PPP and PFI Value for Money

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					                 PPP and PFI
               Value for Money
                   Peter Livesey
               Senior Policy Analyst
           Corporate and Private Finance


26/11/08
       PFI Forces Long-term Thinking, Uses Private
       Sector Risk Management
    Some projects are suitable for PFI           Others have been deemed less suitable

There is a major capital investment             •Small projects
programme                                         •   Performance was good, similar to larger
  • Requiring effective management of risks           projects for completion on time or early
    associated with construction and delivery     •   However, procurement times were
                                                      disproportionately high, as were bid
The private sector has expertise to deliver           costs
and PFI represents good VfM                       •   Overall, these findings suggested it was
                                                      difficult for small projects to obtain VfM
The structure of the service is appropriate
  • Public sector can define its needs as       •PFI for IT projects
     service outputs                              •   Fast changing technology and needs
  • Allows optimal and efficient risk             •   Multiple interfaces
     allocation to both public and private        •   Difficulty of specifying risk transfer and
     sectors                                          substituting suppliers
Nature of assets and services are capable of
being costed on a whole-of-life, long term
basis


                                                                                                   2
     Current Margins on UK PPP Lending




Source: Ernst &Young


                                         3
         Advantages and disadvantages
Conceptual advantages                         Private Sector Capital
•   Integrated whole life management          •Banks capital at risk therefore risk
•   Risk transfer to private sector           transfer incentivised
        Design Risk                          •Project finance discipline leading to
        Construction Risk                    whole life costing
        Financing Risk                       • Bank step in on contractor defaul
        Technology & Obsolescence
        Operating and FM Risk
•   Focus on output specification             Conceptual disadvantages
•   Opportunities for innovation in service   •Cost associated with risk transfer
    delivery
                                              •Price must include profit margin
•   Long term certainty
                                              •Inflexibility
•   Private sector capital
•   Can be off Government Balance Sheet

                                                                                       4
Improved travel environment - London
Underground PPP




                                       5
London Underground PPP - Metronet
Metronet in administration July 2007
Potentially £2bn (30%) over budget by the end of
first period
£350m shareholder equity lost

PPP not PFI
  •not standard form contract
  •debt underpin 95%
  •not fixed price
  •station renewals not clearly specified
  •tied supply chain
  •incentive alignment:DfT, TfL, Metronet

                                                   6
    London Underground PPP - Metronet

                                                     Comf ort letter
                              Lenders                                       DfT
                              (existing)

                                                                                  Funding
                         Loan -                                        Funding    letter
                                     Debt serv ice
                         £2,600m

                                                                            TfL


                                                                       Funding    Guarantee of
                                                                                  PPP ISC
                                                Put Option –
 Metronet                                    95% guarantee of debt
Sharehold ers                Metronet                                       LUL
    x5        Equity -
              £350m
                                               PPP contract; ISC


                                                                                             7
   UK Policy – The Eddington Transport
   Study

The economic case for targeted new infrastructure is
strong and offers very high returns – the best schemes
offer returns in the region of £5-10 for each pound
invested. Government should therefore continue to
deliver, together with the private sector, sustained
transport investment.
Getting the prices right means making a comprehensive
assessment of the full range of economic, environmental
and social impacts of policies, including climate change.



                                                            8
   PPP/PFI in Transport


           All
  Depts.           Transport

Number:      650                48   7%

Value:     £53bn               £22.5bn    42%




                                                9
   Modal shift - Light Rail
                              Croydon Tramlink




Nottingham Express
       Transit
   BCR 2.0 high


                                                 10
   UK Policy - PPP/PFI

At investment appraisal value for money must be
assessed over the whole lifetime of a project, including
disposal, estimating the costs and benefits to society as a
whole, not simply those directly relevant to the purchaser
- e.g. environmental impact.

The decision to use PFI is taken on value for money
grounds alone, but not at the expense of employees’
terms and conditions. The accounting treatment of a PFI
project is not relevant to this decision.


