibility for the project (Yescombe, 2007). The SPV ensures that there

is limited or non-recourse to sponsors of the project and that SPV is not

affected by any unrelated businesses. An SPV will typically have no assets

or liabilities other than those contained to the project (Gatti, 2007). The use


2010 of 129

of an SPV also has further features which can be seen in figure 5.

Figure 5 - Features of SPV (Saunders, 2010a)

The relationships between the various parties involved are governed

by contracts which stipulate the rights and obligations of the parties

involved. These include the concession agreement, shareholder agreement,

construction contract, operations contract and the loan agreement. These

contracts are the mechanisms by which the SPV transfers risks to parties

best able to handle them (Grimsey, 2007).

The operating contract for example governs the business relationship

between the SPV and the party that manages the facility or structure. The

aim for this contract is to mitigate risk by transferring it to the party which

can best evaluate and handle it. The operating party takes an agreed sum

of money or percentage of profit from the SPV in exchange for their

expertise or services provided (Gatti, 2007).

SPV

Non-recoursefunding

Off-balancesheet

transaction

Sound income

stream of theproject

Allocation ofrisks

ComplexContractual

Arrangements


2010 of 129

The loan agreement is used to create a business relationship

between the SPV and the banks or lenders. The purpose of a loan

agreement is to help the SPV secure the financial resources required to

carry out the tasks. Within the contract, lenders would have agreed on terms

such as:

• The amount of funds made available to the project company

• The interest rates and repayments schedule

• Protection to banks against increased cost

• Representation and warranties - actions that the banks are allowed to

take in the case of project failure.

It is in the lenders interests to limit the amount of risk they are being

exposed to, as they cannot reclaim money from the sponsoring company

assets in case of failure of the project (Gatti, 2007).

Construction contracts such as a Turn-key contract or an

Engineering, Procurement and Construction (EPC) contract are used to

legally bind the Contractor to the SPV. The construction contract is a

standard requirement by banks or lenders as a large proportion of risk will

be transferred to the contractor. The Principle Contractor (usually a

reputable organization) is legally bound to all operations relating to the

construction of the project. This type of structuring allows the SPV to only

deal with one principal contractor for the entire duration of the project. This

can often lead to fewer conflicts between the parties involved which can be

costly and adversely affect the project schedule. In effect, the SPV would

deal with “one single point of responsibility” (Gatti, 2007).


2010 of 129

The Concession Agreement is a contractual agreement which

governs the relationship between the government and the SPV. It allows for

all required permits and authorisation to be acquired and stipulates the

rights and obligations of the sponsors and the government as well as the

technical and financial requirements for the length of the project.

A Shareholders Agreement is used to govern the relationship

between different shareholders and makes provisions for percentage share

of ownership, voting rights and distribution of profits.

3.5 PFI tendering process

The use of PFI procurement has been facilitated by the government

through the use of standard contracting. Guidelines on the application of PFI

procurement are published to ensure VfM for the taxpayer by focusing on

the delivery of a service rather than the acquisition of an asset (HEFCE,

2004). This included guidance on the critical tendering process for a PFI

project and the various stages compulsorily involved, 14 stages in the case

of an example from the Higher Education Funding Council for England.

These stages were: (adapted from HEFCE 2004)

• Stage 1: Establishing the business need

o Once the business needs have been established, outline how

these needs might best be met, and identify those areas

where the principles of PFI could be applied

• Stage 2: Appraising the options and choosing procurement

route


2010 of 129

o Specifics of service to be provided and cost of transfer

analysed to determine whether PFI procurement is relevant.

Original project criteria based on assumptions of what could

be delivered.

• Stage 3: Assessing VfM for taxpayer

o Compare funding projects by public or private commercial

sources. Often the Green Book Appraisal and Evaluation in

Central Government guidelines, published by HM treasury, is

used during this process.

• Stage 4: Creating the project team and advisors

o Project team is chosen to deal with project on behalf of public

body. External project management advisors often utilised as

it is often new territory for the public body project team

• Stage 5: Decide tactics on pre selections

o Involves creating a shortlist from 30 possible bidders and

choosing negotiation tactics

• Stage 6: Official Journal of European Union notice (OJEU)

o Projects above a threshold must be advertised in a specific

way in OJEU to invite expressions of interest

• Stage 7: Pre-qualification

o The public institution establishes relevant criteria to ensure all

bidders are capable of carrying out the project

• Stage 8: Short listing

o Applying the pre-qualification criteria to reduce number of

bidders and invite remainder of parties to negotiate


2010 of 129

• Stage 9: Refining original appraisal

o Reassess original appraisal during negotiations to refine what

can be accomplished according to project specifications

• Stage 10: Invitation to negotiate

o Formal document known as “Invitation to Negotiate” issued,

setting out detailed framework within which commercial

organisation can make their offers

• Stage 11: Evaluation of bids

o Carried out according to criteria set out at initial stages of

project

• Stage 12: Selection of a preferred bidder

o Further investigation into the preferred organisation to

ascertain their capability, given that they will be investing in a

medium to long term relationship with the commercial body.

• Stage 13: Contract award

o SPV established as a contractual company between the public

and private body. Design, construction and operation

agreements signed

• Stage 14: Contract management

o Management of the relationship between public and private

bodies - essential to ensure project is run in a cooperative

rather than combative environment

As outlined above, the PFI tendering process is complex with many

stages that need to be completed. This can result in a lengthy and often


2010 of 129

costly tendering process which introduces barriers to entry for new private

sector participants. This is reflected in government figures that show that for

PFI projects between 2004 and 2006 there were two or fewer bids per

project (NAO, 2007). Fewer bidders means that the public sector is at a

disadvantage and susceptible to opportunistic behaviour, a point

documented by the NAO and Public Account Committee reports (PAC,

2003b).

Further research by Akintoye and Dick (1996) identified the ‘PFI

bidding process and costs’ as an 8 out of 10 on the PFI unattractiveness

scale (Akintoye and Dick, 1996). This is also evident in PFI projects in the

Department of Health with academic research highlighting significant

barriers to entry for new consortiums entering the bidding phase (Pollock et

al., 2002, Froud, 2003).

Further justification is also required for the often high costs paid by

the tax payer for legal and financial services, £445 million in the case of the

PPP project for the London Underground (Committee-of-Public-Accounts,

2005). Across PFI projects the average total costs of tendering for private

contractors was 3% of the overall project costs, this is in comparison to just

1% in traditional procurement (Allen, 2001). The increased costs of the

bidding process and the barriers to entry that are introduced cast a shadow

over its effectiveness in ensuring maximum VfM for the taxpayer.


2010 of 129

3.6 VfM determinants

PFI funding benefits the public sector as the money needed to

acquire an asset can be made available immediately even at a time when

public funds are scarce (Fox, 1999). Often the repayments are spread long-

term, easing the burden on public sector funds. This is a disguised form of

borrowing known in the commercial sector as ‘buy now pay later’. Although

this method of procurement allows faster access to much needed funds, the

long-term nature of concession period in PFI contracts, often 30 years, can

result in the overall cost of the private sector option proving to be more

costly for the taxpayer (see figure 6).

Figure 6 - Timing of payments under the PFI and conventional procurement adapted from(PAC, 2003a)

An additional long-term cost of the PFI procurement method can be

attributed to the higher rate of interest for private companies compare to the


2010 of 129

government’s ability to secure funds at a lower interest rate. This

differentiation in costs also needs justification if PFI projects are to go

ahead.

As discussed previously, one main benefit of PFI is the transfer of

risk away from the public sector, as discussed in section 3.2. Other benefits

include the private sector’s ability to deliver projects on time and to budget,

in contrast to traditional public procurement. An HM treasury publication

(1999) found that the first Design, Build, Finance and Operate (DBFO) road

projects delivered average savings of 15% (Fox, 1999). These savings were

realised in decreased construction durations and lowering costs by bringing

together the previously separate design, construction and operations

phases of a project (PAC, 2003a). The full list of benefits and related

disadvantages for PFI projects as listed by committee of public accounts

can be seen in appendix A.

To ensure VfM for the taxpayer, it is essential that other possible

procurement options are fully considered before a PFI project is approved.

This will ensure that the option which delivers the best VfM for the taxpayer

is in the short and long term is chosen. To enable this comparison, a Public

Sector Comparator (PSC) is often used to determine whether PFI

procurement offers VfM when compared to the traditional public sector

procurement (Yescombe, 2007). The methodology for the calculation of the

PSC is stipulated in the HM Treasury’s Green Book (HM-Treasury, 2010a).

The Green Book defines the PSC as a “hypothetical risk adjusted costing,

by the supplier to an output specification as part of a PFI procurement

exercise”. The calculation of the PSC is a hypothetical, whole of life, risk


2010 of 129

adjusted cost of the government delivering the project and in addition to the

costs of retained and transferred risks, includes costs of construction,

operation and maintenance (HM-Treasury, 2010a). The use of the PSC

allows for financial comparison to be made to the Net Present Value of the

PFI option, as can be seen in figure 7.

Figure 7 - PSC comparison with the PFI option (Canadian-Council-for-PPP, 2003)

Government guidelines stipulate that a PSC should only be used when

the public sector finance option is a genuine alternative to the PFI option

and should be utilised at the outset of the project (PAC, 2003a). The use of

the PSC is beneficial as exact figures are given for often unquantifiable

aspects of a project, such as the value given to risks transferred to the

private sector. Other benefits as highlighted by the British Columbia council

for PPP guidance (2003) include:


2010 of 129

• Financial and cost disciplined approach to PFI project evaluation

• Full consideration of risks in a project and the threats and

opportunities to the project

• Encourages competition and consideration of management

(Canadian-Council-for-PPP, 2003)

There are however limitations to the use of the PSC which will be

discussed in chapter 4.6.

The monetary value for the PSC is calculated by determining the

value of the project income in future rates discounted at the cost of money.

This Net Present Value (NPV) or discounted cash flow is calculated by

using the following formula:

𝑃𝑉 = 𝐹𝑉

(1 + 𝑖)𝑛

Where: PV = present value, i.e. money of today

FV = future value, i.e. money of the future

i = interest of discount rate and

n = number of periods

A Discount Cash Flow (DCF) is the NPV of a series of future cash

sums and is calculated as:

�𝐹𝑉𝑛

𝑛(1 + 𝑖)𝑛

∑ is the sum of the net cash flow for each period, usually

semi-annually in PPP/PFI projects. (Yescombe, 2007)


2010 of 129

In addition to comparison of the PSC and PFI bids, the VfM process

also requires critical analysis of the received bids to ensure the optimum

blend of financial and non financial benefits for the public sector. In order to

determine the financial benefits, the public sector uses an Economic Rate of

Return (ERR, a type of Internal Rate of Return) to measure the return of an

investment over it’s lifetime before deciding to proceed with the procurement

of a PFI project (PAC, 2003a).

The cost of financing infrastructure development often represents a

significant proportion of the costs of a PFI project. Government guidelines

stipulate that the benefits of using private finance must outweigh the costs

of using such a method to ensure VfM. In order for the government to

maintain a strong negotiation position it is also essential that competition

exists between a number of bidders for a PFI project during the tendering

process (PAC, 2003a).

3.7 Financing PFI projects

The main difference between PFI and the traditional procurement

process is that in PFI projects the private sector finances the project upfront

and only receives remuneration by ensuring the capital asset adheres to the

performance criteria set by the government (Fox, 1999).

The scale of funds required often results in project sponsors

approaching third party sources for the sums required. The third party

involved, often a commercial bank will often require evidence of commercial


2010 of 129

viability of the project and the robustness of cash flows before the decision

to lend can be made. This is due to the third party funders being limited to

having recourse only to the assets and cash flows of the project and not the

project sponsors (Yescombe, 2007). The various potential sources of

finance for PFI projects can be seen in figure 8.

Figure 8 - Typical sources of Finance for PFI projects, Adapted from (Fox, 1999)

Equity funding is commonplace in PFI projects and is provided

through investment by the private consortium in return for shares in the

SPV. It is possible for the awarding public authority to require a certain level

of equity funding as part of the PFI contract. Increased levels of equity

represent a greater commitment from the project sponsors, therefore

commercial banks evaluating a proposed project often review the equity to

debt ratio in order to assess their exposure to risks in a project (Gatti, 2007).

Sources of

Finance

Bond issues

Bank DebtEquity


2010 of 129

There are rare cases where funding for PFI projects occurs without any

equity from the project sponsors. In the case of the Queen Elizabeth II

bridge, the project was deemed to have minimal risks associated due to the

inelasticity of demand of road users and lack of alternative routes that could

threaten the project’s cash flow (US-DoT, 2007).

The majority of funding for PFI projects is done through commercial

Bank Debt, also known as senior debt. The funds are drawn with

commitment from commercial banks for the term of the project with a

structured drawdown and repayment profile in place (Fox, 1999). Often a

number of banks are recruited by a lead arranger bank to form a syndicate

that will provide the total funds required. This syndication allows for funds to

be drawn as and when necessary allowing for repayments to be linked with

anticipated cash flows. The covenants and warranties required by the

syndicate is often dependant on the nature of the project and its risk profile

(Yescombe, 2007).

The third source of funding available is Bond Financing of PFI

projects. This is often prevalent following the completion of the construction

phase where the risk profile of the project has changed. The sponsors often

refinance a project by issuing bonds to take advantage of the high credit

ratings the bonds will receive due to the low risks and the guaranteed

income stream of the project. Furthermore bond refinancing in the UK is well

regulated and a buoyant bond market offers a cheaper source of finance

post-construction in comparison with bank debt. The use of bond financing

allows for the involvement of a broader investor base with less stringent

covenants (Fox, 1999).


2010 of 129

Although equity, bank debt and bond financing represent the majority

of funds for PFI projects, there are additional sources that can be utilised.

These are lease financing, investment from the European Investment Bank

and in some cases government grants.

Regardless of the funding combinations used, all funds for a project

are raised through limited recourse financing, with financers of the project

still having recourse only to the assets of the SPV established for the project

(Fox, 1999).

3.8 Payment mechanisms in PFI projects

PFI projects are financed using funds from the private sector with

commercial lenders providing the majority of this funding through senior

loan debt. The repayment of this debt is via payments from the government

to the SPV. The timing and amounts of these payments are stipulated in the

concession agreement between the SPV and the awarding public body.

The payment mechanisms stipulated in PFI procurement allow for

risks to be shared in two distinct ways. The first is that the PFI operator is

partly paid for services it provides, i.e. number of available beds in a

hospital or cells in a prison project. The second performance related portion

of payment allows for the incentivisation/disincentivisation of the operator for

poor performance, e.g. escaped prisoners in the prison service or extended

waiting times in a hospital. In essence in a PFI project, the public authority is

not concerned primarily with the ownership of assets, but more with the


2010 of 129

quality of services provided for the general public (Hogg, 1996). This

requires the public sector to specify both the quality and quantity of services

required and also to have the ability to measure them correctly in order to

utilise the risk sharing capability of the payment mechanism.

The overall unitary payment is often made following the initiation of

the operation phase of the project and is comprised of elements relating to

various attributes of a project. These various elements as described by the

PFI panel can be seen in figure 9.

Figure 9 - Unitary payment components (Hogg, 1996)

The first payment component relates to the minimum levels of

capacity available for the service being provided. The second relates to

measurement of the performance of a particular support service against

preset minimum levels required. The third component relates to the future

usage of the facility where it is anticipated demand will increase or


2010 of 129

decrease. The final component relates to any particular incentives agreed

with the operator regarding service provision.

3.9 Summary

In this chapter the objectives of the government to take major

infrastructure spending off the government balance sheet was identified as

the major reasons why initiatives such as Ryrie rules were introduced.

These initiatives led to the involvement of the prvate sector in the form of

PPP/PFI projects which have become an important part of public

infrastructure provision in the UK and other countries around the world.

The implementation of PPP/PFI procurement was made possible

through various government guidelines such as the tendering process, VfM

appraisal process and the various participants involved were also

discussed. Furthermore PFI theory on the payment of the unitary charge

and the various sources of finance were discussed.


