Private Finance Projects (EAC Report)
(14 years ago)
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Lord Vallance of Tummel
To move that this House takes note of the Report of the Economic Affairs Committee on Private Finance Projects and off-balance sheet debt (First Report, Session 2009–10, HL Paper 63).
Lord Vallance of Tummel
My Lords, although I am no longer a member of the Economic Affairs Committee, I am pleased to introduce its report, Private Finance Projects and off-balance sheet debt, which was published in March while I was still chairman. Before I do so, I should declare an interest as a member of the supervisory board of Siemens AG, one of whose divisions has been party to a private finance project.
I am grateful to all the witnesses who made the report possible and especially to the National Audit Office for its valuable contribution. I should also like to thank Professor Paul Grout of the University of Bristol whose knowledge and experience were essential to our report. The topic is important and affects all of us, but the terminology is pretty turgid: neither private finance initiative, PFI, nor public private partnership, PPP, exactly fire the imagination. “Private finance projects”, or PFPs—the umbrella term that we adopted in our report—is scarcely more compelling, but it has the virtue of embracing both the PFI concept introduced by a Conservative Government and its PPP rollout, largely under a Labour Government. The term “private finance projects” also says what it means: doing public projects with private finance. I will use “PFPs” as a catch-all term today.
PFPs use private sector capital and skills to provide public infrastructure for a lengthy fixed period. Schools, roads and hospitals are typical examples. The public sector client pays the contractors fixed sums over about 30 years for design, build, maintenance and some services. This whole-life bundling of costs into one package sounds straightforward enough but PFPs are still controversial. Their defenders say that risk-taking private contractors bring to public procurement the rigour, efficiency and skills needed to get the most out of scarce resources and that they mostly deliver to time and to budget. Detractors say that PFPs are expensive, inflexible and do not really transfer risk from the public sector. It is not easy to show where the truth lies, since lack of data on the whole-life costs of traditional procurement hampers objective comparison. This sometimes encourages heated assertion rather than cool analysis. In our report we tried to take a balanced view of PFPs, but it can be only an interim assessment; no final verdict will be possible until the bulk of the PFP deals signed in the last decade or so have run their course. Even then, the success or failure of PFPs is likely to be judged on a case-by-case basis, with type of project and local factors helping determine how each is finally evaluated.
PFPs grew from a combination of circumstances arising in the post-war decades. Broadly, growth in publicly funded services and rising expectations meant that far more public infrastructure was needed, but over time the perception grew that traditional public procurement was inefficient. The public sector specified a project, private contractors built it and the public sector was then left holding the baby. There were delays, cost overruns, contractual disputes and chronic neglect of maintenance. At the same time, Governments trying to find resources to meet ever-rising demand were looking for better value for money. It was clearly in the public interest for them to look for a new and efficient approach to public procurement.
The beginnings of what became PFPs were in the 1980s, when use of private finance in public procurement was still hedged about with restrictions. Those restrictions were largely removed in the early 1990s as the Government set out to attract private capital. Typical PFPs bring together private contractors holding shares in a consortium—a special purpose vehicle, in the jargon—formed to carry out a specific public project. The contract bundles together construction and maintenance over a long period and is financed by the contractors, mainly through debt, in return for fixed payments over the years by the public authority. Although the PFP model emerged under a Conservative Government, its use became widespread under a Labour Government such that by 2009 there were about £64 billion-worth of PFP contracts in force. This rapid growth of private finance projects is striking. It is clear that PFPs have played a significant role in the expansion and renewal of the nation’s infrastructure. Most schools and hospitals are now procured through PFPs. It will be interesting to see whether this pattern of procurement continues under the coalition Government.