                                                              11
    Strategic Considerations Change During The
    Procurement Process
                    Outli                                           Pref       Fina
  Departmental       ne                                             erre       ncia
   Investment       Busi              OJEU      ITN      BAFO         d          l
     strategy       ness                                            bidd       Clo
                    Case                                             er         se

Main strategic considerations:           Main strategic considerations:
 • Is the project the right one?             • Is there a competitive market
                                               interest
 • Is PFI the correct procurement
   route?                                    • Is the procurement process being
                                               properly managed
 • Is the project affordable?
                                             • Is the commercial and financial deal
 • Is the project sufficiently
                                               achieved acceptable
   developed to be ready to go to
   market?                                   • Is the deal still in accordance with
                                               what was desired before?
 • Is there sufficient indication
   already of market interest?
 • Is the project team sufficiently
   prepared to go to market?
                                                                                      13
         PPP/PFI VfM Policy
                                   HM Treasury
                         Corporate and Private Finance Team
                               Private Finance Unit

Mandatory PFI Contract                      Mandatory VfM guidance




                                                                     14
        Value For Money Guidance
        3-stage Process
                               • Predict which procurement routes should apply for projects
  Stage 1                        in overall programme, and if PFI is appropriate
Investment     Departments     • Increase transparency and improve deal flow
Programme
                               • Ensure that investments made using PFI are affordable


                               • Verify initial decision to use PFI is valid, and if not change
  Stage 2     Project teams,     procurement route
  Project     monitored by     • Feedback to improve evidence base, market management
Assessment
               departments     • Ensure that project proceeds only if affordable
                               • Test whether the PFI solution is marketable
                               • Ensure an efficient bid process is planned



  Stage 3     Project teams, • Evaluate bids correctly
Procurement   monitored by • Feed back market intelligence to planned projects
Assessment
               departments • Determine if there is market failure or abuse
                             • Ensure proposed risk-sharing is deliverable

                                                                                           15
      UK Policy - VfM


Ex-ante
    • Capital strategy considered as part of Spending Review process
    • Specific investment options identified and appraised using the Green Book
    • Capital projects prioritised within Department’s capital programme
    • Those areas which may be suited to procurement through PFI identified


 Stage 1 Programme Level Assessment

      •Applied to the subset of investment identified as potentially suitable for PFI
      •Central PFU – liasing with team coordinating Spending Review submission
      •Should be done in time with Spending Review submissions




                                                                                        16
           UK Policy - VfM

Stage 2 Project Level Assessment

•Constitutes part of Outline Business Case for each project
•Project team updates analysis from Stage 1 with project specific information and identifies any key
VfM issues
•If VfM is demonstrated then this assessment is noted in the OBC.
•If VfM is not demonstrated, then consider alternative procurement routes. Project should not
proceed as PFI.

Stage 3 Procurement Level Assessment

•Continuous assessment of whether drivers of value for money are maintained until financial
close.
•Proceed with procurement ensuring there are no material changes such as market failure.




                                                                                                 17
  Qualitative Assessment Makes Reasons For
  Undertaking PPP Explicit
                             Categories                     Example question

Viability       Programme level objectives and       Is the procuring authority
                outputs                              satisfied that operable
                                                     contracts could be
                Operational flexibility              constructed for projects
                                                     falling in this area?
                Equity, efficiency, accountability
Desirability    Risk management                      Does the project involve the
                                                     purchase of a significant
                Innovation                           capital asset, where the
                                                     risks of cost and time over-
                Service provision                    runs are likely to be
                                                     significant?
                Incentive and monitoring
                Lifecycle costs, residual value

Achievability   Transaction costs, client capacity   Is there sufficient client-side
                                                     capability to manage the
                Competition                          procurement process?

                                                                                   18
      Where does value for money arise

•   Whole life integrated service - design, build, finance, maintenance,
    service
•   Innovative design
      cheaper construction cost

      cheaper whole - life maintenance

•   Output specification
      services provided in different ways

•   Possible third party income
      catering, nursery facilities, tolls

•   Risk transfer
•   More efficient utilisation of assets


                                                                           20
           Whole life benefits - Street Lighting and
           Highways Maintenance




 BCR
3.5 high




                                                         BCR
           Picture courtesy of PriceWaterhouseCoopers
                                                        2.3 high

                                                                   21
   PPP/PFI delivers Whole Life Benefits

     Strong evidence of innovation in street lighting PFI projects:
        White light lanterns saving 25-30% of energy consumption;
        LED illumination for signs and bollards;
        Lower wattage control equipment;
        Induction lighting (100,000 hours burning time rather than
         20,000)‫‏‬
        Better directed light – projects supported by the Dark Skies
         campaign.
     “The significant investment in street lighting is leading to greater
         expenditure on research and development by manufacturers
         which is resulting in technological innovation.”