2010 of 129

4.0 Critical review of PPP/PFI procurement

4.1 Introduction

In this section a critical review of PFI theory will be carried out. Examples of

operational PFI projects will be used to analyse the success by which risk

transfer to the private sector has been realised. The potential benefits of

private sector involvement are discussed before a review of the

government’s VfM appraisal procedure is carried out. An investigation will

be carried out on recent developments in the PFI market and their

implications on the risk management process. The final section will review

the impact of the recent global recession and comment on the impact of the

recent change in the UK government.

4.2 Utilising the efficiencies of the private sector

One of the benefits of PFI procurement has been the use of expertise

in the private sector, meaning public authorities are more efficient in

procuring major public infrastructure projects. The traditional procurement

approach was often associated with time and budgetary overruns. The

introduction of expertise from the private sector in PFI projects and efficient

project management procedures have resulted in increasing number of

PPP/PFI projects being delivered on time and to agreed budget. This was

evident in the NAO (2003) report which found that up to 2002, 89 per cent of

PFI construction projects were delivered on time or early, whereas 75 per


2010 of 129

cent of traditionally procured hospitals were delivered late (NAO, 2003b).

The report also highlighted price certainty and the achievement of good

quality assets as major advantages of utilising PFI procurement.

There are also benefits to the public sector during the operational

phase of PFI projects. A report by HM Treasury (2006) found that in PFI

projects:

• Users are satisfied with the services provided

• Public authorities report good overall performance and high levels

of satisfaction against contracted levels of service

• The services contracted for are appropriate

• The incentivisation within PFI contracts is working (HM-Treasury,

2006a).

Further benefits for public authorities come from PFI projects having a

knock on effect on facilities still operated by the public sector. This was

evident in the NAO (2003) report into prison operations which found that

when PFI prisons were created, the public sector managed prisons began to

compete, which resulted in them often outperforming PFI prisons (NAO,

2003a). The positive impact of PFI projects is also evident in staff turnover

rates, which was 12.4 percent in the public sector, compared to a

significantly lower PFI staff turnover averaging 7 percent (BERR, 2008). It

can be deduced that the lower staff turnover rates are a result of a more

satisfied workforce in PFI operated facilities.

Analysis of PFI project performance in the education sector found that

PFI funded schools achieved educational improvements 92 percent faster


2010 of 129

than those rebuilt through traditional procurement (KPMG, 2009). The report

by KPMG (2007) identified increased innovation, thorough assessment

methods and benchmarking to be behind improved contract performance in

the majority of projects in the education sector (KPMG, 2007).

A further consideration is that the long-term unitary payment

mechanisms implemented in PFI projects provides incentivisation for the

private sector to provide high quality services for the entire length of the

contract (Grout, 1997).

The private sector participant is also incentivised to design and monitor

the facilities to a high standard to ensure payments are continued by the

public authority. There is a contractual guarantee that the ongoing

maintenance of the infrastructure is maintained, with funding ring-fenced for

the entirety of the concession period, a lesson now being implemented on

publicly procured projects (SCEA, 2010). This transfer of operational, design

and constructions risk to the private sector was one of the core objectives of

PFI contracting.

The use of PFI procurement provides the public body with the

additional financial diligence that is provided by the commercial lenders of

the PFI contract, this in essence reduces financial risk to the project (Gatti,

2007). It also ensures that projects are successful and loans are repaid with

the private operator incentivised to work though problems (SCEA, 2010).

Initial investigation into PFI procurement methodology has

demonstrated private sector efficiencies to be utilised in large scale public

infrastructure projects, efficiencies which in some cases are transferred to

publically operated facilities. There is also evidence of risk transfer to the


2010 of 129

private sector being realised to the benefit of the tax payer. A number of

critical issues were also highlighted for consideration to gain a holistic view

of PFI project performance. These will be discussed in the remainder of this

chapter.

4.3 Risk allocation strategies

As discussed in section 3.2, the transfer of risk to the private sector is

one of the most important features of PFI contracting. The monetary value

given to the risks transferred is often the critical factor in deciding whether

the public or privately funded option is chosen. Moreover it was

demonstrated that risk transfer is facilitated through contracts between the

project company (SPV) and the party best able to handle them. Although

the transfer of risks to the private sector is desirable, government guidelines

suggest that it is not feasible to transfer all risks to the private sector (Hogg,

1996).

In order to achieve the optimal VfM for the tax payer, government

publications stipulate the preferred risk allocation strategy in PFI projects.

These principal risks and government guidelines on preferred allocation are:

Principal Risk Allocated party

Design and construction risk Private sector

Commissioning and Operations risk Private sector

Availability and Performance risk Private sector

Demand for Volume risk Public sector


2010 of 129

Residual Value risk Not of concern for public sector

Legislation risk Public sector

Adapted from (Hogg, 1996, Yescombe, 2007)

A principle of PFI contracts is that since the public sector is

purchasing delivered services at pre-agreed prices, any increase in project

costs or consequence of delays will be borne by the private sector.

Furthermore the provision of services will remain the responsibility of the

private sector for the entirety of the concession period with a whole-life

approach to the construction and maintenance of the facility (Fox, 1999). It

is for these reasons that the operational risks are transferred to the private

sector. Yescombe (2007) states that since the private sector has the ability

to manage the aforementioned risks, the price will represent VfM

(Yescombe, 2007).

Contrary to this, if the private sector has no control over risks

transferred, then the price given to these risks represents poor VfM for the

taxpayer. For example, the Home Office is responsible for determining

which prison an occupant is allocated to, therefore the cost of transferring

demand or volume risk to the private sector would be too high as they have

no control over the number of prisoners in the country (Clarke, 2010). The

trend is now for the usage risks in the Prison Service to be retained by the

public authority (Yescombe, 2007). Risks often retained by the public

authority are the legislative and regulatory risks as they are best placed to

handle them by acquiring necessary permits or licences for completion of

works (Hogg, 1996).


2010 of 129

Some risks that are retained by the private sector are availability and

performance risks and a percentage of the unitary payment is made only

when the facility is available. The public authority is able to alter the

payment of fees dependant on performance or availability of services.

Yescombe (2007) draws on examples of various PFI projects to point out

that this risk transfer has ensured that levels of availability once the PFI

facilities are built are high, since the operators rely heavily on full unitary

payments in order to repay debts secured on the project (Yescombe, 2007).

Having considered government guidelines on risk allocation, it is also

necessary to consider the risk allocation preferences of other parties

involved in PFI projects. Research by Akintoye et al (1998) into risk

allocation in PFI projects found that the parties involved rank those risks

paramount to their business needs as most critical. Whilst the private

consortiums focus on design, construction and budgetary overrun risks, the

public authority is more concerned with availability and performance risks.

The commercial lenders were mostly concerned with capital and interest

risks as well as those associated with payments under the unitary charge

method (Akintoye et al., 1998). The various parties involved also bring to

the table various risk management techniques and approaches which can

lead to conflicting outcomes between the parties. Although the risk

allocation preferences of the private sector are closely matched to those

stipulated by the government, the different risk management approaches

means that coordinated efforts between the parties are required for a risk

management methodology to be applied effectively.


2010 of 129

One such method proposed by Bing et al (2005) is a result of

research using questionnaires to study PFI/PPP project professionals to

gauge their preferences in risk allocation strategies (Bing et al., 2005). The

aim of this research was to classify risks in order to aid contract negotiations

(Bing et al., 2005) and was a continuation of previous research which had

identified risk allocation as one of three critical success factors for the

implementation of PFI/PPP projects (Bing, 2003).

Bing et al. (2005) stated that the initial aims of PPP/PFI projects, to

remove infrastructure project costs from the government balance sheet, had

a lower than expected impact on government borrowing. This resulted in

public authorities using PPP/PFI projects as a new approach to risk

allocation (Bing et al., 2005). One of the major issues with PFI/PPP projects

to be discussed in section 3.5, was the complicated tendering process

which can be time consuming and costly and result in barriers to entry being

introduced (Bing et al., 2005). A risk allocation scheme as proposed by Bing

et al (2005) can be used to assign risks to the party best able to manage

them with any agreements stipulated in a binding final contract. Bing et al

(2005) drew on earlier research which stated that to ensure success; the

public authorities should identify risks before transferring them to the private

sector. This will allow for analysis of potential costs and allow for other

stakeholders such as the end user to consider other risk allocation

processes (Grant, 1996, Al-Bahar and Crandall, 1990). Furthermore for the

risk allocation strategy to succeed it is important to understand the various

perceptions of risk by public and private sectors and how they prefer to


2010 of 129

allocate them. The aim of their paper was to propose a matrix which would

provide this information to aid the contracting process.

In their previous work, Li et al. (2003) had begun to categorise risks

into three meta classification categories (Bing, 2003). These were macro,

meso and micro categories which were concerned with risks outside project

boundaries, risks inside project boundaries and risks found in stakeholder

relationships respectively. Each category was also given subcategories to

further differentiate the risks involved (Bing et al., 2005).

The method used by Bing et al. was to send out 600 questionnaires

to organisations/professionals in PFI/PPP projects. The results were

analysed to give risk allocation preference tables which allocated risks into

four main categories. These were risks that should be allocated to public,

risks that should be allocated to the private sector, risks that should be

shared between both sectors and finally a group of risks whose allocation

depended on the circumstances (Bing et al., 2005).

This comprehensive list of risks and the recommendations into which

party should manage them should help both public and private parties agree

to a risk allocation scheme, which can aid in a smoother and more efficient

contract negotiation process. Although the relatively small number of

respondents is not fully representative of PPP/PFI projects as a whole, it

provides valuable information to aid the risk allocation and contracting

phase of projects, an issue highlighted as critical by Akintoye et al (Akintoye

et al., 1998).


2010 of 129

4.4 New Risks being introduced to the public sector

Transfer of risk away from the public sector is a key benefit of PFI

procurement with robust risk transfer methodology used to ensure VfM for

the public sector. Academic research into the transfer of risk has however

identified new risks being introduced to the public sector through the use of

PFI projects.

Cooper et al. (2005) critiqued the robustness of the Scottish Prison

Estates Review which was carried out by Jim Wallace (Cooper and Taylor,

2005). Wallace’s report (2002) on the Scottish Prison Service identified a

need to build three new prisons in order to meet the demand caused by the

closure of older facilities. In the Wallace report it was recommended that the

new prisons should be built using private finance via the PFI procurement

method (Wallace, 2002).

The Wallace report (2002) identified a potential saving of £700 million

when comparing private to public sources of finance. This was based partly

on the transfer of risks to the private sector as well as savings to be realised

by the projects being completed on time and on budget. In addition it was

argued that the private sector would introduce innovation into the PFI

projects during the design and construction phases due to the expertise of

the personnel they had onboard. The aforementioned savings were

confirmed by the a report by the accounting firm PriceWaterhouseCooper

(2002) and as such were quoted as fact in government discussion on the

subject (PricewaterhouseCoopers, 2002). The report also highlighted as a

benefit the government’s ability to ensure the provision of superordinate


2010 of 129

services in the long term through the use of incentivisation and penalisation

mechanisms linked to the payment of the unitary charge.

In their publication, Cooper et al. (2005) analysed the underlying

assumptions used to determine the savings figure of £700 million which was

calculated by comparing Net Present Value (NPV) figures for both public

and private procurement options. Cooper et al (2005) argue that using this

accounting figure alone does not take into account all the factors that should

be considered and is therefore inherently inaccurate.

Cooper et al (2005) pointed out that new risks to the public sector,

such as lower staffing levels and inferior build quality were not fully

considered for the purposes of cost comparison in the private option.

Furthermore they go on to comment that regardless of contractual

provisions, the government will remain as the ultimate risk bearer. This is

due to the fact that if the private sector company were to fail, the

government would have to step in to take over the provision of such critical

services with any additional costs borne by the taxpayer (Cooper and

Taylor, 2005).

The exposure of the public sector to new risks through PFI

contracting is also commented on by Pollock et al (1999) in their findings on

PFI projects in the National Health Service (NHS). Pollock et al (1999)

highlighted that for projects up to the turn of the millennium, the level of

service provided by private funded hospitals was lower than those publically

funded (Pollock et al., 1999). Furthermore the long term nature of

concession agreements was identified as the cause of inflexibilities for local

hospital trusts in coping with the ever changing demands of the health


2010 of 129

sector. Pollock et al (1999) also highlighted poor contracting strategies as

the reason why NHS Trusts were not able to be compensated for poor

hospital design. This would introduce long term operational risks for the

public sector bodies (Pollock et al., 1999).

The needs of the taxpayer change over time, therefore public

infrastructure must also adapt to adhere to these needs. Also hospitals,

schools and prison facilities need to adapt to take advantage of

technological advances in order to introduce efficiencies. Pollock et al.

(1999) and Cooper et al (2005) indicate a flaw in the PFI procurement

method in that although long term contracts allow for project debts to be

repaid over a number of years, it prohibits public bodies from adapting

assets to meet the ever changing needs of critical public infrastructure. This

contradiction between the need of the public for adaptable infrastructure and

the inflexible nature of PFI contracts was also raised in recent research by

Professor Corrigan (2010) who was advisor to the previous Health

Secretaries for the Labour Government (Davies, 2010).

The above inflexibility inherent in PFI projects can introduce the

public sector to operational risks, risks that would not have been borne if the

infrastructure was funded using traditional public procurement. The only

solution to this inherent inflexibility is for the public authority to buy-out the

PFI contract if needs change. However this is not guaranteed to ensure

savings for the public sector, as was the case of Norfolk and Norwich

University Hospital Trust PFI projects which found that the predicted savings

of £217 million were overshadowed by the £300 million cost of a buying-out

the private sector (Edwards, 2009).


2010 of 129

4.5 Is the transfer of risk feasible

The transfer of risk to the private sector is one of the fundamental

objectives of PFI procurement. However academic research has raised

questions of whether this transfer of risk to the private sector is feasible.

The point raised is that the critical nature of public infrastructure funded

means that should these PFI projects were to fail, the government would be

forced to bail out the project and bear the resultant costs (Akintoye and

Dick, 1996, Pollock, 2005, Hogg, 1996, Ball et al., 2003).

An example of this is the Balmoral High School project which was

completed in 2002 by the Northern Ireland NAO as a pathfinder PFI project

(N.I-National-Audit-Office, 2004). However the school was closed in 2007,

only five years after its opening due to as lower than forecasted number of

pupils. The severe penalties for early termination of the concession contract

however meant that although the school was no longer feasible, the

education board was still committed to pay the unitary PFI payments for the

remainder of the concession agreement (CONNOLLY et al., 2008).

There are further examples public sector having to bail out failing

operators at an additional cost to the taxpayer (SENATE, 2000). Arguably

however, the most high profile PPP/PFI project to fail was that of Metronet.

In 2002 the government announced that the maintenance and renewal of

the London Underground infrastructure would be undertaken through a PPP

project (Kellaway and Shanks, 2007). The PPP consortium consisted of five


2010 of 129

companies, all of which held equal shareholding in the new SPV. The five

companies involved can be seen in Figure 10.

Figure 10 - Metronet Consortium, adapted from (Kellaway and Shanks, 2007)

In July 2007 Metronet went into administration with significant debts

and having failed to meet its obligations for network improvement (HOUSE-

OF-COMMONS, 2009). In this case the government was forced to bail out

the company by financing the £2.6 billion of debt owed by Metronet which

was guaranteed by the government (Kellaway and Shanks, 2007). This

guarantee, written into the original concession agreement meant that in

essence, the government bore the risks of the project in the case of failure,

irrespective of the public authority’s risk transfer objectives at the outset of

the project. This was in spite of the government spending £500,000 in the

negotiation phase on lawyers and advisory fees alone (Edwards, 2009).

Metronet

Electricite de France

W.S Atkins

Balfour Beatty plcBombadier

Kemble Water Ltd.


2010 of 129

The cases of Balmoral High school and Metronet demonstrate the

fact that due to contractual obligations, the government is the ultimate risk

bearer should the PPP/PFI project fail. The private sector can be seen to be

reaping large returns without carrying substantial risks., a statement

supported by Edwards et al (2004) who draw on the findings of the financial

service company, Standard and Poor’s who found that in their analysis of

the PFI capital market, PFI consortiums carried little risk (Edwards et al.,

2004).

