Post-PFI preparations

As Private fi nance initiative (PFI) service arrangements wind down, what lessons can be learned from the PFI era and what will future public / private funding of building projects mean for the way facilities services are provided? Kerry Lorimer reports

he demise of the private finance initiative (PFI) is set to be the catalyst for a transformation in the way public infrastructure is funded, delivered and maintained. With more than 200 PFI contracts due to expire over the next decade according to the National Audit Office, a new landscape for public private partnerships could see the monopolies of large service providers broken up to create a more flexible and diverse marketplace.

However, the winddown of those contracts will pose serious challenges for public authorities, who face a choice between reprocuring a service provider or bringing services in-house.

It could also see a shake-up in the market which may challenge service providers who have relied on the guaranteed income of long-term PFI deals for a sizeable proportion of their business.

“You might have service providers who pick up additional work, but you’ve potentially got some big players who are suddenly going to be at risk of losing several long-term, high value, contracts within a relatively short space of time,” says Chris Reeves, Partner at P2G, a social enterprise set up to help the public sector manage PFI contracts, including the expiry and reprocurement process.

In the meantime, managing the hand back and re-procurement process could be risk and resource intensive for both sides, says Reeves, who is also deputy chair of the IWFM’s Special Interest Group for Procurement. Misplaced or outdated documentation, including as built drawings, asset registers and maintenance records, along with the potential mismanagement of asset condition, could derail the re-procurement process, leading to legal disputes and reputational damage for the service provider.

“That, inevitably, is going to get out into the marketplace, impacting your reputation in bidding for future work or even retendering for what you’ve got,” he says.

“The key from a client perspective is very early engagement and collective planning for hand back between all parties, because the closer it gets the more difficult it’s going to be.”

Reeves also recommends that surveys be carried out as early as possible to validate the condition of assets, the

accuracy of asset registers and sufficiency of planned maintenance plans, as well as to assess performance against environmental and fire safety parameters.

It benefits all parties to identify issues early so they can work together to resolve them well in advance of contract expiry, he says, and helps to ensure the public sector is inheriting “an asset rather than a liability”.

However, as the number of PFI expiries ramps up in the coming years, there is a risk of conflict between the public sector and outgoing service providers if hand back is not planned, managed and suitably resourced in a pro-active and collaborative manner, he warns.

A question of capacity

James Larmour, partner at law firm Freeths, agrees that early engagement is crucial to avoiding a fall-out that could be damaging for both sides.

“What I would advocate for is for people to start collaborating to avoid conflict – it’s not going to be in the interests of any of the parties to end up in dispute over this,” he says.

In practice, however, lack of capacity has meant little activity to date on the public sector side.

“They’ve got an awful lot on their plates; they have to manage the contracts on an ordinary day to day basis and on top of that they’ve got the hand-back process and also what comes next in terms of reprocurement,” he says.

The worst-case scenario for public authorities is that the hand-back process is not completed by the time the work is to be handed over to the incoming contractor.

“If you’ve got ongoing disputes in relation to the facilities, that’s just another headache in terms of the ongoing management of facilities because you won’t have a clear line in the sand between the outgoing contractor and the incoming contractor,” he says.

It’s also the worst outcome for the contractor, who instead of handing back the keys and moving onto the next deal finds itself embroiled in a messy and potentially costly dispute.

Mark Williams, public services advisory at Grant Thornton, says there are grounds for optimism that with early preparation most PFIs will be resolved harmoniously, especially now the public sector has far more experience in dealing with complex contracts.

“There will be some of the circa 700 PFIs that will be really challenging and there will be problems, but that’s the same in any portfolio,” he says.

Where there is good contract management and a good relationship between parties, there is no reason why the expiry should not go smoothly, he says.

However, complications are more likely to arise where that relationship has broken down and the contract neglected by the procuring authority.

“If you’ve got yourself into an adversarial relationship with the private sector, life is going to be more difficult and it’s what you do to reset that,” he says.

Negotiating the wind-down

Looking ahead, one way in which the relationship can be put onto a more positive footing is where the parties agree to extend the contract, whether in terms of scope or duration, but on a renegotiated basis which helps both sides meet their objectives.

They could, for example, extend the scope of an agreement to include an element of energy efficiency retrofitting work to enable a council to deliver on its net zero commitments.

“It would be a bit daft to rigidly follow the contract even though 25 years have passed,” says Williams.

“While these are contractually bound arrangements,” he continues, “if the incentives align for both parties, ultimately you can work with your lawyers and put the contract aside.”

Some public bodies, especially those with the infrastructure for managing estates already in place, may opt to bring services back inhouse when the PFI contract expires, while others will prefer to continue to outsource to the private sector, says Reeves.

So far, he has seen some clients take services back inhouse to manage themselves, but ultimately, the landscape will depend on the skill, capacity and appetite of the public sector to do that work.

“The whole reason outsourcing exists is because clients want to focus on their core business and transfer the responsibility for delivering facilities management services to the party best placed to manage it” he says.

A toxic legacy

Governments have struggled to come up with a public private partnership model that leverages the benefits of private finance and experience while avoiding the pitfalls – and toxic legacy – of PFI.

The Scottish Government experimented with a nonprofit distributing model which was designed to cap excessive private profits while increasing public sector influence over projects.

However, it was scrapped after value-for-money concerns and a ruling that the level of public control in such schemes meant they had to be included in capital budgets.

It is now considering a mutual investment model developed by the Welsh Government under which the public sector acts as a co-investor and co-owner of up to 20 per cent of each project delivery company.