Source – 4Ps review of operation PFI projects



                                                                            22
    Main Considerations - Approving a Business
    Case Before Going to Market
              Main question                                  Assessments required

1   Is the project the right one?                  Long term needs assessment
                                                   Scope of project

2   Is PFI the correct procurement route?          Value for Money Guidance (financing decision)‫‏‬

3   Is the project affordable?                     Affordability assessment – budgeting

    Is the project sufficiently developed to be    Design quality assessment
4
    ready to go to market?                         Output specification
                                                   Risk allocation

    Is there sufficient indication already of      Market interest assessment – contractors
5   market interest?                               Market interest assessment – funders

    Is the project team sufficiently prepared to   Documentation and process
6
    go to market?                                  Suitability of advisers
                                                   Indicative timetable
                                                   Project team
                                                   Commitment of sponsors, users
                                                   Statuatory process



                                                                                                    23
      Qualitative Assessment: Viability, Desirability
      And Achieveability
                              Questions to be answered – VIABILITY AND ACHIEVABILITY

Programme         Is the procuring authority satisfied that operable contracts could be constructed for projects falling
level             in this area? Can these contractual outputs/requirements be robustly assessed?
objectives and    Could the contracts describe service requirements in clear, objective, output-based terms?
outputs           Could they support assessments of whether the service has been delivered to an agreed
                  standard?
                  Is the fit between needs and outcome sufficient to proceed?
                  In the event of staff transfer, can the contracts be drafted to avoid perverse incentives and deliver
                  quality services?

Operational       Is the procuring authority satisfied that operational flexibility is likely to be maintained over the
flexibilIty       lifetime of the contract, at an acceptable cost?
                  Have the long term tradeoffs between operational flexibility and cost been identified?

Equity,           Are there public equity, efficiency or accountability reasons for providing the service directly, rather
efficiency and    than through a PFI contract?
accountability    Are there regulatory or legal restrictions that require services to be provided directly?
                  Have the expected staff terms and conditions at stage 2 been considered and what are the
                  impacts on the contract, equity, efficiency and accountability?

Transaction
costs and         Is there sufficient client-side capability to manage the procurement process and appraise ongoing
                  performance against agreed outputs? Can appropriately skilled procurement teams be assembled
client capacity   in good time?
Competition
                  Is there evidence that the private sector is capable of delivering the required outcome? Is there
                  likely to be sufficient market appetite for the project? How is it expected that the market will
                  receive the proposed risk profile?                                                                24
      Qualitative Assessment: Viability, Desirability
      And Achieveability
                                         Questions to be answered - DESIRABILITY

Risk              Does the project involve the purchase of a significant capital asset, where the risks of cost and
management        time over-runs are likely to be significant?

Innovation        Does a preliminary assessment indicate that there is likely to be scope for innovation? To what
                  extent‫‏‬are‫‏‬the‫‏‬projects’‫‏‬scope,‫‏‬specification‫‏‬and‫‏‬operation‫‏‬pre-set or open to negotiation with the
                  private sector?

Service           Are there good strategic reasons to retain soft service provision in house? What are the
                  implications in the longer term for the organisation in losing these skills – are all the expertise
provision
                  transferring or is there some retention?
                  Is soft service transfer essential for achieving the overall benefits of improved standards of service
                  delivery?
                  Where‫‏‬soft‫‏‬services‫‏‬are‫‏‬not‫‏‬transferred,‫‏‬is‫‏‬this‫‏‬consistent‫‏‬with‫‏‬the‫‏‬Prime‫‏‬Minister’s‫‏‬commitment‫‏‬to‫‏‬
                  flexibility of public service provision?

