FIN(3)-PPP-009
John Grimes
Clerk
Finance Committee
National Assembly for Wales
CARDIFF CF99 1NA
Karl.gomila@wales.gsi.gov.uk
30 November 2007
BY mail and email
Dear Mr Grimes
Finance Committee Inquiry into Public-Private Partnerships
The Institute of Chartered Accountants in England & Wales is pleased to have the opportunity to submit initial evidence to the Finance Committee’s Inquiry into Public-Private Partnerships (PPP) including Private Finance Initiative (PFI) Schemes.
The Institute of Chartered Accountants is the largest professional accountancy body in Europe with over 129,000 members working across every single economic sector - more than 3,000 of them in Wales. The Institute is an active member of Business Wales and the Business Partnership Council, and most of our members either advise or run small and medium sized businesses; in fact, evidence suggests that over 80% of businesses in Wales use the services of a chartered accountant. By drawing on their collective experience, the Institute is well placed to act as a barometer for the views of the private sector. Our members have experience of the operation of PFI schemes both from the contractor and client perspective and Chartered Accountants are key advisors on both the public and private sides of PPPs.
General Points
The Institute’s starting position is neither one of blinkered support for, nor ideological hostility to, PPPs in general and PFI in particular. Rather it is based on what we perceive as the public interest: it is in the interest of the taxpayer and of the competitiveness of our national economy, that public goods and services are procured and paid for in the way which ensures best value for money (in other words, provides the desired level of service at least cost). From this point of view, the key question is whether efficiency gains achieved by applying the discipline of private sector management to a particular project outweigh the additional costs - both in terms of what are recognised as being complex procurement processes and the increased costs that come from raising finance in the private market compared to Government borrowing and generating profits for the operators.
PFI/PPP schemes undoubtedly have a place in meeting the demands of infrastructural development. However, we do not believe that the fact that Wales has thus far been a relatively minor player in terms of PFI (with less than 1% by value of all UK projects being accounted for by public bodies who are financed by the Welsh Assembly Government) should be regarded as a problem as such. Rather, we believe that too often in the past the driver for PFI schemes (as has already been suggested by the evidence given to the Committee) has been that it has been perceived as not an, but the only, alternative, given inadequate capital budgets and Government policies.
We now turn - very briefly - to the three specific areas of your enquiry, i) the potential costs, benefits and risks that may be involved, ii) any policy changes that may be needed to realise the optimum outcome and iii) practical guidance to enable the public sector to strike the most advantageous arrangements.
The potential costs, benefits and risks
Although more than six hundred PFI projects have been approved across the UK, relatively few have operated for more than a small proportion of their overall term (which is often thirty years or more) and it needs to be recognised that the evidence base is thus limited. Initial views from the public sector clients (e.g. the report of Cambridge Economic Policy Associates (CEPA) for the Scottish Executive) are largely positive about the effectiveness of the balance of rewards and penalties of PFI contracts in ensuring a good level of service provision in a wide range of different public sector schemes (roads, hospitals, schools), while the National Audit Office (NAO) has suggested that the initial evidence from the construction phase of PFI contracts suggests far better performance in terms of buildings completed on time and to budget under PFI compared to the historic performance of traditional public sector procurement.
However, this positive view needs to be heavily qualified. Firstly, the main negative factor which has been highlighted is the relative lack of flexibility of PFI schemes in the operational phase to respond to changing circumstances and demands of service-users, and the complexity of renegotiating contracts when this is necessary. It is likely that such problems will increase, rather than diminish, as schemes reach 15 or 20 years after they were commissioned. While to some extent problems such as these may reflect inadequacies in developing the original specification (see below), with the pace of social (e.g. the changing patterns of migration; the expectation of wrap-around childcare) and technological (e.g. changes in medical technology enabling far greater reliance on primary care) change, it may well be unreasonable to expect any public sector body to foresee accurately the service requirements of a given facility two decades into the future. A lack of capacity to respond flexibly to altered circumstances could thus be a fatal flaw.
Secondly, there needs to be careful consideration as to whether the advantages which appear to flow from PFI are impossible to replicate in other procurement methods which do not involve the additional costs of using private finance. Thus (as has been shown in the examples of the Millennium Stadium and to some extent the Senedd building itself) the better performance in terms of construction compared to "traditional” public sector procurement may be achievable through well-managed Design and Build (or even Design, Build and Operate) fixed-price contracts.
Similarly, it is often claimed that PFI schemes have the advantages that they allow for trade-offs between capital and revenue budgets and that maintenance budgets are protected from budget cuts since payments to PFI suppliers are ring-fenced. However, the defectiveness of "traditional” public sector management in contrast to PFI in both these cases results from Government Accounting rules and practices, which (at least in theory) might be changed to achieve the same results quite independently of PFI: PFI may be an expensive way of getting round unhelpful rules.
Finally, as has been recognised in the evidence to your Committee, the terms of the debate over PFI have already been changed by the introduction of prudential borrowing for public authorities, but it remains the case that keeping capital expenditure off the public sector balance sheet continues to be a concern at the macro-level, and in our view this risks distorting a balanced consideration of the costs and benefits of individual PFI schemes.