The aims of risk transfer to the private sector may also be

undermined by further practices. In section 3.7 it was demonstrated that

often equity requirements stipulated by public authorities were used to

ensure commitment by the private consortium and transfer risk however

findings by Froud (2003) demonstrated that the equity requirements

stipulated were often financed through loans and bonds, decreasing the

efficiency of any risk transfer (Froud, 2003). This was further supported by

the National Audit office’s findings that in the majority of projects risk

transfer was not being realised (National-Audit-Office, 1999). However we

must note that a more recent NAO publications has noted some

improvement in the risk management process (National-Audit-Office, 2006).

Another consideration is that the transfer of risk may not be ideal

from the outset. Pollock et al. (2002) refer to contract theory findings which

suggest that the public sector may be better suited to bear the risks

associated with NHS projects (Pollock et al., 2002). This point of view was

supported by Froud (2003) who questioned the wisdom of transferring risk

away from the public sector and argues that governments with numerous


2010 of 129

activities should be risk neutral and are best placed to deal with the various

risks and uncertainties. Instead Froud (2003) suggests a post-modernist

approach be taken to allow uncertainty to positively affect the provision of

public services, with the risk agenda widened to include public infrastructure

projects (Froud, 2003).

4.6 Evaluating the robustness of the Public Sector Comparator

As discussed in chapter 3, the value for money process often

involves the use of a PSC to determine whether the PFI or public funding

option is chosen. It is therefore critical that the calculation of the PSC is

highly accurate to give the evaluation process any validity. Recent

Government reports however highlight that the accuracy of using this purely

accounting tool alone can limited (PAC, 2003a). The increasing complexity

of PFI transactions with uncertain forecasts are quoted as reasons why the

decision on whether to choose the PFI route must not depend solely on this

calculation. Given the central role the monetary value of the PSC often

plays in public authorities’ choice of whether to go ahead with a PFI or

public funding option, the government’s own admission of the PSC’s

inherent inaccuracies may be a cause for concern.

The problems that may arise from the public authority’s over reliance

on the PSC calculation were further analysed by Shaoul et al (2005) who

stated that since the PSC is often a hypothetical and by definition a rough

estimate, its only use may be to ensure that the PFI option is chosen. This is

supported by evidence that since adequate public finances are often not


2010 of 129

available, prospective projects will not receive the go ahead unless the PFI

option is chosen. This creates a bias towards approving the PFI option in

order to make sure that the project is given the go ahead and the much

needed infrastructure is procured (Shaoul, 2005). The existence of this bias

will result in the public sector approaching the negotiation phase of projects

with a weak bargaining power, as there is a distinct lack of an alternative

option. The findings of Shaoul et al (2005) and the weak bargaining position

of the public sector authorities is supported by the governments own

findings into the negotiation phase of various PFI projects (PAC, 2003a).

The findings by Shaoul et al (2005) are mirrored in research from

other public sectors. Broadbent et al (2008) concentrated their research on

PFI projects in the Health sector. Their research pointed to the NAO findings

that described the use of the PSC as prone to error, irrelevant, unrealistic

and based on pseudo-scientific mumbo-jumbo (Broadbent et al., 2008). The

authors also found that in the case of the Dartford & Gravesham and West

Middlesex hospitals, the public sector comparator was often overestimated

to ensure the PFI project was cheaper.

Across the Atlantic, the Canadian council for PPP found that the use

of the correct discount rate and value given to risks transferred often

resulted in inaccuracies within the PSC option. Moreover they highlighted

that PSC calculations did not address long term affordability issues for the

public sector (Canadian-Council-for-PPP, 2003). Their research surmised

that the use of the PSC alone would result in further decision factors being

ignored during the decision making process. These decision factors were:

• Service quality & market innovation


2010 of 129

• •Broader economic benefits

• •Public Interest

• •Access, safety, privacy issues

The general consensus of both government sponsored and academic

research is that the presence of an over reliance on the PSC in deciding

whether to go ahead with the public or private option can result in a one

dimensional comparison based solely on accounting figures, ignoring many

issues beneficial to the public (Clifton and Duffield, 2006). Government

guidelines aim to remedy this over reliance by placing emphasis on the

need for continued review of the choice to procure projects through the PFI

route after the initial decision to go ahead has been made (PAC, 2003a).

This approach will allows for the various technical solutions available

and the long term benefits of the procurement options to be considered as

the project progresses. For this to be effective however there is a need for

the existence of a realistic public alternative available throughout.

Further critical issues with the PSC are the accuracy by which the

various components, namely the value of risks transferred, are calculated.

This will be discussed in detail in the next section.

4.7 Determining the value of risks transferred

A critical part of the VfM appraisal process in PFI procurement

determining the monetary value of risks that are transferred to the private

sector. This criticality arises from the fact that it is often this figure that


2010 of 129

determines whether the public or private procurement option is chosen. (see

figure 11).

Figure 11 - Cost elements in public sector comparators and PFI (Broadbent et al., 2008)

To determine the accuracy of the methodology utilised to determine

the monetary value, a review of HM Treasury publications is required. HM

Treasury (2006) publications emphasise a strict and effective risk transfer

process as central to the justification of individual PFI projects. This is done

through clear and concise guidelines with the calculation of the monetary

values divided into three stages. These were programme, project and

procurement level assessment (HM-Treasury, 2006b).

Given the government’s attempts for a clear and concise approach to

the valuation of risks, it is interesting that the findings of academic research

into existing PFI projects found the process to be far from clear (Froud and

Shaoul, 2001, Froud, 2003, Pollock et al., 2002, Nisar, 2007).


2010 of 129

This academic research was carried out on projects in various public

sector departments over a number of years. For example Froud (2003)

attempted to analyse the ability of PFI projects to transfer risk away from the

public sector and deliver better managed facilities at lower service costs

(Froud, 2003). Froud (2003) pointed out that proposed government risk

management methodology, entitled optimal allocation, conflates risk and

uncertainty in order to be able to assign a probability to all factors.

For PFI projects justification of risk transfer away from the public

sector requires for risks to be quantified to allow for the NPV to be

calculated. Froud (2003) however states that uncertainty by definition

cannot be scientifically calculated and as such, any calculation of risks using

absolute figures to represent uncertainties is narrow and inaccurate. The

author goes on to draw on earlier work which stated that risk perception and

the subjective manner in which it is calculated can lead to significant

variances.

Froud (2003) also alluded to the public bodies’ use of this inaccurate

and often vague approach to ensure the PFI option was chosen. This was

demonstrated in analysis of PFI projects which that found that although the

PSC option was often more cost effective, the addition of the value of risks

transferred would invariably leave the PFI option as the cheaper of the two,

often with negligible difference. (See Table 1).

Table 1 - Risk transfer and value for money in new hospital projects – adapted from (Froud, 2003)

Hospital – NHS Trust

Public sector comparator NPV £m

Private finance option NPV £m

Carlisle Hospitals NHS

Without risk 151.1 167

Trust Risk 21.8 0


2010 of 129

Financial close: 5.11.97

Risk adjusted 172.9 167

North Durham Health

Without risk 157.3 173.9

Care NHS Trust Risk 23.6 3.12 Financial close

31.3.98 Risk

adjusted 180.9 177

South Buckinghamshire

Without risk 161.6 163.3

NHS Trust Risk 7.6 -1.7 Financial close

16.12.97 Risk

adjusted 169.2 161.7

Taking into account Froud’s (2003) finding on the conflation of the f

risk and uncertainty in valuating the risks transferred casts further doubt on

the accuracy of the PSC calculations and the VfM decision making process.

These inaccuracies are also supported by findings of Broadbent et al (2008)

who looked at eight PFI projects in the health sector (Broadbent et al.,

2008). Their investigation found that in PFI project appraisal process,

quantitative risk estimation superseded the qualitative risk estimation of

uncertainties. This was due to the fact that the quantitative approach better

suited government decision to use the NPV method for the purposes of

comparison. In essence, although risks and uncertainties are identified at

the pre-decision stage, the majority of uncertainties are ignored. Broadbent

et al (2008) suggest the removal of the dominance of accounting logic to

ensure better consideration of risks and uncertainties during the initial

decision making processes.

Further research by Pollock et al (2002) found that in two thirds of the

PFI projects analysed, the risks being transferred could not be identified

(Pollock et al., 2002). Therefore any value given to risks transferred was


2010 of 129

inherently inaccurate. The ambiguity of the method used by the public

authority to calculate the value of risks transferred and the fact that this

figure was always almost identical to the figure required to close the gap

with the public option, led the Pollock et al (2002) to deduce that it was

being use as a tool of ensuring that the private option was cheaper. The

results of the analysis from four NHS trusts can be seen in Table 2.

Table 2 – Differences between NPV costs of a publicly funded scheme and those of a PFI scheme (Pollock et al., 2002)

Trust Cost advantage to publicly financed

scheme before risk Transfer (£m) Value of risk transfer to

the PFI scheme (£m) Swindon and Marlborough 16.6 17.3 Kings Healthcare 22.9 23.8 St George's Healthcare 11.9 12.5 South Durham 6.1 9.1

In their paper, Pollock et al. (2002) brought attention to the vast

difference between the proportions of total expenditure allocated to risk at

the various hospitals as further evidence of the use of risk valuation to

ensure the PFI option is chosen. They argued that given the above

inaccuracies in determining the value of risk transferred, using private

finance to provide NHS infrastructure will turn out to be more costly, a view

contrary to government justification of the funding methodology. In fact

drawing on their earlier publications, this increased costs over the life of a

PFI project is coupled with lower levels of services provided by the private

funded hospitals when compared to those facilities which were publically

funded (Pollock et al., 1999).


2010 of 129

The inaccuracies in the determination of the value given to risk

transferred are not exclusive to health sector projects. Khadaroo et al (2008)

examined three PFI projects procured the Department for Education and

Skills (DfES) in Northern Ireland. An section of the published results can be

seen in Table 3.

Table 3 - Calculation of the risk-adjusted PSC for PFI school projects (Khadaroo, 2008)

Net Present Cost (discounted at 6%) School 1

£000 School 2

£000 School 3

£000 Capital costs 12,008 6,025 15,993 Operating costs 5,543 2,692 3,943 Total costs before adj. for risk transfers 17,551 8,717 19,936

Risk transfers (e.g. construction, time 1,420 877 1,526 overrun, site, obsolescence,

planning, maintenance, insurance, operating and maintenance, regulatory and force majeure risks)

Total risk-adjusted PSC 18,971 9,594 21,462 PFI price 17,193 9,711 21,500

Difference = financial VFM benefits/(disadvantage) 1,778 -117 -38

Khadaroo et al (2008) found that in a number of cases, if the private

option was found to be more costly, the private consortium was advised to

“work down” their bid in order to ensure parity with the PSC. From Table 3 it

can be seen that schools 2 & 3 represent a disadvantage if the PFI

procurement option was chosen. Nevertheless these PFI projects were

given the go ahead as they were deemed “pathfinders” by the public

authority. These pathfinder projects were undertaken to overcome a major

capital and maintenance backlog in the education estate and lack of


2010 of 129

available public funding (N.I-National-Audit-Office, 2004). Considering the

observations in section 4.6, it is clear that the lack of realistic alternative will

create a bias towards the PFI option and devaluating the VfM appraisal

process.

The bias towards the PFI option was demonstrated further in the

research by Froud (2003) who ascertained that ambiguous projects with

many bundled services were often proposed over a long term project.

Therefore the value given to the numerous risks involved would ensure that

the PFI procurement option would be chosen.

4.8 Refinancing of PFI projects and the secondary equity

market

As discussed in chapter 3.7, PFI projects are financed using a

mixture of equity and loan debt sourced from the private sector. An analysis

of PFI projects post construction has shown that often these projects are

refinanced, changing the debt profile of the project. To understand the

various methods of refinancing it is advisable to consider the two distinct

phases of a PFI project, the construction and operations phases.

The refinancing of PFI projects often occurs after the initial

construction phase has been completed successfully and the risk profile of

the project has changed significantly (PAC, 2002). Moreover having

successfully completer the construction phase of the project, the consortium

operating the PFI contract is deemed to have demonstrated robust risk

management techniques. The increased maturity of the PFI procurement


2010 of 129

methodology and the guaranteed unitary payment from the public sector

have also resulted in commercial lenders being more receptive of PFI

projects and as a result offering better terms for finance (Finlay, 2003).

It is for these reasons that the consortium are able to approach

commercial lenders and secure funds at lower lending charges and interest

rates, reflective of the lower risks now inherent in the project (Finlay, 2003).

The changes to the project risk profile and the resulting financial costs and

return can be seen in figure 12.

Figure 12 - Project risks, financial costs and return based on phase of project (Finlay, 2003)

As it can be seen, following the refinancing of a PFI project there is

an increase in returns for the private sector. For example in the case of

HMP Altcourse project, expected returns increased from the 16% originally

planned to 39% following refinancing. We must consider that since financial

costing for a PFI project are carried out at the inception of a project; any


2010 of 129

increased returns for the private sector that are not share with the public

authority, will represent lower VfM for the taxpayer. A 2002 NAO report into

refinancing found that of the twelve audited projects, only 2 had shared 50%

of the gains with the public authority, whilst 4 did not share any of the gains

(PAC, 2002).

The bad press that a number of high profile PFI refinancing deals

received and the consensus that following refinancing, the taxpayer was

losing out led to the government introducing mandatory requirements in

2002 which entitled the public sector to receive 50% of any gains from the

refinancing of projects (OGC, 2002a). The report produced in 2002 by the

Office of Government Commerce (OGC) also recommended a voluntary

30% share of gains for the public sector for projects that had been signed

prior to July 2002 (OGC, 2002b).

It was reported by the regulatory bodies that the new mandatory and

compulsory codes would result in the public sector receiving between £175

and £200 of additional funds (NAO, 2006). A later report by the NAO

carried out in 2006 found that the government had secured £137 million of

funds from refinancing of PFI deals. The gains realised can be seen in table

4 (NAO, 2006). This £137 million figure was lower than original estimates, a

shortfall that was attributed to a lack of refinancing activity since late 2004.

Table 4 - Public sector gains from refinancing of projects adapted from (NAO, 2006)

Number of refinancing

Actual gains of the public sector (£m)

OGC estimate of gains (£m)

Norfolk and Norwich Hospital 1 34

Bromley Hospital 1 14


2010 of 129

Darent Valley Hospital 1 12 Other deals 17 12 175-200

Total 20 72 Other refinancing:

London Underground 1 42 Other deals 26 23

Total Gains 47 137 no estimate

Refinancing of projects such as the Norfolk and Norwich NHS Trust

PFI project where the private consortium increased its returns from 19% to

60% following refinancing, led to greater public scrutiny of PFI project

financing. The subsequent government reports raised concerns of the

refinancing method which often accelerated the benefits to the private

sector consortium by increasing the debt ratio of the project. Reports in

2006 for the NAO and PAC also pointed to increased liability of the public

sector in event of contract termination and extension of the concession

period as new risks that the public sector was now exposed to (PAC, 2006,

NAO, 2006).

A report for the Scottish Parliament Finance Committee (2008) also

questioned the justification for new risks being borne by the public sector.

Cuthbert and Cuthbert (2008) found that in the case of the HMP Altcourse,

in addition to new termination liability risks introduced, the refinancing of the

project had allowed the private consortium to take out of the project the NPV

of future profits, therefore if the maintenance costs were higher than

expected, the project would not have sufficient reserves to cover the costs.

Cuthbert & Cuthbert (2008) quantified the costs of new risks borne by the

public sector to be £47 million for the entirety of the project, a figure


2010 of 129

substantially higher than the £1 million the public sector received as a share

of the refinancing deal (Cuthbert and Cuthbert, 2008).

The Addition of new risks post-refinancing, namely in the provision of

services, were also identified by NAO report (2006). These risks stemmed

from private investors being less concerned with the performance of the

project, having received the majority of gains earlier than expected. Any

adverse effect could affect the repayment of the debts for the project which

as mentioned were often increased due to refinancing. In their investigation

of refinancing of projects, HM Treasury also accepted that the public sector

would not receive any proportion of gains from the sale of equity in PFI

projects, a decision taken due to the practicalities of the government

interfering in these transaction (NAO, 2006).