Incentive and     Can the outcomes or outputs of the investment programme be described in contractual terms
monitoring        which would be unambiguous and measurable?Can the service be assessed against an agreed
                  standard?Would incentives on service levels be enhanced through a PFI payment mechanism?

Lifecycle costs   Is it possible to integrate the design, build and operation of the project?Is a lengthy contract
and residual      envisaged? Will al long-term contractual relationship be suitable (or advantageous) for the
value             service?Are there significant ongoing operating costs and maintenance requirement? Are these
                  likely to be sensitive to the type of construction?

Overall           Overall, is the accounting officer satisfied that PFI would bring sufficient benefits that would
                  outweigh the expected higher cost of capital?
                                                                                                                        25
Issues arising from accounting change
                    r p ri n f F r j t n n of h aa c he y e t r
                                    e
                   Po oto o PI po cso a d f t ebl nes e tb s co

            0%
            10
             0
            9%
             0
            8%
             0
            7%
             0
            6%
                                                                    O
                                                                   %N
             0
            5%
                                                                    OF
                                                                   %F
             0
            4%
             0
            3%
             0
            2%
             0
            1%
             0%
                  fE
                  DS    ER
                       DF A     L
                               CG     Hah
                                       e lt   HO      O
                                                     MD      DfT


Stock
- need to manage the impact on existing projects (although 45% on balance sheet,
       mainly due to 3 tube deals)‫‏‬
PFI Pipeline
- rigorous scrutiny of proposed PFI programmes for CSR07
- future procurement of complex project

                                                                             27
Shorter journeys - Mersey Gateway
Bridge




                              Mersey Gateway




                                           28
            Motorway PFI
r et
 o
Pjc                   i ni l e
                       n a o
                      F ac lCs                 C iaV u Bac Set
                                                a tl a e
                                                 p   l     a ne he
                                                           l
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                                               £          ra n
                                                             m
                                                          tet et
af r r s
 r d o n
Dto Csi g                      A- 7
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                                                                 O
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                                                         10

http://www.hm-treasury.gov.uk/documents/public_private_partnerships/ppp_pfi_stats.cfm


                                                                                        29
Databank

 HM Treasury policy guidance:
   Transforming Government Procurement
     http://www.hm-treasury.gov.uk./media/4EA/89/government_procurement_pu147.pdf
    Green Book
     http://www.hm-
            treasury.gov.uk/economic_data_and_tools/greenbook/data_greenbook_index.cfm
    PFI Policy
     VfM, standardised PFI contracts, project list (all financial data)
     http://www.hm-treasury.gov.uk/documents/public_private_partnerships/ppp_index.cfm


    Budget 2007
     http://www.hm-treasury.gov.uk/index.cfm




                                                                                         30
Databank

 Department for Transport policy guidance:
   NATA
          http://www.webtag.org.uk/index.htm
    Eddington Transport Study
     Department for Transport - The Eddington Transport Study
     http://www.dft.gov.uk/about/strategy/eddingtonstudy/pubeddingbase?page=2
    Review of Highways Agency’s Major Roads Programme
     http://www.dft.gov.uk/pgr/roads/nicholsreport/?view=Standard
    Highways Agency
     http://www.highways.gov.uk/default.aspx




                                                                                31
Databank
 Other sources:
      Office of Government Commerce
 http://www.ogc.gov.uk
      Consolidated UK procurement regulations
 http://www.opsi.gov.uk/si/si2006/uksi_20060005_en.pdf
      Partnerships UK
 http://www.partnershipsuk.org.uk/index.asp
      4ps
 http://www.4ps.gov.uk/
      Green Public Private Partnerships
 http://www.ogc.gov.uk/documents/Green_Public_Private_Partnerships.pdf
      National Audit Office
 http://www.nao.org.uk/




                                                                         32
Databank

 Other sources:
      Transport for London
 Home | Transport for London
      Thames Gateway Bridge
 http://www.tfl.gov.uk/corporate/projectsandschemes/networkandservices/thamesgate
        way/2203.aspx
      TGB Public Enquiry
 http://www.persona.uk.com/thamesgateway/
      Mersey Gateway Bridge
 http://www.merseygateway.co.uk/




                                                                                    33

				
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