It is clear that PFPs have built much in a short time, changed the urban landscape and renewed much public infrastructure. It is also clear that PFPs are best suited to certain types of projects, such as roads, schools and hospitals, since they can be clearly specified and are of a size that the private contractor can readily finance. It was striking that very few of our witnesses wanted to go back to traditional procurement in areas where PFPs had become the norm. The PFP model has also been enthusiastically adopted by other countries. On the other side of the ledger, experience already seems to show that PFPs are not the right approach for very large, complex and uncertain projects, such as the renovation of the London Underground. However, even successful PFPs, built to budget and on time, are still at an early stage in their life cycle. Few have been running as long as a decade, whereas many of the contracts are for 30 years. It will be for our successors in the 2030s to draw up a final balance.
Meanwhile our report drew conclusions and made recommendations on the basis of experience so far. Here are some of them. Public authorities should be free to choose the procurement method that offers the best value for money. There should be no institutional bias for or against traditional or innovative approaches. There should be greater clarity about financial liabilities arising from PFPs, which should be published alongside the national accounts. Data should be collected on whole-life costs of projects procured by traditional methods, including maintenance and services over the years, so that there can be meaningful comparison with the value for money of PFPs. The pros and cons of establishing a national infrastructure bank, as a means of combining financing at government rates of borrowing with the rigor and efficiency of private-sector delivery, should be kept under review. The operation of the secondary market in PFPs—the buying and selling of PFP contracts—should be monitored for any signs of a drop in build quality where contractors are able to sell completed projects that they would otherwise have to maintain. The public sector should enjoy a fair share of the benefits from any refinancing of PFPs. We also recommended that the Government should monitor the risk of jeopardising the delivery of essential services where public authorities’ budgets were constrained and where the obligatory nature of payments under PFP contractual commitments might squeeze out other critical but discretionary expenditure.
I am glad to say that the then Government were commendably swift in producing their response to our report. They were positive about many of our recommendations, including the quantification and publication of the country’s PFP liabilities and the collection of comparable data on the costs of traditionally procured projects. The previous Government also declared their intention to establish a green investment bank, which would operate on a commercial basis and involve both public and private sector capital. However, that Government dismissed our concerns about the potential effect on the ability of public authorities to deliver essential services as inflexible PFP payments took a higher share of reduced budgets. We were told that PFP payments represented very little threat to the flexibility of the Government’s budgets.
There is now a new Government. We note the commitment by the Chancellor of the Exchequer to go ahead with a green investment bank, but we have heard little of the coalition Government’s approach to PFPs. Will they still have an important role in public procurement? How far will new private finance projects be constrained by the spending review? What will be the role of the green investment bank with respect to PFPs? Does the coalition agree that public authorities should be free to adopt whatever procurement method offer best value for money? Will the Government ensure that overall PFP liabilities are clearly quantified alongside national accounts? Do the coalition Government share the view of the previous Government that inflexible financial obligations under PFPs will not constrain the ability of public authorities to deliver essential services, even as the comprehensive spending review bites?
We will perhaps not hear all the answers today. That said, it is already clear that PFPs have been a bold innovation and that their impact will remain with us for many years, although, as I have indicated, it is too early for a definitive assessment. Meanwhile, it will remain important for Governments, including the current one, to keep looking for best value for money in public procurement and to keep trying out new methods. These might include: new combinations of private sector rigour and financial accountability with the public sector's ability to borrow cheaply; the extension of PFPs beyond construction, maintenance and ancillary services to include some of the core functions in health, education or even defence; and embracing a flexible approach that allows the choice of the procurement path best suited to each project. The guiding principle of procurement should always be to get the best value for the taxpayer, especially while money is tight. I beg to move.
Lord MacGregor of Pulham Market
My Lords, this was a most interesting inquiry and I was very glad to be involved in it. PFI, or PPP, has come a long way since its initial steps, and it was an appropriate moment to judge its successes and failings and to highlight lessons for the future. It was the first parliamentary inquiry since 2000, and the first comprehensive study outside government. We received a massive amount of evidence and I hope that our report will be a valuable source of information on the issues for national and local government, practitioners and academics. I thank our chairman, my noble friend Lord Vallance, for the excellence with which he chaired some complex hearings. I thank also our excellent special adviser, Professor Paul Grout, our committee clerk and the team.
