Will PFI live to fight another day?

Carillion collapse shows PFI works well when structured correctly

The chancellor’s announcement last week abolishing future private finance initiative (PFI) contracts was widely considered a non-announcement, but it did leave some unanswered questions over the future of the private sector’s role in UK infrastructure projects.

Philip Hammond’s Budget speech showed the ghost of Carillion continues to haunt the UK’s financial sector as he told the House of Commons in no uncertain terms that this government would not be signing another PFI contract.

Describing these deals as “inflexible and overly complex”, Hammond blamed the Labour government for its “disastrous” PFI policy when in power, stating that 90% of such contracts agreed under Labour have cost taxpayers £200bn.

Under PFI, which is a form of public-private partnership (PPP), contractors pay for the construction costs and then rent the finished project back to the public sector. But the Office for Budgetary Responsibility has said the use of these contracts results in “fiscal illusions”.

This, it says, is because most PFI contracts are designed so that they are kept off balance sheet, which means the cost of building infrastructure assets appears in the public finances over the protracted period via a series of annual payments rather than as the asset is built.

A non-event

Industry figures were unfazed by Hammond’s announcement. They note that many existing PFI contracts still have a number of years left to run, and that no one has really been investing in PFI/PPP for the past couple of years.

Will Argent, investment manager of the VT Gravis UK Infrastructure Income fund, says: “While the abolition of PFI removes a particular financing structure, the need for private sector investment remains very real. So, for those companies that have historically focused on government-supported infrastructure projects there are still likely to be opportunities in future.”

Mark Brennan, senior investment manager at Foresight Group, says the chancellor’s announcement just rubber stamped what had in effect already come to pass as the UK infrastructure community had broadly written off PFI structures for future investment.

“New structures will continue to be developed to fund future investment, and Hammond reaffirmed the role of private capital going forward which will be an encouragement for investors,” he adds. 

The re-birth of PFI

Hammond was unwavering in his statement but it is less clear what the government will replace PFI with, because there is no doubt private investment remains vital to the future of UK infrastructure.

A paper by S&P Global Ratings looking at the future of PPP/PFI argues that despite Hammond’s announcement, PFI might not be dead after all and that the government will continue to make use of PPPs in the future in a slightly different form.

It notes two reasons for this. First, the government is not keen to fund all infrastructure on the public balance sheet and second, it remains committed to the use of PPP “where it delivers value for the taxpayer and genuinely transfers risk to the private sector”.

S&P Global Ratings believes any new version of the PPP model will end up closely mirroring the original PFI framework.

“In our view, despite the criticisms of PFI contracts, the framework supports a number of aspects of public infrastructure policy,” it says. The PFI framework has been the subject of criticism over several years now, although much of the debate seems to overlook the benefits of risk allocation among its participants.”

PFI works if structured correctly

S&P Global Ratings says PPPs by whatever name work well if structured appropriately, as demonstrated by the Carillion collapse – and to the benefit of the UK taxpayer.

“The largest hit to the UK taxpayer as a result of Carillion’s demise may come from the hundreds of contracts the public sector negotiated with Carillion directly, rather than through PFI projects that used Carillion as a subcontractor,” it says. “But the recurring narrative around Carillion’s collapse tends to largely fail to distinguish Carillion’s distinct roles as PFI subcontractor.”

It notes the two hospital PFI projects in construction that failed following Carillon’s announced liquidation illustrate that the risk allocation of the PFI model largely works the way it was designed to.

“In those projects the private sector will lose out first. And through the use of PFI, the taxpayer will ultimately pay less for those hospitals than if the public sector had contracted directly with Carillion.”

Tough questions

Whatever the government decides to do, S&P Global Ratings says it will need to address certain “tough” questions when designing a model to replace PFI.

These include whether it is prepared to pay for construction of new projects upfront rather than spread it over, say, 30 years and whether it is prepared to take construction risk on large scale projects that are prone to delays and overrunning budget.

 

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