It can be argued that this has led to the emergence of a thriving

market where equity in operational PFI projects is traded. A large number of

PFI consortiums bid for PFI projects solely to secure a major construction

project. Once the construction phase is complete, the equity stake is sold so

assets can be moved into securing further PFI construction projects. This

allows for much needed additional funds to enter the PFI market, with

pension funds and specialist investment funds being the major players in

this equity market (Rees, 2005). These investment funds often hold

portfolios of interests in various projects which allow for operating

efficiencies to be achieved, as funds are moved across to projects which

represent greater returns.

The emergence of the equity market is a relatively new concept and

as such there is a need for further investigation into the risk management


2010 of 129

implications that may arise. This is recognised by the government’s own

report into dealings within the PFI secondary and tertiary markets (NAO,

2006). The limited research that does exist however, suggests that the

number of projects held in the portfolio of investment firms, results in

investors being so distant from projects that they are not able to implement

robust risk assessment and management procedures (Cuthbert and

Cuthbert, 2008). It should be noted that investment firms such as the

Secondary Market Investment Fund (SMIF, now part of Sempirian) have

set-up specialist divisions dedicated to operation of PFI projects. The long

term implications for the public sector are yet to be determined (Cuthbert

and Cuthbert, 2008).

Cuthbert and Cuthbert (2008) also noted that the potential from the

original consortium to sell off their equity in the project could also have the

implication that they are less concerned with encumbering the project with

long term risks arising from earlier refinancing deals. As higher returns are

sought, more advanced financial efficiencies and financial engineering

methods are sought by the private sector. Furthermore risk stripping, the

batching of several projects in a group and refinancing the portfolio to

benefit from risk diversification, further increases the complexity in the

market (Cuthbert and Cuthbert, 2008).

The sheer number of transaction in the PFI equity market and the

vast and varied nature of project portfolios held by investment funds can

also introduce risks for the public sector in terms of attempts to regulate the

market. The NAO report (2006) into the equity market found that the lack of

transparency in the secondary market was set to be exasperated with the


2010 of 129

expansion of the PFI equity of market (NAO, 2006). This would jeopardise

the government’s position as an overseer of PFI projects and hinder its

ability to introduce corrective measures.

PFI guidelines stipulating that gains from deals in secondary market

do not have to be shared with the public sector may further explain why the

expected returns from refinancing have been lower for the public sector than

those estimated in 2002. This ability to withhold all of the profits may also

explain the rapid growth of this market with interest from insurers and

investment funds boosted be the low levels of risk coupled with the

guaranteed income stream (UNISON, 2005). It is critical that the

emergence of the secondary and tertiary market and its development if

closely monitored by governing authorities, since as with initial refinancing

deals, it can have a detrimental effect on the returns for the public sector.

This need is further augmented as the long term implications of equity deals

may not realised until it may be too late for corrective measures to be

implemented.

4.9 The impact of the recession and change in government

The impact of the global recession and the resultant lack of liquidity

in the private finance sector on PFI projects is a new development that

needs to be considered. The formation of a new coalition government

following general elections in the UK and their possible approach towards

PFI procurement is also considered in order to paint a picture of the future

for PFI projects.


2010 of 129

The recession, which lasted six quarters in a row, unprecedented for

the ONS figures dating back 60 years, resulted in rising unemployment and

problems in the banking sector resulting in a lack of available lending funds

(ONS, 2010b).

Figure 13 - Real quarterly GDP growth (ONS, 2010a)

..

Figures from the Office of National Statistics (2010) shows a 0.2%

increase in GDP for the UK in the first quarter of 2010 (figure 13). This may

suggest the tentative start of a recovery for the UK economy from the global

downturn which began in 2007 (ONS, 2010a). One feature of the recession

was that governments, including the UK Labour government, were forced to

prop failing financial entities and inject billions of public funds into the

financial sector in exchange for stakes in these banks in order to prevent the

collapse of the global financial system. This intervention was followed by

reviews into the practises of the financial bodies and the introduction of new

financial regulations. The rapid changes in the financial sector following the

recession coupled with the role of the finance sector in providing the

majority of funding for PFI projects instigated research by both government


2010 of 129

bodies and academia to assess the short and long term impacts on the PFI

projects.

One result of the recession was the reduction of the Bank of England

base rate to its lowest figure of 0.5%. This represented an opportunity for

public authorities to realise savings in PFI schemes by renegotiating interest

charges on PFI projects which were typically 5-6% when project

agreements were signed (Davies, 2010). The Department of Health (2010)

found that if this were to be done, it would result in savings of up to £200

million to be realised across all PFI projects (McKinsey&Co., 2010). The

NAO (2010) pointed out that the renegotiation of PFI contracts to allow the

proceeds of refinancing to be shared with the public sector is bound to be

met by resistance from the private sector (NAO, 2010). However this was

also the case in refinancing of early PFI projects, before the OGC used its

leverage to negotiate with the private consortiums to introduce new rules,

resulting in £137 million of extra funds to date for the public sector (PAC,

2006). Therefore the possibility of further refinancing with greater gains for

the public sector cannot be ignored.

The changing liquidity in the financial markets and the need for the

PFI sector to adapt to take advantage of these changes is another notion

that needs to be considered by the public authorities. Davies (2010) draws

on comments by the deputy director of the Institute of Fiscal Studies who

stated that difficulties in the current economic climate meant that private

consortiums may find it more difficult to finance PFI projects. This was

stated to result in increased costs and lower VfM for the taxpayer in new PFI

projects (Davies, 2010). Davies (2010) also noted that the PFI market,


2010 of 129

which has so far been excluded from the frequent restructuring of debt with

rapid changes in value and price, must adapt to reflect changes in the

assets it controls and reduce the debt borne by NHS trusts (Davies, 2010).

The most recent review of PFI projects by the NAO (2010) found that

the economic downturn has so far not had a detrimental effect on the

performance of PFI projects, but the NHS must adapt to the rapid changes

in the financial sector to increase VfM for the taxpayer whilst maintaining the

performance of existing projects (NAO, 2010). Increases in the UK GDP in

the first quarter of 2010 officially ended the recession in the UK. It is safe to

say that there will be significant differences in the financial market pre and

post recession. It is therefore of utmost importance for public authorities to

ensure that these developments do not adversely affect potential gains for

the public sector and any possible gains are realised.

The end of the recession coincided with by general elections in the

UK May 2010 which resulted in a coalition government being formed

between the Conservative and Liberal Democrat parties. One of the main

challenges facing the new government is to reduce the public deficit by

reviewing public services and to make savings through efficiencies and cuts

in public services (HM-Treasury, 2010b). This was reflected in the first

budget in June 2010 by George Osborne, the new Chancellor of the

Exchequer, which stipulated an aim to reduce public spending from 47.5%

of GDP in 2009/10 to 39.8% in 2015/2016.first budget (see figure 14) (HM-

Treasury, 2010b).


2010 of 129

Figure 14 - Public spending and taxation % GDP (HM-Treasury, 2010b)

The PFI procurement model which was a major source of

infrastructure procurement for the labour government is not excluded from

the spending review planned by the coalition government. In fact Mr

Osborne was quoted in saying “The Labour PFI model is flawed and must

be replaced. We need a new system that doesn’t pretend that risks have

been transferred to the private sector when they cannot be, and which can

genuinely transfer risks when they can be” (Guardian, 2009). Further

developments included the new Office of Budget Responsibility’s role in

examining the transparency of PFI deals (Davies, 2010). Mr Osborne also

tasked Phillip Hammond, chief secretary to the Treasury, with assessing

alternative methods of financing major public infrastructure projects.

The new thinking brought in by the new coalition government and the

task it has been given to address the large public deficit has cast a shadow

of doubt over whether future PFI projects will get the go ahead. One

certainty is that the objectives of PFI procurement to transfer risk and create


2010 of 129

value for the public sector will be closely scrutinised in the case of future

projects.

4.10 Summary

A review of PFI project theory and operational projects was carried

out. Effective transfer of design and construction was shown in a significant

number of PFI projects being completed on time and budget. Private sector

innovation in the operational phase was shown to be beneficial in a number

of PFI projects. The positive impact of private sector involvement was

questioned however in the new risks that the exposure of the public sector

to new risks. These included inflexibilities in the long term nature of PFI

contract to those relating to increased termination liabilities following project

refinancing. The rapid growth of the secondary equity market was also

highlighted as a future implication that needed close consideration.

There were also questions raised with regards VfM process with

findings from academia suggesting a lack of a public sector alternative had

resulted in a bias towards the PFI option with the appraisal process only

carried out to ensure government rules were adhered to.

In addition the impact of the global recession was analysed. This

identified the need of the PFI sector to take advantage of a rapidly changing

global finance market and reduced interest rates. Finally the new coalition

government’s objectives for major cuts in public spending were investigated

with the Chancellor of the Exchequer keen to review the PFI procurement

method.


2010 of 129

5.0 Case Studies

5.1 Introduction

5.2 Norfolk and Norwich University Hospital care Trust

5.2.1 Background to project

The Norfolk and Norwich University Hospital care Trust (NNUH) was

one of the first NHS PFI projects with the aim of completing a 989-bed

hospital. At the time of construction the hospital was the biggest ever single

build NHS hospital in the country (NNUH, 2009). A £335 million capital

value project, it entered its operational phase in 8th January 2002. Since its

completion the hospital has taken on the role of an undergraduate teaching

hospital for the NHS Trust’s medical school. An award winning hospital at

the Building Better Healthcare awards in 2002, the PFI project was also

nominated for the Best operational Health scheme awards in 2005

(Partnerships-UK, 2010b).

Figure 15 - NNUH trust aerial photo and Hospital main entrance (NNHU, 2010)


2010 of 129

Prior to the PFI project; The NHS trust was operating hospitals on

two separate sites with one in Norwich, Stephen’s Hospital, and the other in

Cromer. Government reviews of the hospitals in the early 1990’s found that

the main hospital in Norwich was in acute need of renovation and expansion

(Edwards, 2009). Following a review of available procurement options, the

NNUH Trust put the project to OJEU/OJEC tender on the 1st February 1995

asking for tenders from consortia who could design and build the new

university hospital (Partnerships-UK, 2010b). From the shortlist of two

consortia, Octagon Healthcare were awarded the contract to build and

operate the PFI project for a period of 60 years with an option for the Trust

to terminate the contract from 35 years onwards (NNUH, 2009).

5.2.2 The Project structure

As with any PFI project, The NNUH Trust PFI project involved

various stakeholders and participants all of whom had a critical role to play

in the decision making process throughout the projects life cycle. The

project participants for the NNUH Trust PFI project involved mainly the

Trust, the Trust’s advisors, the SPV, project shareholders and debt funders.

The structure of the NNUH PFI project can be seen in figure 16 overleaf.


2010 of 129

Figure 16 - NNUH Trust PFI project structure (Partnerships-UK, 2010b)


2010 of 129

5.2.3 Value for money analysis

As discussed in section 3.2, the increased VfM for the taxpayers is

central to PFI procurement. In early 1996 a business case was submitted by

the NNHC Trust for a new district hospital with 809 beds to be built at Coney

Road site through PFI procurement (Edwards, 2009). As per government

guidelines, if the PFI project were to be approved, it would have to provide

evidence of VfM for the taxpayer when compared to the PSC.

The financial calculations prepared by the Trust’s advisors showed

that the NPV costs for the PSC to be only £10 million more than the PFI

procurement (Edwards, 2009). This represented only a 0.6% between the

PFI option and the PSC considering the total costs including of clinical

services of £1.64 billion for the project over the entire contract length.

This minimal difference in the PSC and the PFI option in the case of

the NNUH Trust would seem to mirror the findings of PFI projects analysed

by Froud (2003) and Pollock (2002) (Froud, 2003, Cooper and Taylor, 2005,

Pollock et al., 2002). These authors highlighted that the VfM process was

designed and in cases manipulated to ensure the PFI project was chosen.

In the case of NNUH Trust project, the construction phase for the PSC was

twice as long as that of the privately funded option. This was in addition to A

longer period of inflation when calculating the PSC’s inflation costs

(Edwards, 2009). In his analysis of the NNUH project, Edwards (2009)

found that in addition to the elongated construction phase, the PSC was

adjusted for a 34.22% cost overrun estimate. This 34.22% increase in costs

would seem too precise a figure given that this is the exact figure required to

ensure that the PSC is proven to be more costly. The figure is also


2010 of 129

remarkably precise given lack of transparency that was observed by

Edwards (2009) in attempting to establish the Trust’s methodology for its

calculation (Edwards, 2009).

Another point to consider is the value given to the risks transferred.

According to data sourced from a 2001 publication by Institute for Public

Policy Research (IPPR), the £76 million value given to risks transferred

(Table 5), was just adequate to ensure the PFI option was deemed to be

more cost effective (IPPR, 2001). The £76 figure was attributed to the

design, construction and operations risks transferred to the private sector as

stipulated by the NNUH PFI contract (NNUH, 1998)

Table 5 - Comparison of costs under PSC and PFI options (IPPR, 2001)

Net Present Cost £m PSC minus

PFI £m

Value given to risks

transferred PSC PFI

NNUH 1682 1642 40 76

Further analysis of the VfM process has shown that the estimated

costs given to cost and time overruns attributed to the public sector option

coupled with the value of risks transferred to the private sector ensure that

only the PFI project was chosen. This is in line with the findings of Pollock et

al (2002) whose investigation of other NHS PFI projects reached the same

conclusion (Pollock et al., 2002). The perceived desire of the NHS Trust to

ensure that the PFI option was given the go ahead may be better explained

by a quotation from the regional executive who at the time concluded that

“there was little likelihood of public capital becoming available, even in


2010 of 129

2001/2002 for this scheme (Edwards, 2009). This lack of a realistic public

option undermines the validity of the VfM process and results in the public

sector authority approaching the negotiation phase of the project with a

weakened position.

5.2.4 Financial restructuring of the PFI Project

Octagon Healthcare financed the PFI project using mainly senior

debt from a range of commercial banks, the breakdown of the sources of

finance can be seen from table 6. Funding for the project was in the form of

a £200 senior debt and a further £32 million in subordinated loans (NAO,

2005). The guaranteed income of the PFI project through the payment of

the Unitary charge meant that the project was deemed of low risk by the

private lenders, hence the £1 million required investment from the equity

holders was negligible compared to the total capital value of the project

(Edwards, 2009). The senior and subordinated loans on the NNUH PFI

project were repayable by 2018. In financing the PFI deal, Octagon

Healthcare incurred financing costs of £5.7 million which were added to the

PFI project costs (Edwards, 2009).

Table 6 - NNUH Trust PFI project borrowing pre and post refinancing (NAO, 2005)

Source of funding

Pre-refinancing Post-refinancing Increase on refinancing

£m £m % Senior debt 200 306 53

Subordinated loan notes 32 32 –

Equity 1 1 – Total 233 339 45


2010 of 129

The NNUH Trust PFI project was refinanced just two years after the

opening of the hospital, in December 2003 (PAC, 2006). Following the

completion of the risky construction phase, Octagon Healthcare were able

to refinance senior debt of the project with bond finance which was not

repayable to 2035 (CBI, 2007). The longer repayment schedule and lower

interest rates of bond finance meant that Octagon Healthcare were able to

increase its borrowing by 53% from £200 to £306 (Edwards, 2009). The

changing debt profile of the NNUH Trust PFI project following the can be

seen in table 6.

The refinancing of the project generated a £129 windfall profit for the

project, of which £75 million was earmarked for the projects private equity

holders (Edwards, 2009). It is evident that the refinancing of the project

vastly improved return for the equity holders who had invested a negligible

figure of £1 million into the project. As with other early PFI projects, Octagon

Healthcare was not obliged to share any of the proceeds from refinancing

with the public sector participants. Nevertheless Octagon Healthcare chose

to share £34 million of the proceeds with the NHS Trust under the voluntary

code agreed by the HM Treasury (CBI, 2007). However the NHS Trust’s

share would be paid in instalments over the life of the contract rather than

an immediate payment (Cuthbert and Cuthbert, 2008). This share of the

proceeds from the refinancing of the project represented nearly 30% of the

£109 that was subject to the sharing allocation (Table 7).