My noble friend Lord Vallance gave a very clear introduction to the background, and covered some of our main recommendations. I agree with almost everything he said and will try not to go over the same ground, except where I have a particular point to make.
The response of the then Government was somewhat cursory and dismissive in places, with very brief responses to some important recommendations. It bore all the marks of being got out in haste before the election. I admit that they did it pretty rapidly. As my noble friend Lord Vallance indicated, we produced our report on 10 March and they responded on 7 April, so it was perhaps understandable that the response was cursory in places. For example, at the outset they said that PFI remains a “small” but crucial part of government investment in UK infrastructure. It is hardly small, given that by 2009 there were approximately 800 PFI/PPP schemes with a capital value of approximately £64 billion. The then Economic Secretary to the Treasury told us that 70 per cent of hospital schemes and 60 per cent of new schools were being delivered through PFI. However, I concede that the response of the then Government accepted a number of our recommendations.
We now have a new Government and I hope that the debate is a timely opportunity to set out the Government's approach to these issues, particularly bearing in mind something that we were very much aware of in our hearings and that we acknowledged in our report. I refer to the fiscally constrained environment in which we now live, the pressures on public expenditure and the impact of the credit crunch on the willingness of the banks to finance PPP/PFI deals, 85 to 90 per cent of the costs of which are usually met by borrowing.
My early involvement with PFI came with the Dartford Crossing in the mid-1980s. I was then Chief Secretary to the Treasury. That was an early example of a private finance project—not a PFI in the current sense—in what would traditionally have been a purely public sector and taxpayer-financed infrastructure scheme. I recall there was some discussion of whether it breached the Ryrie rules that any privately financed solution must be shown to be more cost-effective than a publicly financed alternative. In my view, going ahead with it meant that it was clearly built earlier than it would have been had it taken its place in the priority pecking order in the traditional way, and that was a real benefit. Of course, it was different from subsequent PFIs in that it was financed by tolls not taxation, and it has been very successful.
Subsequently, as Secretary of State for Transport from 1992 to 1994, I was much struck when I first arrived in the department by the average cost overrun on all road schemes of 28 per cent on the original contract. We introduced design and build, which brought the contractor much more into the development, design and construction of the project and helped to bring those cost overruns down. Subsequently, there was design, build and operate and I would very much have liked to have gone further to design, build, finance and operate—finance not through taxation but in schemes that were for motorways or motorway expansion by motorway charging. That was then a step too far for some of my colleagues despite the fact that I produced what I thought was a very good Green Paper, which I still stand by, and I hope that some day it will be done, not least when the infrastructure need on the one hand and the public expenditure constraints on the other make it more desirable.
From the early days, I was a strong supporter of the PFI concept and the report shows that PFI has gone a long way to improving this overrun problem. However, inevitably with a major new innovation one learns lessons as one proceeds and some of the critics of the early PFI projects gave evidence to our committee. Broadly, I think that on the key points that they and others made, lessons have indeed been learnt and implemented and I illustrate this with three examples from our report.
The first is on refinancing. In the early days substantial gains were made by the financial partners by refinancing at lower costs once the building project had been completed and some of the attendant risks had been removed. We drew attention to this in paragraphs 84 and 85 of our report. The National Audit Office particularly criticised the Norfolk and Norwich Hospital project and its refinancing. That was one of the very early ones. Refinancing by PFI partners after the building had been completed resulted in the public sector securing about only 29 per cent of the refinancing gain while increasing the contract’s termination costs. In the report, we welcomed the Government’s action to secure for the public sector a substantial share of refinancing gains. We believe that that has now been recommended and recognised and accepted.