Because it would not be used to finance soft services or capital equipment, the Welsh model is able to distance itself from PFI and its association with bloated service providers charging hospitals hundreds of pounds to change a lightbulb.

A neat alternative, suggests Larmour, would be to let a long-term FM concession for the facilities, for which the successful bidder would pay an upfront premium funded through senior debt and equity. That premium would then be repaid through the service fee for the duration of the concession, generating a capital receipt for the procuring authority which could then be reinvested to finance other projects.

The successful bidder could be tasked with using the capital raised to redevelop, extend or refurbish the existing facilities, including the retrofitting of energy generation/storage assets, energy efficiency measures and/or electric vehicle charging infrastructure.

“But it looks way too much like PFI for me to think anyone is ever going to adopt it,” he says.

As opposed to illustrating the weaknesses of outsourcing, the fact that there was so little slack in the system that contractors like Carillion went bust shows how well public procurement worked, Larmour argues.

“In many respects it shines a light on how aggressively run some procurements are,” he says.

According to Williams, the benefits that made PFI attractive in the first place - risk transfer, innovation, due diligence and the long-term integrated view provided by combining design, build, operations and maintenance – should not be overlooked.

“I’m not going to say it should be the only game in town – it shouldn’t, and when it was the only game in town that was a problem,” he says.

“But it is one of the models that should be put into a business case assessment to consider whether it has merit.”

Otherwise, the public sector risks closing down the whole potentially valuable avenue of private or alternate finance.

PFI - A TROUBLED HISTORY

KILLED BY ITS COMPLEXITY

The number of PFI project commencements hit a high of 68 in 2004. In 2018, when the then chancellor Philip Hammond announced their abolition, just one was commenced.

The PFI idea came under strain during the 2008-2010 financial crisis when the introduction of tighter regulations on banks meant higher lending costs on longterm debt and a consequential rise in costs and charges relating to PFI projects.

Whether PFIs gave value for money came under question during the early period of the 2010-2015 coalition government, with a particular concern about fixed PFI charges during a time when public finances were under extreme pressure. Public bodies questioned the long-term viability of PFIs should further funding reductions become likely.

Countering these concerns, the government introduced a new model of PFI – ‘PF2’ – ten years ago. A few projects were started using the PF2 model, but this, too, was withdrawn in 2018.

Ultimately, the government came to accept that the PFI model is restrictively inflexible and complex, and a potential risk to government finances. The National Audit Office’s inability to provide any clear data on the model’s benefits helped to seal its fate.

The heyday of the PFI deal is over, but the ramifications for service providers of clients being locked into PFI deals continue. Payments for some PFI projects are set to continue for decades – PFI contracts typically run for 25-30 years – but the 2020s will see a steady decline in the number of such deals remaining operational. Nevertheless, it won’t just suddenly all end: the last PFI payment, for the Oxleas NHS Foundation Trust PFI is not due until 2049/50 on an unusually long contract that was signed in 1998 to last for a truly extraordinary 52 years.

“When we’ve got to spend billions on things like net zero, do we want to cut off a whole form of finance and project delivery?” he says.

Opportunity knocks

The extent to which the landscape changes post-PFI will be driven by whether customers opt to “buy big” to secure best value or place greater weight on the green agenda, SMEs and the local economy.

“One can view this as an end of an era, or the start of a new opportunity for those willing to think differently and take on risk, particularly where the customer is willing to help support this shift to a new operating model,” says David Millar, managing director of Eastern & Wychwood.

In the past, a procuring authority’s commitment to, for example, cut food miles and award contracts to local firms were rarely followed through in practice.

“When it came to awarding the contract, often, if not always, it went to the lowest bidder who bought from their designated supply chain,” says Millar.

Historically, small firms have been precluded from pitching for public sector contracts as they lacked the resources to compete with bigger operators’s dedicated bid teams. Times, though, are changing, and social value is becoming a key public sector issue. Millar suggests looking at what other countries are doing to create a more diverse supplier base. In the US, a public sector contract may require a certain level of involvement from small firms. It must then report on which small firms it has used, to what value and whether the small firms have been paid on time.

“Bidding credits, and points for smaller businesses that are actually reinforced rather than paid lip service to, are critical if we are to avoid the failures of the past,” concludes Millar.

PFI - A TROUBLED HISTORY

PUTTING FM PROVIDERS UNDER PRESSURE

In the early 2000s, concerns about PFI operation came to a crescendo, being focused on the burden of risk being put on the FM contractor. It was seen that FM firms were being unfairly targeted by other parties to the PFI deal, exposed to extra operational costs.

While FM contractors always knew that the risk profile of PFI contracting was more onerous than that of more traditional forms of procurement, many FM contractors had to mitigate these risks when negotiating the terms of the FM contract with the special purpose vehicle (SPV).

One such risk was limitation of liability. In seeking to keep control, capping the FM Contractor’s annual liability under the FM Contract, to a sum equivalent to 100% of the annual fee paid to the FM Contractor.

Another was the imposition of deductions, with The SPV agreement oft en allowing for deductions against the FM contractor despite any unavailability being the fault of the building contractor, not FM contractor.

These also included ‘interface agreements’ between the FM contractor, building contractor and SPV. These were oft en seen by the building contractor as a way of passing on liability to the FM contractor.

FM contractors were also oft en pushed to accept comprehensive “sweep-up” clauses in which they would find themselves responsible for SPV obligations in respect of the ‘operational phase’ of the facility, having to ensure that, instead, all aspects of their responsibilities wer laided out wholly in the FM contract.