Table 7 - Gains rising from refinancing of NNUH Trust PFI project (NAO, 2005)

Gains arising from the refinancing

£ %


2010 of 129

millions Trust share of refinancing gains 33.9 30.9 Octagon share of refinancing gains 75.8 69.1 Total refinancing gains subject to sharing allocation 109.7 100

The refinancing of PFI projects can result in new risks being

introduced for the public sector. In the case of NNUH Trust PFI, a report by

the NAO (2005) found that following renegotiations with the Octagon

Healthcare, the NHS Trust had been exposed to new risks in terms of

increased contract termination liabilities (NAO, 2005). This included risks

associated with extension of the contract agreement period, with the first

agreed break point being prolonged by 5 years from 2032 to 2037

(Edwards, 2009). This would expose the NHS Trust to new risks as it would

not be able to adapt to changes in clinical provision, changes that could not

be predicted so far in advance. Furthermore the fact that the NHS Trust

agreed to receive its share of refinancing over the life of the contract meant

that should Octagon Healthcare fail, The Trust would not be guaranteed the

remaining proceeds it was owed (PAC, 2006).

As part of the negotiations following the project refinancing, the NHS

Trust would be liable to repay all borrowings of Octagon Healthcare should

it wish to terminate the contract before the 2037 break point. This would

result in an increase in liability of the Trust to a maximum of £257 million

(Cuthbert and Cuthbert, 2008). The changing termination liabilities of the

Trust post and pre refinancing can be seen in figure 17.


2010 of 129

Figure 17 - NNUH Trust termination liabilities post and pre refinancing (PAC, 2006)

As it can be seen, the NHS Trust’s exposure to new risks was

significantly increased post refinancing. It is arguable whether the possible

impact of these risks occurring can be justified by the 30% share of

refinancing proceeds that the Trust received. Further analysis of the findings

of this research study including the VfM process will be carried out in fifth

chapter.


2010 of 129

5.3 HMP Altcourse (Fazakerley)


HMP Altcourse (Formerly Fazakerley) PFI project consisted of the

provision and operation of a 600 place category A + B prison near Liverpool

with a space for a further 300 Prisoners (Partnerships-UK, 2010a). One of

the first PFI (Pathfinder) projects in the Justice and Custodial sector, the

case of Altcourse Prison will be used to demonstrate various aspects of risk

management and transfer processes within PFI projects.

Following the tender and negotiation process, the HMP Altcourse

project was awarded to Tarmac and Group4 in December of 1995 with the

project entering the operational phase in December of 1997 (Partnerships-

UK, 2010a). The two companies then formed the Fazakerley Prison

Services Limited (FPSL), a SPV set up as part of the PFI agreement (NAO,

2000). The construction phase of the £88 million capital value project was

completed five months ahead of schedule and with the facility seen to set

new standards in design and cost effectiveness (Partnerships-UK, 2010a).

Figure 18 - HMP Altcourse Prison aerial photo and main entrance (Google Images)


2010 of 129

The Ministry of Justice who were the central government sponsor of

the project selected Group 4 and Tarmac as the consortia tasked with

delivering the PFI project following a OJEU/OJEC tender process which

began in October of 1993 (Partnerships-UK, 2010a). As it can be seem from

table 8, following the completion of the VfM process the Ministry of Justice

found that the costs of the PFI project where similar to that of the PSC

(Grimsey, 2007). However the Ministry of Justice decided to go ahead with

the PFI project as a pathfinder project for future prison infrastructure

projects. Increasing conviction rates and changes to the sentencing

practices of the time had resulted in a shortage of capacity under the

government’s prison construction programme, therefore a new method of

procuring of procuring Prison Infrastructure to meet future demands was

required (BERR, 2008). This lack of availability of public finances explains

the reasons why the Ministry of Justice decided to go ahead with the PFI,

option regardless of the fact that it did not offer significant savings over the

PSC.

Table 8 - Comparison of costs under PSC and PFI options (Grimsey and Lewis, 2007)

Net Present Cost £millions PSC minus

PFI

£millions

PSC PFI

HMP

Altcourse

248 247 1


2010 of 129


As one of initial two prison projects to be procured through PFI

methodology, the Prison Service involved a number of legal, financial

advisors. These advisors were in addition to those from central government

and were employed to ensure that the objectives of the public sector would

be realised by the PFI project (Partnerships-UK, 2010a). The project also

involved numerous participants from the private sector who also employed

their own independent advisors. The structure of HMP Altcourse PFI project

incorporating the above participants and other stakeholders can be seen in

figure 19 overleaf.


2010 of 129

Figure 19 - FPSL project structure (Partnerships-UK, 2010a)


2010 of 129

5.3.3 Financial restructuring of the PFI Project

HMP Altcourse along with HMP Bridgend were the first corrections

facilities to be procured through the PFI procurement method (NAO, 2000).

The initial financial structure of the project did not raise any concerns as it

was typical of other PFI projects. This involved a total of £95 million of debt

funding repayable by 2015 in addition to £4 million of funding from each of

the two members of the consortia, Tarmac and Group4 limited (Grimsey,

2007).

In November of 1999 the consortia refinanced the project following

two years of operation (NAO, 2000). This was done for a number of reasons

including the change to the projects risk profile following the completion of

the construction phase. The efficient operation of the PFI infrastructure by

FPSL up until that point and the increasing confidence of the financial

markets towards PFI projects in general allowed for the private consortium

to approach commercial lenders with the aim of refinancing the project

(Allen, 2001).

The refinancing of the project resulted in the £95 million bank loan

accruing interest at a lower rate, however this debt would be repaid over a

longer period of time and accrue interest at a lower rate (NAO, 2000). The

report by NAO (2000) found that post refinancing, the private shareholders

of the project were able to increase their returns and also bring forward the

potential gains for the project. The gains for the project were quantified as

£17.5 million prior to refinancing to £30.5 million post refinancing, an 81%

increase (NAO, 2000). This increase in returns and how the returns from the

projects are brought forward following refinancing can be seen in figure 20.


2010 of 129

Figure 20 - How the HMP Altcourse refinancing increases, and brings forward, the returns to the shareholders of the consortium (NAO, 2000)

The original PFI contract did not obligate the consortia to share any

of the proceeds of the refinancing with the Prison Service. However it was

stipulated that the consortia would need consent of the Prison Service

should it change the termination liabilities of the Prison Service. Otherwise

the Prison service had the ability to end the contract prematurely without the

payment of any termination liabilities (NAO, 1997). To ensure that the

Prison Service could not refuse to pay its termination liabilities at a later

date, the consortia approached the Prison Service for consent and offered a


2010 of 129

share of the proceeds from the refinancing of the project. As it can be seen

from table 9, following negotiations, the Prison Service received a £1 million,

the equivalent of a 7% share of refinancing proceeds (NAO, 2000).

Table 9 - Gains rising from refinancing of HMP Altcourse PFI project (NAO, 2000)

£ millions %

Prison Service share of refinancing gains 1 7 Consortia’s share of refinancing gains 13.1 93 Total refinancing gains 14.1 100

By agreeing to new contract terms, the Prison service introduced

itself to new risks. Cuthbert and Cuthbert (2008) point out that following

refinancing, the increased termination liability of the Prison Service could be

as high as £47 million, a figure significant figure considering that the private

sector consortium had already covered its costs and could look forward to a

profitable future (Cuthbert and Cuthbert, 2008). Furthermore the

restructuring of project meant that the consortia were able to take out the

NPV of future profits from the project which exposed the Prison Service to

new operational risks in relation to maintenance of the project.

HMP Altcourse project was one of the two initial PFI projects

sponsored by the Prison Service. It is for this reason that the NAO

accepted that the higher than expected returns for the private sector were

just reward for it taking the risk to enter the new PFI market (NAO, 2000). In

fact the refinancing of HMP Altcourse was one of the main projects

analysed by HM Treasury and led to new regulations being drawn up that

stipulated the mandatory sharing of any proceeds for PFI project refinancing

post 2002 (OGC, 2002a).


2010 of 129

5.3.4 The Secondary Equity market

At the inception of the PFI project, the HMP Altcourse PFI project

structure included two main shareholders who were Tarmac and Group 4.

However as it can be seen from figure 21, the case of HMP Altcourse was

one where the current shareholders in the scheme are no longer those at

the inception of the project. The changing equity holders of the project

through the life of the project can be seen below.

Figure 21 - Changing shareholder profile of HMP Altcourse PFI project (Partnerships-UK, 2010a)

As it can be seen the shareholder profile of the PFI project has

changed over the life of the project with Semperian (formerly Secondary

Market Investment Fund) currently holding a full stake in the project. Other

than HMP Altcourse, the specialist investment fund also own and manage


2010 of 129

over 100 other assets with a total value of £1.3 billion (Semperian, 2010).

Semperian acquired the economic stake in the HMP Altcourse PFI project

from Land Securities Trillium (LST) in February of 2008 who in turn had

taken over the project portfolio of Secondary Market Investment Fund

(SMIF) in 2007 (Hogan-Lovells, 2010). SMIF had bought a 50% stake in

HMP Altcourse in October 2005 from Global Solutions limited and the

remaining 50% stake in September of 2006 from Carillion (Partnerships-UK,

2010a). As part of the transfer of the deal, SMIF would hold economic

interests in the project whilst GSL would keep its place on the board of SPV,

share decisions and continue as the project manager of the PFI, a role it still

plays to this day in the guise of G4S (Ellis, 2006).

As it can be seen three different investment funds have held stakes

in the PFI project since 2006. As per government guidelines in relation to

activities within secondary market, the Prison Service did not receive any of

the proceeds of the sale of the equity in the project (NAO, 2006).

Like many other specialist funds, Semperian used funds from their

investors, such as pension funds, to purchase assets in operational PFI

projects and increase returns for their investors (NAO, 2006). As discussed

in section 4.8, the portfolio held by Semperian ensures that they are able to

manage the risk they are exposed to by risk stripping and moving funds

between multiple PFI projects, thereby ensuring maximum returns for their

investors. The long term operational phase of HMP Altcourse PFI project

post refinancing coupled with the guaranteed payment of the unitary charge

meant the investment fund could expect large returns in return for taking on

minimal risks (NAO, 2006). The NAO report (2006) on the emerging equity


2010 of 129

markets highlighted the distance between the investors and the PFI projects

as an additional risk introduced following the transfer of equity of PFI

projects. The specialist skills of G4S in management of Prison Service

facilities is utilised to mitigate this risk. Nevertheless the increasing distance

between the equity holders of a project and the operation of the facility itself

is an unwanted by-product of the trade of the PFI project’s equity within the

secondary market.

5.3.5 Risk Transfer

The PFI contract for HMP Altcourse stipulated that the design,

construction and operation risks were transferred to the private sector. The

first of two prison projects to be procured using the new Design, Construct,

Manage and Finance (DCMF) contract meant that risks in both the

construction and operational phases of the project were transferred to

private consortium of Carillion and Group 4 (NAO, 1997).

However the transfer of risks to the private sector was not without

problems itself. Complexities arose when the Prison Service attempted to

transfer Volume or usage risk to the private sector (Clarke, 2010). The

Home office is responsible for determining which prisons any new prisoners

are allocated to; therefore the cost of transferring this risk to the private

sector would be too high, as they do not posses any method of mitigating

this risk. In the case of Altcourse prison the government initially asked the

private consortium to accept a fee per prisoner, however the compensation


2010 of 129

required by the consortium to handle this risk was deemed unacceptable

and the idea was quickly shelved (Clarke, 2010).

As discussed above, post refinancing, the risk exposure to the Prison

Service changed in relation to increasing termination liabilities. However a

bigger cause for concern is that in the original PFI contract, the government

agreed to act as “insurer of last resort”, effectively transferring the risk back

to the Prison Service (Hall, 1998). If the project consortia were to go

bankrupt, the Prison Service would have to step in to operate the facility at

cost to the taxpayer, making the risk transfer process null and void.

In this case of HMP Altcourse, the contractual obligations of the

Prison Service would undermine the objectives to transfer risk to the private

sector. Also the failed attempts to transfer volume risk to the private sector

exhibit deficiencies in the risk transfer process as the private sector was

reluctant to accept new risks it had little control over. As in the case of the

financial restructuring of the project, the fact that HMP Altcourse was a

pathfinder project resulted in a number of undesirable outcomes. The new

refinancing regulation by HM Treasury and the NAO report into improved

risk transfer process however indicate that this project may represented an

important leaning experience.


2010 of 129

5.4 Queen Elizabeth II Bridge, Dartford crossing


At 137m high and 2872m long, the cable-stayed Queen Elizabeth II

Bridge was opened in 1991 by Queen Elizabeth II. At the time of

construction the project consisted of the longest single span suspension

bridge in Europe and one of the first projects in the United Kingdom to use

Private Finance to fund a major infrastructure project (Carlile, 1994). Since

its construction the QE II bridge has become an extremely important

transport link to the South East region and the major ports located on the

coasts of Kent and Essex, which acts as a 'gateway' for a large proportion of

the UK's trade with Europe (Highways-Agency, 2010).

The QE II Bridge is part of the Dartford crossing located south east of

London which along with the bridge consists of two tunnels. Originally the

crossing were called the "Dartford tunnels", the first tunnel was completed in

1963 and was originally designed with traffic forecasts of 2 million cars per

year. These early forecasts however proved to be inaccurate and traffic flow

more than doubled in the first year, requiring a second tunnel to be built.

The second tunnel was completed in 1980 and increased the capacity of the

tunnels to 65,000 cars per day (Highways-Agency, 2010). In 1986 the M25

motorway was completed and new forecasts showed that daily traffic flow

would increase to 110,000 per day. At this point the government decided

that a new crossing would be required to satisfy the demand of traffic into

the new century.


2010 of 129

With limited public funding available for improvements to the UK's

transport infrastructure, the Queen Elizabeth II Bridge became an early

example of a Private Finance Initiative (PFI) project. The project consisted

of a project consortium tasked with responsibilities to design, finance, build,

operate the infrastructure, before transferring the bridge back to government

ownership at the end of the 20 year concession agreement (Carlile, 1994).

Figure 22 - Queen Elizabeth II Bridge - Dartford crossing

In the mid 1980's, the Government invited the private sector to come

forward for the PFI project with the promise that prior to construction of the

bridge, the Dartford tunnels could be transferred to the selected consortium

to allow for finances to be raised (Carlile, 1994). Eight consortia submitted

proposals, which included bridges, submerged twin tube tunnels and a twin

bored tunnel. Of these three tenders were shortlisted, and after a period of

negotiation the project was awarded to the Trafalgar House Group for their

bridge scheme (Harris, 1991). Trafalgar House plc in turn created the


2010 of 129

Dartford River Crossing Ltd. (DRC) as a SPV to own, design, build and

operate the combined crossings. In order to facilitate the transfer of the

tunnels, the construction of the bridge, the acquisition of land and the

authority to collect tolls on the combined crossing, the approval of

Parliament was needed. This was done by implementing the Dartford-

Thurrock crossing Act in 1988 to allow transfer of the crossing from Kent

and Essex County Councils to Dartford River Crossing Limited (Carlile,

1994).

The original concession was awarded to Dartford River Crossing Ltd

for a maximum time period of 20 years or until the debt had been repaid,

whichever was earlier. Due to significantly higher than expected traffic

volumes and the resultant increased revenues meant the Queen Elizabeth II

Bridge was handed back to the Government earlier than planned in 2003

(US-DoT, 2007).


Being of the first projects within the UK to involve the PFI

procurement method required the involvement of a broad range of parties.

Of these many were working on this type of project for the first time. The

expertise that the various parties brought to the table was essential in order

to complete the project to the required technical specifications (US-DoT,

2007).

The design of the cable-stayed bridge superstructure was done by

Dr. Ing Hellmut Homberg and Partners whilst Kvaerner Technology Limited


2010 of 129

designed the substructure. The construction of the bridge was completed by

a joint consortium consisting of Kvaerner Construction Limited and Kvaerner

Cleveland Bridge Limited (Highways-Agency, 2010). The structure of the

PFI project can be seen in figure 23 overleaf.