Secondly, there is the question of lack of skills in government departments—inevitably in project management and contract negotiations in the early stages. Again we made a recommendation on this. We recommended that public authorities should do more to maintain and improve commercial skills of staff dealing with private finance projects, with emphasis on long-term contract management as well as contract negotiation. Again, I think the Treasury has recognised and acted on the importance of this point.
Perhaps the third and most important of all the lessons is the failure of the London Underground Metronet PFP, which as we say in our report gave private finance projects in general a bad name. It was of course an exceptional project because of the huge debt guarantees the Government gave—95 per cent of the banks’ loans being guaranteed—which meant that the transfer of risk to the private sector did not happen and the loss to the taxpayer was estimated by the National Audit Office to be between £170 million and £410 million. Unfortunately, the government response does not really deal with our recommendation that PFP should not be used where the state is guaranteeing large amounts and a high proportion of debt as a means to make highly geared PFP happen. The then Government’s response simply noted our views. I hope that the Minister will look at this one again.
Before I turn to what I may describe as the big issue, there is one other detailed recommendation to which I wish to refer. In recommendation 145 we suggested, as Sir John Bourn told us, that the credit crunch, through its limitation on access to funds, thus making them more expensive and available for a shorter period, has tended to reduce competition. We drew attention to one of the problems about the lack of competition related to the high bidding expenses involved in bidding for PFIs. Of course, reducing the competition for private finance projects would increase the cost to taxpayers. We recommended that the Government should examine possible mechanisms for encouraging competition, such as returning an element of bid costs. The then Government in their reply said that the Treasury was reviewing that and that it would publish its findings shortly. I may have missed it, so I ask the Minister whether that has happened and, if so, could he comment on it?
I turn from the detailed recommendations to what I might describe as the big issue. I was an early supporter of PFI, not least for the better project management it involves and the effect it has on maintenance. Quite clearly, one of the other benefits of PFI is that maintenance is contracted for a long period ahead—and all of us who in the past have been involved in public expenditure issues know very well that if the pressures on public finance are very high, maintenance is often the thing that is cut. One of the benefits of PFI is, of course, to be able to do that.
I became somewhat alarmed at the scale and speed with which the Labour Government over the years embraced PFI and appeared to run away with it. It looked like a big wheeze, getting the credit for substantially increasing capital expenditure but without regard to the implications for many years ahead. Also, many witnesses told us that when they approached local authority projects and other projects, the Government implied that there was no game in town other than PFI. It looked like typical off-balance sheet financing, particularly when so little information was available about the level and future consequences of that PFI expenditure. Just as in the private sector, where off-balance sheet financing led to so many consequences for companies and banks, were we building up equal problems in the public sector? The problem was that, in the early stages, we could not get at the figures. Much progress in the accounting for PFI has now been made. In the earlier years, when many of us were in Opposition, we were already expressing concern about increasing public expenditure, and we knew at that stage that this did not even include all the off-balance sheet financing expenditure. At least we know about it now.
Is my noble friend confident that we now have a clear picture of current and future liabilities, and is he satisfied that the response of the previous Government to recommendations 59 and 60 on this matter have been sufficient? Above all, will he look again at our recommendation in paragraph 24? In that recommendation we draw attention to the problem of the build-up of contractual commitments over the years. We advocated that the Government should monitor and control, year by year, the impact of PFI commitments on the budgets of departments and public authorities with a view to ensuring that delivery of essential public services in future years is not unduly constrained or jeopardised by such commitments. As we move into a period of public expenditure constraint, which looks as though it will be here for some years ahead, that becomes more important. The then Government tended to respond by saying that everything was very satisfactory, that there has been full publication of all the details and, after all, that these annual payments under PFI unit charges make up a very small proportion. I do not think that is fully satisfactory. We need to know, and I hope that this Government will look again at our recommendation in paragraph 24. We need to be sure that the crowding-out effect of these future liabilities will not have a major impact on future public expenditure projects. The government response was that if a project had been financed in the traditional way, then of course there would be maintenance requirements in future years. These maintenance requirements were sometimes cut and they will not now be.