Policy Changes Needed
We have already suggested that there is a need to examine some fundamental policy issues in terms of public sector practice (e.g. the priority given to maintenance budgets; restrictions on public sector borrowing even in respect of meeting clear capital project priorities; using design and build approaches to ensure that the public sector is disciplined about clearly formulating its requirements and not changing specifications in mid-project) to ensure that decisions to use the PFI route in any particular case are taken for the right reasons. Only by ensuring that the dice are not loaded either for or against PFI and that other options are not ignored, is it possible to take an objective view of whether or not it is merited in a particular case.
In more practical terms, it is essential to ensure that where PFI is chosen as a way forward, the choice is made on objective grounds and there is broad political acceptance and support in order to create the right climate in which public and private sector can work together. Contractors will not want to work in an environment where every move is scrutinised for signs of failure or inadequacy, or will charge a premium for doing so. By contrast, the politicisation of such projects can create an unsuitable 'climate’ in which to do business. If there are clear public statements that a project is essential and that PFI is the only way of making it happen, this is unlikely to strengthen the hand of the public servants in negotiating a good deal with the private sector.
Moreover, there needs to be a much stronger emphasis on developing long-term business partnerships between client and contractor. Like marriages, long term business partnerships require cultural and business compatibility. Although difficult to guarantee, this is often not given sufficient importance at strategic and operational level. Understanding, trust, and confidence are vital on both sides - and are particularly important if the requisite flexibility is to be built into the long-term relationship. As with much of public sector procurement, the process itself takes over the business aspects of this crucial relationship and while the competitive nature of procurement is essential to ensure good value, once a preferred bidder has been selected, it is essential to build a relationship which is based on the mutual recognition of the legitimacy of each partner’s interests.
We have already emphasised the paramount importance of accurate scoping of the requirements of the client - though arguably this should apply to all major public investments, regardless of the method of implementation. Much greater attention needs to be placed upon:
Planning and developing "business” requirements - not only to meet current needs but also how those needs might change in the future; their implications on the venture; and how to cope with this.
The use of sensitivity analysis to build in provision for altered circumstances - not only from the public sector perspective but also full consideration of the private sector provider’s perspective.
Above all, it is essential to ensure that the focus remains clearly on defining the requirements according to what is needed, on "why are we doing this?”. Evidence from England suggests there have been serious problems e.g. with capacity of hospitals where scoping has been determined not by forecasts of patient flows/requirements but by "working backwards” from budgetary constraints, while conversely, the concern to guarantee flexibility may in some circumstances lead to building in redundant capacity or features.
In terms of implementation of PFI projects, while performance penalties are necessary to ensure high standards of provision, too little attention is paid to encouraging innovative approaches (from either "side”) to introduce beneficial changes in the way things are done. There need to be clearer incentives on both sides to seek improvements over time to realise mutual benefits.
Practical Guidance
If it is decided to go forward with PPP/PFI projects, the key issue is to ensure that the commissioning public sector authorities possess adequate commercial awareness and knowledge "in-house”: this may be a major challenge for the public sector in Wales, given the limited experience of such schemes and the small size of local authorities and health bodies compared to counterparts in England. Consultants can provide guidance but they generally cannot offer "ownership” and can be excessively expensive if used in the wrong manner. It will be essential to draw heavily on expertise from within the public sector elsewhere in the UK and place a real emphasis on developing expertise in managing such projects within Welsh public sector organisations, not to regard PFI as a way of simply cutting back on or contracting out project management.
It is also essential to realise that there is no one simple detailed model for a PPP and partners must be prepared to work flexibly to achieve a detailed model that works for both.
Conclusion
To sum up, we believe that:
PPP/PFI may have a place where it is clear that the additional efficiency of private sector management outweighs the additional costs of private sector financing and the profit element of contractors;
While there are many positive experiences of PPP/PFI to date, concerns about the inflexibility of such solutions to adapt to changes in service requirements over time may well grow as such projects mature;
Arguments over PFI, in particular, have been distorted by representing the way in which PFI enables unhelpful public finance practices to be avoided or circumvented (the rigid separation of capital and revenue budgets, the failure to ensure adequate maintenance budgets for publicly operated facilities are respected, the tendency of "traditional” public sector procurement to allow frequent changes of design and specification once contracts have been let) as advantages which are a product of PFI in itself. This is not necessarily the case;
It is essential to weigh up the case for any PPP/PFI scheme in a way which disregards these arguments and the distorting impact of the concern to get capital projects off the public sector balance sheet. Too often in the past, PPP/PFI has been seen as the only alternative for achieving major public sector projects, which undermines real consideration of the benefits and disbenefits of going ahead on this basis and weakens the public sector’s negotiating hand;
PPP/PFI requires a genuine partnership between both "sides” which incentivises each of them to identify ways in which service improvements can be achieved;
This partnership requires genuine expertise, ownership and involvement from the public sector partner: it should not be an excuse for cutting back on project management expertise and, in the case of Wales, any move to increase the use of PFI would require a concerted effort to increase the skills base within the public sector;
There are requirements for a much clearer focus on the needs which any major project is seeking to meet, for much greater attention to the way in which such needs may change over time, and for greater flexibility to be built in to projects which are selected for PPP/PFI approaches.
We hope these thoughts are of use to the Committee.
Yours sincerely
David Lermon
Director for Wales
Regus House Falcon Drive Cardiff Bay
Cardiff CF10 4RU
www.icaew.com/wales
T 44 (0)29 2050 4595
F +44 (0)29 2050 4199
Ewales@icaew.com