2010 of 129

Figure 23 - Queen Elizabeth II Bridge PFI Project Structure. Adapted from (Saunders, 2010b, Highways-Agency, 2010)


2010 of 129

5.4.3 Risk transfer to the private sector

Queen Elizabeth II Bridge was at the time the largest single span

bridge in the UK and as such it involved various risks in the construction

phase of the project (Highways-Agency, 2010). This PFI project was

chosen as it demonstrates on a number of levels the possible positive

impact of the involvement of the private sector in large scale infrastructure

project.

One of the risks to be transferred to the private sector was the

financial risks involved. The concessions agreement stipulated that DRC

Limited would gain ownership of existing tunnels for the duration of the

concession. This coupled with a distinct lack of available alternative routes

and the inelasticity of demand from users meant that DRC limited were able

to finance the project wholly trough debt (US-DoT, 2007). As it can be seen

The transfer of the financial risks allowed the required funds for the project

to be sources without any demand from the public sector.

Other risks to be transferred were the design and construction risks.

The scale and complexity of the proposed bridge would introduce numerous

design and constructions risks with significant technological issues needing

to be overcome. The completed structure had to be resistant against the

high wind speeds at a height of almost 200m above ground level. The

bridge also had to be resilient against significant traffic loads whilst making

for safety provisions in the event of an impact from ships. The 450 meter

main span made the bridge particularly difficult to erect, the completion of

which was set to uncompromising deadlines in the construction schedule

(US-DoT, 2007).


2010 of 129

Other construction challenges faced by the construction team was

the technical specifications of the cables that were required. The

foundations of the bridge, its piers and structural steelwork were established

technologies, however what made the Queen Elizabeth II Bridge unique

were the cables used which were to become the focal point of the bridge

upon its completion. The cables used would total 1600 tonnes of galvanised

steel and would represent a significant proportion of the projects budget,

accounting for £5 million of the total allotted construction budget of £86

million (Construction-News, 1991). The bridge would comprise of a total of

112 cables, half will support the centre span, and the rest will act as back

stays. The use of construction expertise and the extensive supplier network

of the construction contractors ensured that the construction process of the

cabling and the bridge superstructure and substructure were completed to

the desired specifications. The bridge was completed on schedule and to

this day caters for the requirements of users.

Further risk to be transferred were those associated with the

operational phase of the project. These included the collection of tolls and

the maintenance of the bridge and tunnels as part of the concession

agreements. As part of the concession agreement, DRC Limited was tied

into toll prices set by the Highways Agency which could only be adjusted for

inflation. Therefore the efficient collection of tolls was essential if the project

was to repay the large loans secured against its assets. DRC limited

overcame this problem by bringing in expertise to run the operational phase

of the project to achieve an efficient and safe path to achieving the financial

goals of the project (Carlile, 1994). The use of expertise resulted in new


2010 of 129

technologies such as automatic vehicle identification and a fully integrated

toll collection system. Systems such as the DART-Tag provided a prepaid

account for drivers and provided a method for drivers to pass the toll in

quickly and efficiently (US-DoT, 2007).

Figure 24 - One of FSD’s buses during the Dartford Crossing installation (FSD, 2010)

Another prime example of private sector efficiency and innovation

was the methodology adopted to maintain the tunnel lighting, a contract

awarded to FSD electrical contractors in 2001. In order to transport the

maintenance equipment to and from the site, a double Decker bus (Figure

24) was modified to include an integrated scissor lift which would provide a

quick moving and perfect working platform for electricians during any

maintenance work. This method significantly reduced the time the tunnel

was out of operation for electrical maintenance (FSD, 2010).

The involvement of the private sector in the PFI project preceded the

contract award by a number of years. Prior to construction of the bridge the

government used global expertise in the financial, legal and engineering


2010 of 129

sectors to carry out studies on the capacity of the existing two tunnels and

possible solutions to problem of overcrowding in the existing tunnels (US-

DoT, 2007).

The concession agreement for the PFI project started on the 31st

July 1988 and was set to run for a period of 20 years. However the Queen

Elizabeth II Bridge was handed back to the government in 2003, four years

earlier than expected, due to higher than expected levels of traffic flow (US-

DoT, 2007).

The case of the Dartford Crossing was chosen as it is one of the few

PFI projects to have completed the operational phase and been handed

back to the government at the end of the concession agreement. As one of

the early infrastructure projects to use project finance, it also demonstrates

the benefits of using an array of reputable firms with sufficient expertise and

available resources to deliver large scale projects. Private sector

involvement was included in the design, construction and operational

phases of the project (Carlile, 1994). To this day the Bridge operates as a

tolled crossing over the river Thames and is a significant source of income

for public sector.

5.5 Summary


2010 of 129

6.0 Conclusion

6.1 Introduction

In this chapter, the aims, objectives and research question stated in

the initial chapter are assessed against the findings of the research

conducted. Evidence from case studies carried out on operational PFI

projects are used in conjunction with those identified in chapter four to

answer the research question identified at the outset of the research project.

Conclusions are then drawn from key findings of the research before

recommendations for future research and limitations of this study are made.

6.2 Discussion

The evidence from operational PFI projects at NNUH care Trust,

HMP Altcourse and the Queen Elizabeth II Bridge are used to demonstrate

the critical issues identified in the fourth chapter. The issues investigated

through the use of case studies included investigation into:

• risk transfer methodology and feasibility

• the validity of the VfM process

• the effects of refinancing on PFI projects

• the identification of new risks borne by the public sector

• the emergence of the secondary and tertiary markets

• the potential benefits of involving public sector participants


2010 of 129

• and the future implication of PFI procurement

To guide this section, reference is made to the original research

questions put in the first chapter. This is carried out in order to gauge the

extent to which the objectives of the research project have been met.

6.2.1 Research Question 1

To what extent do government regulations stipulate risk transfer and

management as a requirement of PPP/PFI procurement and whether

implementation of PFI project shows evidence of this occurring?

In section 4.3, the findings of Hogg (1996) and Yescombe (2007)

were adapted to develop guidelines for the optimal risk allocation strategy

according to government guidelines. A review of PFI publications indicated

the lack of available public finances and the desire to take public

infrastructure spending off the government’s balance sheet as primary

reasons for the use of Private finance to procure public infrastructure (Hogg,

1996, Fox, 1999). It was also observed that the government regulations that

facilitated this use of private finance, i.e. Ryrie Rules, stipulated clear

objectives to transfer risk to the private sector (Mackie and Smith, 2005). It

was also commented the transfer of risk to the private sector had become

more critical given the lower than expected impact on the government

balance sheet following the introduction of PFI projects (Bing et al., 2005).


2010 of 129

In the case studies analysed, it was observed that the strict covenant

of PFI contracts meant that the risk allocation was as per government

guidelines. In the case of NNUH the design, construction and operational

risks were transferred to the private sector as part of the PFI contract to

ensure the project was completed on time, cost and to the stipulated quality

specification (NNUH, 1998).

The risk allocation strategy in HMP Altcourse also stipulated the

transfer of the design, construction, operational and financing risk to the

privates sector (NAO, 1997). However complications arose with the

attempted transfer of volume risk to the private consortium, an attempt

abandoned following the high costs given by the consortium. In both these

cases the identification and allocation of risk was simplified by government

guidelines to ensure VfM for the taxpayer was achieved.

Furthermore the case of an the Queen Elizabeth II Bridge was used

to demonstrate that the complex infrastructure was completed successfully

through the transfer of the financial, design, construction and operational

risks to the private sector participants. This helped ensure that the

infrastructure project was delivered on time and to government

specifications.


Is the transfer of risk to the private sector feasible?


2010 of 129

The cases of the Metronet PFI agreement and Balmoral high school

were used in section 4.5 to highlight the government’s position as the

ultimate bearer of risk (Kellaway and Shanks, 2007, N.I-National-Audit-

Office, 2004). In these cases, contractual obligations such as government

guarantees of debt meant that the public sector was in fact the ultimate

bearer of risk. This was also observed in the case of HMP Altcourse where

the government’s contractual position as the insurer of last resort negated

any risk transfer process (Hall, 1998). It was also demonstrated that the

critical nature of healthcare provision through the NNUH care Trust PFI

project meant that the government would have to intervene in the event of

failure of the private consortium. The cases of HMP Altcourse and NNUH

care Trust have only cast further doubt on findings of authors discussed in

section 4.6 which questioned the feasibility of any risk transfer to the private

sector (Ball et al., 2003, Hogg, 1996, Akintoye and Dick, 1996).

Although the aim of this research question was to investigate the

feasibility of risk transfer to the private sector, the author found that the

public sector was in fact exposed to new risks following implementation of

PFI contracting. This was raised in section 4.4 with the findings of Pollock et

al (1999) who stated that the long term nature of the concession

agreements caused the public sector to be exposed to risks through lack on

inflexibility to adapt to changing demands of infrastructure users (Pollock et

al., 1999).

In the case of the NNUH care Trust, the public authority is not able to

easily adapt their assets to changing needs and development in the medical

field until the end of the concession agreement in 2037 (Edwards, 2009). In


2010 of 129

the case of HMP Altcourse, this inflexibility is in place until the end of the

concession period in 2020. In both these cases the public sector will not be

able to introduce efficiencies through the implementation of new

technologies or significantly change its requirements from the infrastructure

without incurring heavy costs.

These findings would seem to support concerns of Professor

Corrigan (2010) who questioned the contradiction of the public’s need for

evolving infrastructure and the static nature of PFI concerns. The use of PFI

procurement may have allowed the NNUH care Trust and HMP Altcourse to

repay debts over a longer period of time; however the resultant operational

risks borne by public sector cannot be quantified.

Having analysed the risk transfer process has identified another

contradiction in the objectives of the private and public sector participants.

Whilst the public sector must ensure that significant risks are identified and

transferred to the private sector to justify PFI procurement, private sector

participants must ensure that risks in projects are minimised in order to

ensure that the required funds for the project can be sources at minimal

interest rates.


How accurate is the VfM appraisal process and does the transfer of

risk to the public sector represent VfM for the taxpayer?


2010 of 129

The deductions made in chapter 4.6 into the inaccuracies of the PSC

comparison method and the central role it played in the VfM appraisal

process were compared to those findings from case studies. Although the

researcher readily found absolute values for PSC figures for both the NNUH

and HMP Altcourse PFI projects analysed, no information could be found on

the exact method by which this monetary figure was calculated. This raised

further doubt on the VfM process as this lack of information was in line with

the findings of further academic research into other PFI projects (Pollock et

al., 2002, Froud and Shaoul, 2001).

In the case of NNUH there was only a 0.6% difference between the

PFI option and the more costly PSC. The unexplained nature of how the

33.24% figure used to signify the construction phase overrun was calculated

and lack of information on how the £76 million risk transfer cost was

calculated supported the statement by Broadbent (2008) that the value for

money process is prone to error, irrelevant and unrealistic (Broadbent et al.,

2008).

The gap between the PSC and the PFI option was smaller yet in the

case of HMP Altcourse where there was a mere 0.4% difference between

the PFI option and the more costly PSC (Grimsey and Lewis, 2007). Given

this negligible difference, the prison service nevertheless decided to go

ahead with the project as a pathfinder project to facilitate the future

procurement of prison infrastructure and meet future demands for prison

places.

Evidence from the HMP Altcourse and NNUH care Trust would seem

to support findings in sections 4.6 and 4.7 that the VfM appraisal process is


2010 of 129

skewed towards the PFI option. The bias of public authorities towards the

PFI procurement options can be explained by a lack of an alternative. The

lack of available funds meant that unless the PFI option was chosen, the

projects could not be procured. In the case of NNUH care Trust, unless PFI

procurement was chosen, the provision of the much needed infrastructure

could not be funded until 2002 at the earliest (Edwards, 2009). This

supports the findings of Froud (2007) and Pollock (2008) who pointed out

that the VfM appraisal process was only carried out to comply with

government guidelines and that the PFI option was often the only option. In

the cases of NNUH care Trust and HMP Altcourse, this bias towards the PFI

option resulted in a lack of transparency in the finer details of the VfM

process, an observation mirrored by the findings of other academics

identified in chapter 4.7 (Pollock et al., 2002, Froud and Shaoul, 2001).


What have been the major developments in the PFI procurement

method and how have government guidelines adapted accommodate

these?

In section 4.8, the refinancing of PFI projects post construction and

the emergence of the secondary and tertiary equity markets were identified

as recent developments in the PFI procurement model. It was also

demonstrated that both these introduced the public sector participants to


2010 of 129

new risks and that public uproar following initial PFI refinancing had led to

new guidelines being introduced by HM Treasury.

Both HMP Altcourse and NNUH care Trust were examples of

projects which were refinanced with increasing gains for the private sector.

In fact the cases of HMP Altcourse and NNUH care Trust were both quoted

by the OGC and PAC in their respective investigation into PFI refinancing

(OGC, 2002b, PAC, 2006). This investigation led to the introduction in 2002

of mandatory requirements in sharing of gains from refinancing of PFI

projects was discussed.

In both of the aforementioned case studies, it was observed that the

private consortium greatly increased returns for its investors following the

refinancing of the project. The public authorities were to receive a share of

the refinancing proceeds only after agreeing to increased termination

liabilities. In the case of case of NNUH care Trust, an extension of the

concession period was also required for the NHS Trust to receive its share

of proceeds (PAC, 2006). The long term implications of the public

authorities accepting new liabilities cannot be ignored.

For the NNUH care Trust, the £33.9 million refinancing share of the

trust would be paid in instalments over the length of the concession period

and not guaranteed should the project fail (PAC, 2006). In the case of HMP

Altcourse the agreed public sector share of the proceeds was £1 million.

This was an insignificant figure compared to the £47 million calculated by

Cuthbert and Cuthbert (2008) as the potential cost of new risks borne by the

Prison Service (Cuthbert and Cuthbert, 2008). In both these cases it can be

seen that the public sector had emerged in a weaker position post


2010 of 129

refinancing with increased liabilities not justified by the refinancing share

received.

The effects of the emerging secondary market were also shown in

the case of HMP Altcourse where the equity stakes in the project had

changed three times since 2006. With each subsequent sale of , the private

investors received considerable gains with no share given to the public

sector. With the risky construction phase completed, Semperian as the

current stakeholders were set to receive large returns in return for taking on

minimal risks. The NAO (2006) report stated that ownership of infrastructure

projects by investment groups introduced new risks for the public sector with

the distance between the stakeholders and the PFI project a concern.

Although in the case of HMP Altcourse, Semperian utilise the specialist

skills of G4S to manage the facility, the lack of transparency in secondary

market transactions and the complex nature of PFI project portfolios held by

investment group remains a concern. New government guidelines in

reaction to refinancing of projects resulted in £137 million of extra funds

being gained by the government. However the relatively new development

of this market and the inherently complex transaction involved may

introduce significant barriers for the government when attempts are made to

regulate the market, a view supported by the government’s own admission

following a review of the secondary market (NAO, 2006).


2010 of 129


What has been the positive impact of transferring risks to the private

sector and the benefits realised through their involvement?

All of the three case studies analysed gave clear examples of how

private sector efficiencies had benefited the infrastructure procurement

process.

In the case of NNUH care Trust, the hospital was completed on time

and to budget. This was contrary to NAO report in 2003 that found 75% of

publically procured projects were delivered late (NAO, 2003b). In addition to

timely completion, NNUH care Trust went on to win awards at the Building

Better Healthcare awards in 2002 in addition to awards relating to

successful operation of the facilities (Partnerships-UK, 2010b).

The implications of using private finance and the subsequent

refinancing of projects have been discussed above. What cannot be

ignored however is that private funding had facilitated the inception of this

project in order to meet the needs of the general public. This was well in

advance of public funds being made available in 2002.

These benefits were also highlighted in the analysis of the HMP

Altcourse where the project was completed five months ahead of schedule.

(Partnerships-UK, 2010a). At the time of project appraisal, the Prison

Service were not able to cope with future demands for prison places,

therefore the involvement of the private sector to meet these needs was

essential. In section 4.2, the results of a NAO (2003) report into prison

operations highlighted that the incentivisation programme in PFI projects

was succeful and that the private sector efficiencies introduced in PFI


2010 of 129

projects such as HMP Altcourse had replicated in publicly operated facilities

(NAO, 2003a). This could be regarded as an indication of long term benefits

for the public sector for the involvement of the private sector.