Finally, I have one last question on our recommendation on a national infrastructure bank. We recommended that the pros and cons should be kept under review and the previous Government agreed with our recommendation. Can I ask my noble friend to what extent the green investment bank, now proposed by the Government, will meet our recommendation?
In conclusion, there is no doubt that the PFI/PPP project and the whole concept has been a welcome and successful development for all the reasons our report outlines. It has been for many up to now a somewhat esoteric area, perhaps accountancy-led and with, as my noble friend Lord Vallance said, pretty turgid terminology, but it is critical. It needs greater public debate and I am glad that our report has contributed to that. I look forward to my noble friend’s speech, not only responding to some of the questions I have raised, but also giving us some idea of how our new Government see the scope and scale of PFI/PPP in future years.
Lord Lipsey
My Lords, I was not on the Economic Affairs Committee for the whole of the period of this inquiry, but I was there long enough to appreciate greatly the qualities which the then chairman, the noble Lord, Lord Vallance, brought to its proceedings and which he again demonstrated in his admirably concise speech this afternoon. Our report is clear and I do not want to attempt another summary. Rather, I want to draw the attention of the House briefly to two things that it does not conclude—the two dogs, as it were, that did not bark in the night.
The first concerns the view put to us by a minority of witnesses that PFI and PFPs are taxpayer-unfriendly rip-offs. This was put to us—not, of course, quite in those terms—by, for example, the trade union UNISON and by Professor Allyson Pollock of Edinburgh University who writes a column to this effect in the Guardian every month or two which I always look forward to. As the chairman of the committee said, it is too early to be sure on a lot of these matters, but the gap between those who advance these arguments and the majority of our witnesses is a Grand Canyon. It would be to go too far to say that we refuted the arguments of the opponents and it is fair to note that many of the witnesses who gave evidence as to what a wonderful thing PFP was were at the same time lining their pockets from the proceeds of it. However, the evidence we received from the NAO, which I think can be taken as objective in this matter, seems to get it about right. The NAO said:
“Having examined many PPPs, we have concluded that private finance can deliver benefits, but is not suitable at any price or in every circumstance. It is one of many routes of delivery, which, when used for the right reasons and managed effectively, can work well. When it is used for the wrong reasons or is managed badly, it does not deliver projects well”.
That seems good judgment and it contains the view as to why the critics, in my view, are getting it wrong. What they tend to do is take the odd project that has gone wrong and present that as if it were typical. As every speaker has mentioned so far, the project that most obviously went wrong was the ludicrous London Underground project, which was far too complex to be done through this kind of contractual obligation. I do not expect to say this very often in my life, but Ken Livingstone was right and Gordon Brown was wrong. We need to balance those failures against the many successes and the general feeling that our public infrastructure is a great deal better at less expense and to greater benefit to the public as a result of these schemes.
The second dog that did not bark—the noble Lord, Lord MacGregor, just referred to it—is the case for a national infrastructure bank, often referred to as a national investment bank. Fortunately, they have the same initials so it does not matter—NIB. I noted that the noble Lord, Lord Myners, called for such an institution when he spoke in the debate on the comprehensive spending review on Monday. On this matter, the committee sat firmly on the fence. We resoundingly concluded that the pros and cons should be kept under review and, the nature of that recommendation being what it was, the Government cheerfully agreed with us. I do not think, however, that the recommendation quite captured the general tone of the group’s discussion. Some of us, at any rate, find it hard to see what it is, precisely, that such a bank would do. Is it going to lend at rates keener than private sector banks? If so, that distorts the market. If the rates are the same, why bother? Despite the failings of the banking sector over the past three years, not all of us are convinced that more publicly owned banking is the long-term answer to Britain’s economic problems. After all, the crash itself, to a great extent, owed its origins to the misdoings of two American public institutions—Fannie Mae and Freddie Mac.
