Declan O’Brien asks whether a new raft of public-private partnerships can shake off the reputation risk associated with the old PFI regime
The UK government is expected to announce a new pipeline of public-private partnership (PPP) projects that could offer opportunities for savvy investors in both debt and equity. PPPs are contractual structures between the public and private sectors where the latter builds and operates an infrastructure asset for a concession period (typically 25 years) in return for a fee for operating and maintaining the asset (availability payment), that is sized to cover operating costs, debt service and equity returns.
Between 1990 and 2012, the UK government procured its PPP projects under the private finance initiative (PFI), before introducing the Private Finance 2 (PF2) structure in December 2012. PFI has arguably been the most debated sector within the UK infrastructure market over the past 20 years. The key observation from our sector analysis was that PFI is often viewed as representing poor value for money for the taxpayer, particularly for social infrastructure.
The government used the initiative to finance more than 730 projects equating to capital expenditure of £60bn (€70bn) in the healthcare, education, defence and accommodation sectors. However, since the introduction of PF2, the volume of PPPs procured in the UK has fallen; this is in contrast to other major PPP markets, such as Canada and Australia. We believe a key inhibitor to the deployment of PF2 projects is a hangover from PFIs, which received widespread criticism from the government, the national audit office, and in the national and local press.
We conducted primary research on the top 100 articles on Google News referencing PFI (sorted by relevance) to assess the extent of reputational risk from existing investments; we used negative press as a key indicator for potential reputational risk. Our analysis found that 98% of the articles were negative about the initiative; 24 mentioned the equity provider whereas only four mentioned the debt provider. This analysis suggests that debt providers are less exposed to reputational risk than equity. The research also showed that hospitals were most criticised, with a notable link between PFI and deteriorating finances in the UK’s National Health Service (NHS).
Regardless of whether you believe PFI projects are good value for money, there does not seem to be a strong link between PFIs and financial stress in the NHS. While some NHS and Foundation Trusts required financial support to make payments under PFI schemes, research undertaken by the Health Foundation charity found that PFI is a significant factor in only a small number of trusts – although PFI payments accounted for more than 5% of total spending for nine trusts in 2014/15, across all providers they accounted for only 1% of total operating costs. Further research from Monitor, the sector regulator for health services in England, found that having a PFI scheme was correlated with better financial performance.
Another criticism directed at PFI is the high financing cost. Critics suggest that the government could finance social infrastructure projects by issuing lower-cost government bonds instead of using private finance. However, this analysis ignores the risk transfer benefits of PFI. The bulk of existing PFIs were financed between 2006 and 2008, when the cost of financing was about twice current rates – this makes these legacy PFIs look poor value for money for the taxpayer by current standards. While PFI contacts include refinancing sharing provisions between the government and the private sector, the swap break costs associated with out-of-the-money, long-term interest rate swaps generally make refinancing prohibitive.
However, the UK government has evolved the framework for PPPs with PF2. This was designed to address the failings of PFI, as identified by the Treasury. The key changes under PF2 were mechanisms that focused on limiting private-sector equity upside, improving transparency and delivering better value for money through rigorous procurement procedures.
PF2 has now successfully delivered 46 schools under the Priority Schools Building Programme (PSBP), and the £340m Midland Metropolitan Hospital is on schedule to be opened in 2018. The announcement in the Autumn Statement that the government will publish a new pipeline of PF2 projects in early 2017 gives a positive indication that the National Infrastructure Commission (NIC), the independent advisory body to the government, is supportive of deploying PF2 to deliver social and economic infrastructure.
In November 2016, the Chancellor sent a letter to the NIC outlining details of its expanded fiscal remit, emphasising its responsibility to ensure that its recommendations would be affordable. The government also declared that the NIC was “at the heart of its infrastructure policy”, and gave the NIC clear guidance that public investment in economic infrastructure would be 1-1.2% of GDP in each year between from 2020-2050. While not binding, this declaration, combined with the increased remit of the NIC, should give investors some assurance around the future pipeline of new UK infrastructure.
New PPP opportunities have been limited, forcing investors into ever more tightly priced secondary assets. This is partly a legacy caused by the value-for-money debate over previous transactions. Recent announcements imply a renewed desire to use the PF2 framework as a funding mechanism. This should create a wider universe of opportunities for long-term investors to contribute to the renewal and expansion of social and economic infrastructure in the UK.
Declan O’Brien is infrastructure strategist at LGIM Real Assets
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UK Infrastructure: Still suffering from a PFI hangover