The involvement of the private sector and its possible benefits were

mostly discussed in the third case study on the Queen Elizabeth II Bridge as

part of the Dartford crossing PFI. The transfer of risk to the privates sector

to finance, design, build and operate the bridge was shown to effectively

overcome the technological barriers posed by the scale of the proposed

infrastructure. The bridge was completed on time and to budgetary

requirements with private sector efficiencies ensuring a successful

operational phase. In fact the collection of tolls through systems such as

DART-Tag ensured that the project was handed back to the public sector

ahead of schedule.

The three case studies analysed provide evidence to the statements

made in chapter 4.2. The involvement of the private sector had ensured that

projects were completed to proposed schedules, to budget and to the

required quality. This indicates that the transfer of design and construction

risks to the private sector had been successful. However new operational

risks as identified in section 4.4 and the fact that many PFI projects are yet

to complete their operational phases means that a full analysis of the impact

of private sector involvement could not be gauged.


2010 of 129

6.3 Ensuring PFI project success

The information gathered in this research project can be concluded in

the form of simple activities which can ensure that PFI contracting is

implemented in a way that allows for the effective transfer of risks to the

private sector. These activities have been segmented into the three different

phases of the project. These included actions prior to PFI project being put

to tender, activities during the appraisal and negotiation phase and finally

actions following the reward of the contract.

Project Appraisal and Negotiation with private sector

• Increase number of Private sector tenders through the simplification of the bidding process

• Implement standardised risk classification and transfer process • Implement a transparent VfM appraisal process including the costing of

risks transferred • Ensure effective risk transfer through exclusion of practises such as the

guarantee of debt by the government • Apply stringent performance criteria linked to unitary payment charges • Improve government’s long term position through the inclusion of realistic

termination liabilities • Increase public sector commitment through high equity requirements • Apply lessons learnt from NAO reports into refinancing to ensure

government position not undermined following debt refinancing • Apply equity sale procedures to diminish effect of secondary markets • Ensure provision in PFI contracts to allow facilities to be adapted to meet

changing needs of public without excessive costs to public sector

Prior to Project Award • Determine lessons learnt from previous PFI projects in relevant public

sector are considered • Carry out extensive feasibility studies to determine needs of infrastructure

and possible early solution to problem posed • Identify perspective private sector participants from previous PFI projects • Identify principal risks to project in order to determine public sector

capability in their management • Identify the availability of a realistic public sector alternative


2010 of 129

Projects such as HMP Altcourse were implemented as pathfinder

projects; therefore it is critical that lessons learnt from these are

implemented in future projects. As identified by US-DOT (2007), carrying

out feasibility studies are critical to ensure long term needs of public sector

infrastructure are identified as so the problems of Balmoral High school and

risks identified by NI-NAO (2004) are mitigated. The identification of

principal risks associated with a project at an early stage will ensure that a

logical analysis of public sector capability can be carried out. As identified

by Pollock (2002) and Froud (2003) the public sector might be the party best

placed to handle these risks. The importance of a public sector was

highlighted by Khadaroo (2008), Froud (2003) and Shaoul (2005) amongst

others. Ensuring that this alternative exists will improve the government

position in negotiations and remove the biases in the VfM appraisal process

identified by Cooper (2005) and Pollock (2002).

The simplification of the tendering process through the use

standardised risk allocation such as the framework proposed by Bing (2005)

will decrease negotiation costs and reduce the lengthy time process. this will

Following contract reward • Ensure Government liabilities are not increased through drive for economic

gains • Implement adequate performance measurement of PFI projects to ensure

desired operational risk transfer through unitary payment is realised • Identify changing needs of the general public for the infrastructure and

drive negotiations with public sector operator to implement these changes • Aim to transfer private sector efficiencies developed in PFI project to other

public sector operated facilities for the benefit of the taxpayer • Allows comparison of the operations of PFI operated and publically

operated Facilities


2010 of 129

go some way to reduce the barriers of entry to the market and reverse the

decreasing trend in the number of bids that was identified by NAO (2007).

The presence of a public sector alternative will remove any bias in the VfM

appraisal process and increase the transparency of the methodology

involved. The feasibility of risk transfer which was questioned by Ball (2003)

and Connolly (2008) can also be ensured by excluding contract provisions

that hold the government as the ultimate bearer of risks. the position fo the

government can also be included through the use of realistic termination

liabilities.

The issues identified by Froud (2003) in the financing of equity

holdings can be overcome by implementing strict equity requirements form

the sponsors and limiting the sources of finance that can be utilised to fund

equity purchases will ensure greater commitment in the PFI project form the

private consortium. New risks to PFI projects, such as the inflexibility of PFI

contracts as identified by Pollock (2005) and Cooper (2005) can be

overcome by ensuring provision in contract for the adaptation of facilities to

meet changing demands without excessive charge to the public sector.

Furthermore the introduction of new risks as a result of refinancing of

projects and trade in the secondary equity market, as identified by Cuthbert

and Cuthbert (2008) and NAO (2006), can be mitigated through the sharing

of proceeds with the public sector and strict governance of equity trades to

facilitate possible additional returns for the public sector.

These activities will need to be monitored as so to ensure that the

government’s risk management liabilities are not increased following private

sector activities in financial markets. Adequate operation performance


2010 of 129

measurement and consequent incentivisation and penalisation through the

use of the unitary charge payment schedule will ensure that the initial

objectives of operational risk transfer stated by Hogg (1996) are realised.

Furthermore the transfer of PFI project working efficiencies, such as those

identified by KPMG (2009) and HM Treasury (2006), to other public sector

facilities can prove beneficial in the long term. This can be expedited by

allowing for comparison of PFI project with those publically operated, such

as initiatives in the Prison Service identified by NAO (2003).

By implementing the above set activities, public sector bodies can go

some way in ensuring effective risk transfer to the private sector in PFI

projects and that this procurement method represents long term Value for

the general public.

6.4 Final Conclusion

In this section an assessment of the findings from the research

project against the aims and objectives is carried out.

6.4.1 Aims

The aims of the research project are considered in order to determine

the extent to which this research project has achieved them.

To complete qualitative research using academic and government literature

of the PPP/PFI procurement model.


2010 of 129

To review the risk management and transfer process in PFI projects and

critically review the wider VfM objectives of PFI projects.

This research project has succeeded in completing the aim of

conducting a qualitative research project through the use of various

government and academic literature on the subject of PPP/PFI

procurement. The establishment of background theoretical principles was

followed by the identification of key critical success factors that are required

for successful implementation of PFI contracting. Furthermore a critical

review of PFI projects was completed to gauge the success of risk transfer

objective s and the accuracy of the VfM appraisal process. this was used to

determine whether PFI contracting represented Value for the Taxpayer.

The findings from the aims were then used to guide the research in

relation to the objectives in the introduction of this dissertation.

6.4.2 Objective One

Determine the extent to which risk transfer is central to the

development of PPP initiatives and whether the government’s

justification of such initiatives has changed.

Early publications into PFI contracting were used to demonstrate that

although the transfer of risk to the private sector was one of the aims of the

governments, it was subordinated to the governments objective to take the


2010 of 129

cost of public infrastructure provision off the government balance sheet.

However since the impact on the government’s balance sheet was lower

than expected, the transfer of risk to the private sector became the critical

objective in pursuing PFI procurement. Results from academic research

was used to show that in recent projects, the value given to the risks

transferred was often the critical component in the VfM appraisal process in

determining whether the public or private procurement option was chosen.

6.4.2. Objective Two

Critically review government guidelines on the successful

implementation of PFI procurement

The third chapter surmised the findings of research into the PFI

procurement approach as recommended by government though guidelines.

The typical parties involved within a PFI project and the required negotiation

and tendering process were analysed in detail. This chapter also included

investigation into the various sources of finance often used in project

finance and the mechanisms by which public bodies repaid the private

consortium. A detail examination of the VfM appraisal process was also

carried out and government guidelines into risk allocation strategy was also

carried out.

In this chapter the complicated and often lengthy tendering process

and the extensive costs involved were highlighted as weaknesses in the PFI

procurement model. It was also demonstrated that the tendering process

had introduced significant barriers to entry into the PFI market and reduced

completion in the market, a situation contrary to government objectives. The


2010 of 129

unitary payment mechanism was shown as an effective method of

transferring operational risk to the private sector, however complexities in

performance measurement and a lack of skills in the public sector to

implement these measures were also identified.

6.4.4 Objective Three

Examine the extent by which government objectives of risk transfer

are realised in operational PFI projects

A critical review of PFI methodology was carried out in chapter 4. A

number of PFI projects were used to demonstrate the successful transfer of

financial, design and operational risks to the private sector. The involvement

of the private sector was shown to ensure projects adhered to time, cost

and quality constraints. The introduction of public sector efficiencies and the

resultant operational successes were identified as further advantages of the

long term involvement of the private sector. The ability of these efficiencies

to be transferred to the other publicly operated facilities was also identified

as another long term benefit.

The disadvantages of PFI procurement in relation to risk transfer

were also investigated in this chapter. This included the identification of new

risks that the public sector participants were exposed to following the

procurement of projects through PFI methodology. The long term

inflexibilities of the concession agreement and the extensive termination

liabilities of the were highlighted as two of these new risks. The introduction

of new risks following refinancing of PFI project and trade in the growing

secondary market were also highlighted. It was highlighted that the financial


2010 of 129

benefits of accepting these risks did not justify the exposure of the public

sector participants.

The feasibility of risk transfer to the public sector was also

investigated. The critical nature of public infrastructure and the government

need to take over PFI projects in event of project failure were identified as

reasons why the government was the ultimate bearer of risks. Other

contractual provisions such as the government’s guarantee of all debts of a

project were identified as other reasons why in some case the transfer of

risks had been nullified. The findings of academic research were further

supported by the use of case studies from the health and transportation

sectors in addition to an example of a project from the Prison Service.

6.4.5 Objective Four

Critically review the VfM appraisal process and the method by which

valuation of risks transferred is carried out

The findings of a number of academic publications into the VfM

appraisal process was used to demonstrate that this critical stage of a

project was often associated with a lack of transparency. Although the figure

given for the PSC and the value of risks transferred was easy to find,

information on the methodology by which they had been obtained was not

made available. It was also observed that often the gap between the public

and PFI funded options was negligible with a number of academics pointing

out that the VfM process was skewed to ensure the private option was

chosen. This statement gained further when the lack of a public alternative

was considered. Often the provision of the much needed infrastructure


2010 of 129

could not be facilitated unless the PFI option was chosen with the VfM

process only completed to ensure that government guidelines were adhered

to. The observed bias towards the PFI procurement option was also

observed in the case studies observed in chapter five.

6.4.6 Objective Five

Determine the future implications for PFI procurement methodology

Following the completion of this research project, a number of actions

at various stages of a PFI project were proposed in section 6.3. The

implementation of these actions will ensure the effective transfer of risk to

the private sector whilst ensuring the benefits of private sector involvement

are maintained.

The implication of recent events in the UK and abroad however

cannot be ignored. The effects of the recent worldwide economic recession

on financial markets and lending rates were investigated in section 4.9. It

was identified that the public sector must drive PFI projects to adapt and

take advantage of the rapid changes occurring within the financial markets

and to ensure that maximum VfM is achieved for the taxpayer.

The impact of the recent election of a coalition government in the UK

could not be fully gauged. Recently there has been an impetus by public

sector to review and cut its spending. The biggest indication that PFI project

would also be under review was the admission by the Chancellor of the

Exchequer, George Osborne that the PFI procurement method is in need of

change. It would seem that although PFI procurement has been a major


2010 of 129

player in recent provision of public infrastructure, the exact implication for its

future cannot be gauged as of yet.

6.5 Limitations

6.6 Recommendations


2010 of 129

7.0 References AKINTOYE, A. & DICK, W. Year. Private Finance Initiative Procurement. In: Proceedings of

COBRA 1996, The construction and building research conference of the Royal Institution of Chartered Surveyors, 1996 Bristol.

AKINTOYE, A., TAYLOR, C. & FITZGERALD, E. 1998. Risk analysis and management of Private Finance Initiative projects. Engineering Construction & Architectural Management, 5, 9-21.

AL-BAHAR, J. F. & CRANDALL, K. C. 1990. Systematic Risk Management Approach for Construction Projects. Journal of Construction Engineering and Management, 116, 533-546.

ALLEN, G. 2001. The Private Finance Initiative (PFI). HOUSE OF COMMONS LIBRARY. BALL, R., HEAFEY, M. & KING, D. 2003. Risk transfer and value for money in PFI projects. Public

Management Review, 5, 279 - 290. BELL, J. 2005. Doing Your Research Project: A Guide for First-Time Researchers in Education,

Health and Social Science (4th Edition), Open University Press. BERR 2008. Public Services industry review. In: DEPARTMENT-FOR-BUSINESS-ENTERPRISE-

&-REGULATROY-REFORM (ed.). BING, L. 2003. Risk management of public/private partnership projects. Un-published PhD thesis.

School of the Built and Natural Environment. Glasgow Caledonian University. Glasgow, Scotland.

BING, L., AKINTOYE, A., EDWARDS, P. J. & HARDCASTLE, C. 2005. The allocation of risk in PPP/PFI construction projects in the UK. International Journal of Project Management, 23, 25-35.

BOUSSABAINE, A. 2006. Cost Planning of PFI and PPP Building Projects, Spon Press. BROADBENT, J., GILL, J. & LAUGHLIN, R. 2008. Identifying and controlling risk: The problem of

uncertainty in the private finance initiative in the UK's National Health Service. Critical Perspectives on Accounting, 19, 40-78.

CANADIAN-COUNCIL-FOR-PPP 2003. The Public Sector Comparator. In: CANADIAN-COUNCIL-FOR-PUBLIC-PRIVATE-PARTNERSHIPS (ed.).

CARLILE, J. L. 1994. Private funding of public highway projects. Proc. Instn Civ. Engrs Trans. CBI 2007. Building success, the way forward for PFI. CLARKE, N. 2010. FINANCIAL STATEGY & Private Finance Initiative. In: UNIVERSITY, O. (ed.). CLIFTON, C. & DUFFIELD, C. F. 2006. Improved PFI/PPP service outcomes through the

integration of Alliance principles. International Journal of Project Management, 24, 573-586.

COMMITTEE-OF-PUBLIC-ACCOUNTS 2005. London Underground Public Private Partnerships. In: ACCOUNTS, H. O. C. C. O. P. (ed.).

CONNOLLY, C., MARTIN, G. & WALL, A. 2008. EDUCATION, EDUCATION, EDUCATION: THE THIRD WAY AND PFI. Public Administration, 86, 951-968.

CONSTRUCTION-NEWS. 1991. Decking out Dartford Crossing [Online]. Available: http://www.cnplus.co.uk/news/decking-out-dartford-tunnel/901833.article, [Accessed 18/04/2010].

COOPER, C. & TAYLOR, P. 2005. Independently verified reductionism: Prison privatization in Scotland. Human Relations, 58, 497-522.

CUTHBERT, M. & CUTHBERT, J. 2008. Inquiry into the methods of funding capital investment projects.

DAVIES, P. 2010. Is this the end of the road for the PFI? British Medical Journal, 341, 176-177. DIXON, T. 2005. Lessons from the private finance initiative in the UK. Journal of Property

Investment & Finance, 23, 421. EDWARDS, C. 2009. Private Gain and Public Loss; the Private Finance Initiative (PFI) and the

Norfolk and Norwich University Hospital (NNUH); a Case Study. University of East Anglia.

EDWARDS, P., SHAOUL, J., STAFFORD, A. & ARBLASTER, L. 2004. Evaluating the operation of PFI in roads and hospitals.

ELLIS, S. 2006. SMIF/GSL Investment Partnership. Infrastructure Journal, 19, 74-76. FINLAY, D. 2003. Refinancing PFI Projects. In: NATIONAL-AUDIT-OFFICE (ed.).

http://www.cnplus.co.uk/news/decking-out-dartford-tunnel/901833.article�


2010 of 129

FORSHAW, A. 1999. The U.K. Revolution in Public Procurement and the Value of Project Finance. Journal of Project Finance, 5, 49.

