PPP/PFI review: Bridging the funding gap

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By Ian Fraser

Published: Scottish Business Insider

Date: 3 June 2008

Is PPP a thing of the past? And if so, what replaces it?

ON THE first anniversary of gaining the keys to Bute House, Alex Salmond won many plaudits from the business community for his stewardship of the Scottish economy. However, there is one area where his government was seen as having scored less well – its approach to PFI/PPP.

The nationalists’ hostility to this funding method has been known for some time but it became abundantly clear within a few days of them taking office, when justice secretary Kenny MacAskill killed off plans for the £100m Low Moss prison near Bishopbriggs. Rather than being built under PPP as planned, MacAskill decreed the new gaol would be built using public sector procurement.

Salmond stuck a further two fingers up to the country’s PPP establishment in April when he said Scotland’s biggest ever hospital building project – the £842m New Southern Hospital in Glasgow – would also be built using traditional public procurement. This led some private sector players to question Greater Glasgow Health Board’s ability to deliver the project on time and on budget.

The nationalists’ long term plan is to replace PFI with the Scottish Futures Trust (SFT). Yet plans for the SFT remain vague. Perhaps unsurprisingly, the plan came in for a slating during a consultation period that ended in March.

The Chartered Institute of Public Finance Accountants said greater clarity was required on the SFT’s aims and remit. “Is it to be a funder, service provider/contractor, advisor or procurement agent? If the SFT is to take on a number of roles how will it manage potential conflicts of interest?” Other respondents questioned whether the new body would be able to issue bonds to raise finance without an Act of Parliament in Westminster.

Michael McAuley, partner at law firm Dundas & Wilson says: “My main concern is the SFT could prove more expensive for the taxpayer than PPP and that it will fail to get the support of local authorities and health boards, as having a centralised body will limit their opportunities to have an input into the design of new projects.”

Given the current vagueness of the proposal, the new body is unlikely to see the light of day until 2011 at the earliest. In the interim, the Scottish Government is insisting that a variant of PPP known as the non-profit distributing (NPD) model – which was initially piloted by Argyll & Bute council for a schools project in 2005 – is used for all PPP-type projects in Scotland.

But the blanket use of the NPD model is alienating many in the private sector who do not like to see their profits capped.

Juliet Haldane, a partner in law firm Shepherd & Wedderburn, thinks a combination of uncertainty over SFT and the government’s insistence on NPDs “means the market is losing interest in Scotland. There’s a huge amount of frustration. This was a very mature and busy market but that has just gone. There is really no pipeline at all. We’re looking to England, Poland and Estonia. I expect every law firm in this sector to do the same.”

Already it seems that NPD projects are attracting fewer bidders than PPP projects. NHS Tayside, for example, intended to use a PPP for a £100m project at psychiatric units, but has since changed its mind and will do it as a NPD. “At least six consortia could have been expected to bid had that been a PPP, but they struggled to even get three,” says McAuley.

Kevin Bradley, a partner in construction consultants Davis Langdon, says: “The perception is that PPP is dead in the water in Scotland – which is frustrating given that the industry has spent ten years developing a very good market here, with lots of very experienced people. There’s a very real concern that the Scottish Government is throwing the baby out with the bathwater.”

The absence of a pipeline of PPP projects is a particular disincentive for construction firms, facilities managers and advisors to the PPP sector. Bradley says many are moving resources away from Scotland. Paradoxically, he thinks this will lead to a lack of competition – and higher costs to the taxpayer – once projects do come up for grabs.

Chris Elliott, managing director and head of infrastructure investment at Barclays Private Equity, says: “Some of the things we’re seeing in Scotland, like the ability of a third party to determine the cancellation of commitments and determine when you refinance, might deter investors.”

McAuley believes that the government’s ambivalent approach to infrastructure funding will see it struggle to deliver its ambitious infrastructure investment programme between 2008 and 2011.

Major projects requiring funding include the circa £4bn Forth Road Bridge replacement, a freight hub for Grangemouth, a container facility at Scapa Flow, electricity grid improvements, and facilities for the 2014 Commonwealth Games.

McAuley believes the SNP has based its antipathy towards PFI on flawed evidence and based its value-for-money calculations on “historical and unrepresentative projects” which were signed off in the early days of PFI, including the Edinburgh Royal Infirmary and Hairmyres Hospital.

“These were signed off 10 to 12 years ago and are unrepresentative of what’s happening now,” says McAuley. “The world has moved on and finance has become cheaper – rates of return are now sitting between 12 per cent and 13 per cent and the cost of senior debt is closer to 5 per cent.”

Others believe the SNP is misguided to focus exclusively on the PPP projects’ cost of capital, while disregarding other positive benefits which some argue merit the payment of a premium. These include the transfer of risk to the private sector and a degree of certainty over delivery time and cost.

However Christopher Blunt, a partner at accountants Deloitte, believes the PPP model was far from perfect. He says that, since it gave private sector partners a monopoly of the profits, the public sector rarely saw them as true partnerships. “This definitely created some ideological hostility.”

Another weakness of the PPP was that it skewed the market towards new-build facilities and away from refurbishments, which are of little appeal to large construction firms. And many of the buildings built under PPP are shoddily built, something even Shepherd & Wedderburn’s Haldane acknowledges.

So the Scottish Government has an opportunity to come up with something better. The trouble is, if it takes too long, the PPP establishment may be too busy with projects elsewhere.

This article was published in the June 2008 issue of Scottish Business Insider. To read the article on the Insider website click here .

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