The committee believes that this report represents a reasonable and balanced contribution to the ongoing debate about an evolution of a public finance initiative and so we commend it to the House.
Lord Newby
My Lords, I commend the committee on this extremely interesting and timely report and my noble colleague Lord Vallance for his clear introduction to today’s debate. I was amazed, in reading the report, to see that, despite the amount of political discussion there has been on the subject, there has been no comprehensive review of PFPs by any parliamentary body for a decade. This report certainly helps fill that gap. I was also surprised, as the NAO pointed out, that there is no apparent robust and systematic evaluation of the use of private finance at either a project or programme level across government. So it is no wonder that it has proved so difficult to form a definitive view of the effectiveness of PFPs and no wonder that so much of the political debate on the subject has been so ill informed.
However, the report points out that PFPs have a better record of being produced on time and to budget than traditionally procured projects. For the period ahead, as we look to radically update our infrastructure, private finance is clearly going to play an even greater role. One has to accept at the start, as the noble Lord, Lord Lipsey, pointed out, quoting the NAO, that this model does not work for everything. In some areas where it has been tried—London Underground being one example—it has failed pretty spectacularly. In other areas, such as defence and IT projects, the basic underpinning concept does not work very well because you cannot, at the end of the day, transfer the risk so the Government end up bearing the risk. So there are clear limits to where this approach is the most appropriate.
However, in many areas it clearly has worked relatively effectively and, given that the estimate of the infrastructure expenditure we need over the next decade in the UK is £400 billion, we are clearly going to need to look to sources of funding beyond general taxation to meet the majority of that. I wanted this afternoon to concentrate on looking at the funding of future infrastructure projects in the UK. In some respects the UK should be relatively well placed to attract the funds. In a report produced and published yesterday by Berwin Leighton Paisner, 85 per cent of the experts on infrastructure it surveyed believed that the climate for global investment in infrastructure would improve over the years ahead, and that the UK was considered the most attractive location for delivering infrastructure projects anywhere in the world, but that the availability of funds would be a major constraint. Fifty-nine per cent of the respondents to that survey saw PFP as being important or very important in stimulating demand for infrastructure investment.
In the report, the committee looks at potential sources of funding for infrastructure investments and specifically refers to pension funds as an area of potential. It is interesting that at the moment UK pension funds lag behind in the proportion of their funds that go into infrastructure investment. In the UK, only 0.5 per cent of pension fund investment goes into infrastructure compared with 2 per cent in the Netherlands, between 4 and 5 per cent in Australia and as much as 10 per cent in Canada, so there is clearly considerable scope if the structures are right for greater pension fund involvement in this sector.
There are clearly significant amounts of overseas funding looking for a home in UK infrastructure. I understand that the Mayor of London’s office is regularly approached by potential investors, including sovereign wealth funds, that are looking to invest in infrastructure in London because they see it potentially as an extremely safe, long-term bet. Does the Minister believe that at present there is an effective way of capturing approaches that are coming in to the UK, to the mayor’s office, to central Government or elsewhere, from sovereign wealth funds and others that are looking to invest in infrastructure? At the moment, I am not sure who I would tell any such person to approach in government, and I do not know how successful we have been in converting such approaches into the hard cash that we need.
A further area that is cut out for infrastructure expenditure is the sukuk model of Islamic finance. An asset-based approach to finance could be developed very significantly here. Given that that sector is increasing by 20 per cent a year globally and that there are already very strong links and a very strong Islamic finance sector in the UK, that is a specific area that we could look at further.
The noble Lord, Lord Lipsey, referred to the national infrastructure bank. The report refers to the European Investment Bank, which is committing €1 billion a year to the UK. There is a wonderful quote in the report from Mr Simon Brooks who said that it would be ridiculous to introduce an investment bank in the UK. He said,
“nobody in Europe needs to introduce a NIB because they have got us!”.