FOX, J. 1999. The PFI handbook, Bristol : Jordan. FROUD, J. 2003. The Private Finance Initiative: risk, uncertainty and the state. Accounting,

Organizations and Society, 28, 567-589. FROUD, J. & SHAOUL, J. 2001. Appraising and Evaluating PFI for NHS Hospitals. Financial

Accountability and Management, 17, 247-270. FSD 2010. FSD Brochure. GALLIERS, R. 1992. Information Systems Research: Issues, Methods and Practical Guidelines,

Alfred Waller Ltd. GATTI, S. 2007. Project Finance in Theory and Practice: Designing, Structuring, and Financing

Private and Public Projects, Academic Press. GRANT, T. 1996. Keys to successful public-private partnerships. Canadian Business Review, 23, 27. GRIMSEY, D. 2007. Public Private Partnerships: The Worldwide Revolution in Infrastructure

Provision and Project Finance, Edward Elgar Pub. GRIMSEY, D. & LEWIS, M. K. 2007. Public private partnerships: the worldwide revolution in

infrastructure provision and project finance, Edward Elgar Publishing Ltd. GROUT, P. 1997. The economics of the private finance initiative. Oxford Review of Economic

Policy, 13, 53-66. GUARDIAN. 2009. We'll bring a new model PFI, vows George Osborne [Online]. Available:

http://www.guardian.co.uk/politics/2009/nov/15/osborne-replace-pfi [Accessed 27/07/2010].

HALL, J. 1998. Private opportunity, public benefit? Fiscal Studies, 19. HARAKE. 2006. Investigation in achieving the best value in Private Finance initiative projects and

the effect of Risk management, Knowledge Management and Innovation in improving these projects. MSc, Univeristy of Manchester.

HARRIS, S. R. Year. Dartford-Thurrock Crossing, informal discussions. In: Proceeds of the Institute of Civil Engineering, 1991. 1139-1142.

HEALD, D., GEAUGHAN, N 1999. The private financing of public infrastructure, The New Management of Local Governance: Audit of an Era of Change in Britain. The New Management of Local Governance, 222-36.

HEFCE 2004. Practical guide to PFI for higher education institutions. In: (HEFCE), H. E. F. C. F. E. (ed.).

HIGHWAYS-AGENCY. 2010. History of Dartford crossing [Online]. Available: http://www.highways.gov.uk/roads/projects/4073.aspx [Accessed 22/08/2010].

HM-TREASURY HM Treasury Task Force - PPP Projects HM-TREASURY 2006a. PFI: strengthening long-term partnerships. HM-TREASURY 2006b. Value for Money Assessment guide. In: TREASURY, H. (ed.). HM-TREASURY 2010a. Green Book. In: HM-TREASURY (ed.). HM-TREASURY 2010b. June 2010 Budget: a summary. In: HM-TREASURY (ed.). HM-TREASURY 2010c. PFI projects in Procurement. HM-TREASURY 2010d. PFI signed projects list. HOGAN-LOVELLS. 2010. Creation of Semperian - Company Web Page [Online]. Available:

http://www.hoganlovells.com/newsmedia/newspubs/detail.aspx?news=1298 [Accessed 15/08/2010].

HOGG, D. 1996. Risk and reward in PFI contracts - Practical guidance on the sharing of risk and structuring of PFI contracts. In: PRIVATE-FINANCE-PANEL (ed.).

HOUSE-OF-COMMONS 2009. Update on the London Underground and the public-private (PPP) partnership. In: HOUSE-OF-COMMONS-TRANSPORT-COMMITTEE (ed.).

IPPR 2001. Building better partnerships : the final report of the Commission on Public Private Partnerships, London : Institute for Public Policy Research.

KELLAWAY, M. & SHANKS, H. 2007. Metronet, Tube Lines and the London Underground PPP. In: OFFICE-OF-NATIONAL-STATISTICS (ed.).

KHADAROO, I. 2008. The actual evaluation of school PFI bids for value for money in the UK public sector. Critical Perspectives on Accounting, 19, 1321-1345.

KPMG 2007. Over three quarters of PFI contracts are profitable. KPMG. KPMG 2009. PFI in school building – does it influence educational outcomes? : KPMG. MACKIE, P. & SMITH, N. 2005. Financing Roads in Great Britain. Research in Transportation

Economics, 15, 215-229.

http://www.guardian.co.uk/politics/2009/nov/15/osborne-replace-pfi�

http://www.highways.gov.uk/roads/projects/4073.aspx�

http://www.hoganlovells.com/newsmedia/newspubs/detail.aspx?news=1298�


2010 of 129

MAXWELL, J. 2005. Qualitative Research Design, An Interactive Approach, London, Sage Publications.

MCKINSEY&CO. 2010. Achieving World Class Productivity in the NHS 2009/10. In: D.O.H (ed.). N.I-NATIONAL-AUDIT-OFFICE 2004. Building for the future: a review of the PFI education

pathfinder projects. In: NAO, C. A. A. G. (ed.). NAO. National Audit Office (NAO) [Online]. Available: http://www.nao.org.uk [Accessed]. NAO 1997. The PFI Contracts for Bridgend and Fazakerley Prisons. NAO 2000. The refinancing of the Fazakerley PFI prison contract. In: NAO, C. A. A. G. (ed.). NAO 2003a. The Operational Performance of PFI Prisons. In: NAO (ed.). NAO 2003b. PFI: Construction Performance. In: NAO (ed.). NAO 2005. The Refinancing of the Norfolk and Norwich PFI Hospital: How the deal can be viewed

in the light of the refinancing. In: NATIONAL-AUDIT-OFFICE (ed.). NAO 2010. The performance and management of hospital PFI contracts. In: NATIONAL-AUDIT-

OFFICE (ed.). NAO, C. A. A. G. 2006. Update on PFI debt refinancing and the PFI equity market. National Audit

Office. NAO, C. A. A. G. 2007. Improving the PFI tendering process. In: NATIONAL-AUDIT-OFFICE

(ed.). NAOUM, S. G. & COLES, D. H. 1998. Dissertation Research and Writing for Construction

Students, Architectural Press. NATIONAL-AUDIT-OFFICE 1999. Examining the value for money of deals under the FPI. In:

NAO, C. A. A. G. (ed.). NATIONAL-AUDIT-OFFICE 2006. A Framework for evaluating the implementation of PFI

projects. In: NAO, C. A. A. G. (ed.). NISAR, T. M. 2007. Value for money drivers in public private partnership schemes. International

Journal of Public Sector Management, 20, 147-156. NNHU. 2010. Norwich and Norfolk University Hospital NHS trust Webpage [Online]. Available:

http://www.nnuh.nhs.uk/ [Accessed 04/08/2010]. NNUH 1998. Norfolk and Norwich Trust PFI - Project Agreement. In: NNUH (ed.). NNUH 2009. Private Finance Initiative – Norfolk and Norwich University Hospital. In: NNUH-

NHS-TRUST (ed.). OGC. The Office of Government Commerce (OGC) [Online]. Available: http://www.ogc.gov.uk

[Accessed]. OGC 2002a. Guidance Note: Calculation of the Authority’s Share of a Refinancing Gain. In:

OFFICE-OF-GOVERNMENT-COMMERCE (ed.). OGC 2002b. REFINANCING OF EARLY PFI TRANSACTIONS CODE OF CONDUCT. In:

OFFICE-OF-GOVERNMENT-COMMERCE (ed.). ONS. 2010a. GDP Growth figures [Online]. Available:

http://www.statistics.gov.uk/cci/nugget.asp?id=192 [Accessed]. ONS. 2010b. The recession - Facts and figures, Daily telegraph, sourced from Office for National

Statistics (ONS) [Online]. Available: http://www.telegraph.co.uk/finance/financetopics/recession/7077442/Recession-Facts-and-figures.html [Accessed].

PAC 2002. PFI refinancing update. In: COMMITTEE-OF-PUBLIC-ACCOUNTS (ed.). PAC 2003a. Delivering better value for money from the Private Finance Initiative. PAC 2003b. New IT systems for Magistrates' Courts: the Libra project. In: COMMITTEE-OF-

PUBLIC-ACCOUNTS (ed.). PAC 2006. The refinancing of the Norfolk and Norwich PFI Hospital. In: COMMITTEE-OF-

PUBLIC-ACCOUNTS (ed.). PARTNERSHIPS-UK. 2008. Investigating the performance of operational PFI contracts [Online].

Available: http://www.partnershipsuk.org.uk/PUK-Background.aspx [Accessed]. PARTNERSHIPS-UK. 2010a. Case Study : HMP Altcourse (Fazakerley) Prison [Online]. Available:

http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=North+West&Project=11429 [Accessed 03/08/2010].

PARTNERSHIPS-UK. 2010b. Case Study : Norfolk & Norwich University Hospital [Online]. Available: http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=East%20of%20England&SubRegion=&Project=11334 [Accessed 03/08/2010].

http://www.nao.org.uk/�

http://www.nnuh.nhs.uk/�

http://www.ogc.gov.uk/�

http://www.statistics.gov.uk/cci/nugget.asp?id=192�

http://www.telegraph.co.uk/finance/financetopics/recession/7077442/Recession-Facts-and-figures.html�

http://www.telegraph.co.uk/finance/financetopics/recession/7077442/Recession-Facts-and-figures.html�

http://www.partnershipsuk.org.uk/PUK-Background.aspx�

http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=North+West&Project=11429�

http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=North+West&Project=11429�

http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=East%20of%20England&SubRegion=&Project=11334�

http://www.partnershipsuk.org.uk/PUK-Case-Study.aspx?Region=East%20of%20England&SubRegion=&Project=11334�


2010 of 129

PEREZ, B. G. 2006. Public-Private Partnerships and the Development of Transport Infrastructure: Trends on Both Sides of the Atlantic. First International Conference on Funding Transportation Infrastructure.

POLLOCK, A. M. 2005. NHS Plc: The Privatisation of Our Health Care, Verso Books. POLLOCK, A. M., DUNNIGAN, M. G., GAFFNEY, D., PRICE, D. & SHAOUL, J. 1999. The private

finance initiative: Planning the "new" NHS: downsizing for the 21st century. BMJ, 319, 179-184.

POLLOCK, A. M., SHAOUL, J. & VICKERS, N. 2002. Private finance and "value for money" in NHS hospitals: a policy in search of a rationale? BMJ, 324, 1205-1209.

PRICEWATERHOUSECOOPERS 2002. Financial review of Scottish Prison Services Estates Review.

REES, R. 2005. Liquidity and the secondary PFI market. The PPP Journal, 32. SAUNDERS, F. 2010a. Project Finance MoP lecture notes - Week 1. SAUNDERS, F. 2010b. Project Finance MoP lecture notes - Week 9. SCEA 2010. Private Finance Projects and offbalance sheet debt. In: SELECT-COMMITTEE-ON-

ECONOMIC-AFFAIRS (ed.). SEMPERIAN. 2010. Semperian Home page [Online]. Available: http://www.semperian.co.uk/

[Accessed 15/08/2010]. SENATE, A. O. T. 2000. Senate Community Affairs References Committee. Healing our hospitals. SHAOUL, J. 2005. A critical financial analysis of the Private Finance Initiative: selecting a

financing method or allocating economic wealth? Critical Perspectives on Accounting, 16, 441-471.

UNISON 2005. PFI: Against the public interest. US-DOT 2007. Case Studies of Transportation Public-Private Partnerships around the World. In:

US-DEPARTMENT-OF-TRANSPORTATION (ed.). WALLACE, J. 2002. SCOTTISH PRISON SERVICE ESTATES REVIEW. YESCOMBE, E. R. 2007. Public-Private Partnerships - Principles of policy and finance, Oxford,

Butterworth-Heinemann.

http://www.semperian.co.uk/�


2010 of 129

Appendix A

Benefits Disadvantages

There can be greater price certainty. The department and contractor agree the annual unitary payment for the services to be provided. This should usually only change as a result of agreed circumstances.

The department is tied into a long-term contract (often around 30 years). Business needs change over time so there is the risk that the contract may become unsuitable for these changing needs during the contract life.

Responsibility for assets is transferred to the contractor. The department is not involved in providing services which may not be part of its core business.

Variations may be needed as the department's business needs change. Management of these may require re-negotiation of contract terms and prices.

PFI brings the scope for innovation in service delivery. The contractor has incentives to introduce innovative ways to meet the department's needs.

There could be disadvantages, for example, if innovative methods of service delivery lead to a decrease in the level or quality of service.

Often, the unitary payment will not start until, for example, the building is operational, so the contractor has incentives to encourage timely delivery of quality service.

The unitary payment will include charges for the contractor's acceptance of risks, such as construction and service delivery risks, which may not materialise.

The contract provides greater incentives to manage risks over the life of the contract than under traditional procurement. A reduced level or quality of service would lead to compensation paid to the department.

There is the possibility that the contractor may not manage transferred risks well. Or departments may believe they have transferred core business risks, which ultimately remain with them.

A long-term PFI contract encourages the contractor and the department to consider costs over the whole life of the contract, rather than considering the construction and operational periods separately. This can lead to efficiencies through synergies between design and construction and its later operation and maintenance. The contractor takes the risk of getting the design and construction wrong.

The whole life costs will be paid through the unitary payment, which will be based on the contractor arranging financing at commercial rates which tend to be higher than government borrowing rates.

Benefits and disadvantages of PFI procurement adapted from PAC (2002)


2010 of 129

Appendix B Risk meta-level Risk factor category group Risk factor Macro level risks Political and government policy • Unstable government

• Expropriation or nationalisation of assets • Poor public decision-making process • Strong political opposition/hostility

Macroeconomic • Poor financial market • Financial sector volatility Legal • Legislation change

• Change in tax regulation • Industrial regulatory change

Social • Lack of tradition of private provision of public services

• Level of public opposition to project Natural • Force majeure • Geotechnical conditions • Environment Meso level risks Project selection • Land acquisition (site availability) • Level of demand for project Project finance • Availability of finance • Financial attraction of project to investors • High finance costs Residual risk • Residual risks Design • Delay in project approvals and permits

• Design deficiency • Unproven engineering techniques

Construction • Construction cost overrun

• Construction time delay • Material/labour availability • Late design changes • Poor quality workmanship • Excessive contract variation

• Insolvency/default of sub-contractors Operation • Operation cost overrun

• Operational revenues below expectation • Low operating productivity • Maintenance costs higher than expected • Maintenance more frequent than expected

Micro level risks Relationship • Organisation and co-ordination risk

• Inadequate experience in PPP/PFI • Inadequate distribution of risks • Inadequate distribution of authority in partnership • Differences in working method and know-how between partners • Lack of commitment from either partner

Third party • Third Party Tort Liability • Staff Crises

Typical risks in a PFI project Adapted from Bing et al. (2005)


2010 of 129

Risk factors Risk group Preferred allocation Nationalisation/expropriation Macro Public sector Poor public decision-making process Macro " Political opposition Macro " Land acquisition/site availability Meso " Unstable government Macro " Traditional public opposition Macro Dependent on project Project approvals and permits Meso " Excessive contract variation Meso " Lack of experiences in PPP/PFI Micro " arrangement

"

Responsibilities and risk distribution Micro Shared Force majeure Macro " Authority distribution between Micro " partners

"

Lack of commitment from public/ Micro " private partner

"

Legislation change Macro " Tax regulation change Macro Primarily to the

private sector

Late design changes Meso " Residual risk Meso " Inflation rate volatility Macro " Lack of tradition of private provision Macro " of public services

Sta. crises Micro " Third party tort liability Micro " Influential economic events Macro " Financial attraction of project to Meso " investors

Level of demand for project Meso " Different working methods Micro " Industrial regulation change Macro Solely to the private

sector

High financing cost Meso " Interest rate volatility Macro " Organisation and co-ordination risk Micro " Weather Macro " Environment Macro " Availability of finance Meso " Geotechnical conditions Macro " Operational revenue below expectation Meso "

Risk allocation preference in PFI projects Adapted from Bing et al (2005)

behnam sarani - msc dissertation - risk management in ppp pfi projects - 2010

Documents