We may have the European Investment Bank, but if the sum total of its potential in terms of the UK is €1 billion a year, it is clearly not going to fill the gap. I am a lot less sceptical than the noble Lord, Lord Lipsey, about the potential of the green investment bank because, as the Wigley report pointed out, there are a number of areas of market failure in the area of infrastructure investment which can be met only by new mechanisms of financing, and the green investment bank is potentially one of them.
The big question about a lot of this kind of expenditure is that it will take place only with some sort of government guarantee: underwriting, a cap of risk or some sharing of risk. The obvious example is that if we are going to build the high-speed rail link with private finance, investors are almost certainly going to need to be guaranteed a baseline level of revenue if they are to invest the billions of pounds that will be required. I welcome the Minister’s view on this. The role of government is hugely significant here, not just because many projects will not go ahead at all unless there is an element of government underwriting, but because the cost of financing the projects will fall to the extent that government accepts some of the risk. I was interested and intrigued by paragraph 3.16 of the National Infrastructure Plan, which came out last week:
“Reducing the cost of capital by reducing the level of risk transfer to the private sector has the potential to achieve considerable cost savings. A one per cent reduction in the cost of capital on a total infrastructure investment programme of £500 billion is worth £5 billion per annum”.
That is significant money, and the attitude of government towards accepting risk will therefore be crucial. Unfortunately, having made that immensely interesting comment, the National Infrastructure Plan gives no indication of whether the Government are therefore going to take their own advice, but risk is central to infrastructure expenditure more generally and to PFPs in particular.
There is great potential in infrastructure expenditure and investment in future using the model that is described in the report if the Government and the private sector can build on experience to date and look to more flexible and innovative ways of developing it in future.
Lord Tunnicliffe
My Lords, it is the lot of a Whip, whether a government Whip or an opposition Whip, that by the time a topic has cascaded down to one’s level, one usually finds oneself talking about a subject that one had not heard about 48 hours before. It is therefore a refreshing change, although it is perhaps going to be a painful one, to find myself talking about a subject in which I have had very considerable personal involvement. I shall declare my interests in PFI; I was managing director of London Underground and subsequently its chairman between 1988 and 2000, a period in which it was a leading player in PFIs. London Underground bought a fleet of Northern Line trains on PFI, handed over management of its power and communications systems, both telephone and radio, to the private sector, had a very successful ticketing programme, to which I shall return, and had the infamous London Underground PPP, of which I will admit to being the architect. I say that because it has been explained to me that success has many parents, whereas failure is an orphan, so there will be little contention of my claim to be the architect of the London Underground PPP.
I shall touch on the contributions of other Peers before I start. I thank the members of the committee for the work they have done on this report, and the noble Lord, Lord Vallance, for his presentation of it. I am very respectful of the report and greatly welcome its contribution. I thank the committee for finding the new term—PFP—which I shall try to use in future in this confusing terminology. I shall touch on a number of the points made by the noble Lord, Lord MacGregor, but we have a joint confession to make that during that period he was at one point my boss, so there is some coresponsibility in this Chamber. I thank the noble Lord, Lord Lipsey, for his quote from the NAO. It is probably a good summary of where we are on what we now call PFP. It is like the curate’s egg, but there is a lot of good in this egg as well as some problems. On banking issues, I would be trespassing on areas where I have no in-depth knowledge. The noble Lord, Lord Newby, brought up risk. I shall spend a little time on it. It is ill understood in the realm where PFPs happen.
The Opposition’s position on the report is in many ways the Government’s, in so much as it is contained in HL 114. I am sorry that the noble Lord, Lord MacGregor, found the Government’s response dismissive. I will concede that on some issues there should have been more reflection and more depth, but one is between a rock and a hard place in trying to get the response out quickly—we are grateful for the commendation—and responding in depth. Tonight is only the beginning of what will be a continuing debate on how the new Government will respond to the issues brought out in the report.
The first area that I would like to touch on, which is touched on gently in the report, is what I will call government pressure on public sector managers to use the private road for procurement. In the 1990s—I will limit myself to that time because I have no direct personal experience—the pressure at official level was not gentle, it was brutal. You were flatly faced with the fact that if you wanted your project, it had to be done the private way. I tried all I could to make sure that our submissions were honest and fair and balanced, but when you think of that pervasive pressure right the way through the system, it is not surprising that questions are asked as to whether the right public sector comparator was used, et cetera.
Treasury pressure is touched on in the report, but possibly the strongest paragraph is paragraph 61 in which the Government are asked to commit to not bringing institutional pressure on parts of the public sector to use private procurement. So, the first assurance I seek from the Minister is that best value for money will be the principal consideration when deciding whether to use a PFP procurement road. In responding to that question, I would like him to reflect upon the need for there to be practical public alternatives if that evaluation is to be made in an even-handed way.
All Governments fail to see—they say the words but they do not enact them—that investment in infrastructure is investment in what makes our country work. That is quite different from present consumption. The actuality of finding the money for investments from public sources is extremely difficult for a public sector manager; he is driven in this private direction. It was seen as almost the only way for investment to be brought into the business one was responsible for.
It is extremely easy to talk about risk at a theoretical level, but in the real world it is not like that. When you have big projects and you are in the public sector, you do not say “you take the risk” and that is the end of it. In practice, with a big project you are in what I describe as a deadly embrace. Yes, the survival of your supplier depends on your behaviour towards them, how you push risk and how you prosecute the route, but your ability to trade tomorrow depends on that supplier. The worst example in my professional career was not in private sector procurement; it was in the acquisition of 85 trains for the Central Line. That company threatened to go broke about a year and a half into the project. Our problems were so extreme and our options so few that we seriously considered buying the factory off the receiver and going into train manufacture. In the end we did a deal with one of the co-parents and paid the money for a parent company guarantee to see the project through.
It is a fact of life that in these big projects risk migrates to the party of substance, and that is the public sector. The real risk transfer is extremely modest. The value of private sector initiatives is the way in which small behaviours are incentivised to the public good. I will touch more on that later. For this reason I question the value of the off-balance sheet charades that we have played in this area. The report very much gets to the nub of this. I confess that my Government did not perhaps answer these questions in the required depth. This is brought out particularly in paragraphs 59 and 60. I would like the Minister to answer the challenges in those paragraphs with much greater clarity and much greater depth. Public/private finance capital is, frankly, part of the real balance sheet, and at least it must be exposed in a clear way so that we can see what has happened.
The rest of the report shows guarded support for PFI. I share that view. We have had good experiences. One of the worst things about having Her Majesty’s Government as your banker is that they are stunningly unreliable. They will promise you money one year—sometimes just before an election—and suddenly it is withdrawn the next year. The ability through the PPP to assure a partnership and funding is very much demonstrated by today’s Oyster card. That development is possible because of a long- term relationship. That programme started 25 years ago. It was translated into the private sector in the late 1990s and flourishes because the private sector has money to develop it and because the partnership works relatively well.
Whole-life costings work. When we acquired the Northern Line trains we discovered, largely because it took them a year and a half extra to build the damn things, that for the first time in all the time we bought electric trains—and we have been buying them for 100 years—the manufacturer suddenly discovered that he could make them more reliable and easier to maintain, which was not exactly surprising because the manufacturer was going to make all the money out of the deal by repairing them and maintaining them. It was a complete re-design. The concentration of whole-life costing was absolutely invaluable.
Finally, I come to my experience, in a sense. The Underground PPP was a ludicrous failure and so on and forth, but its failure was more complex than the report suggests. I put that down to two things. First, the special purpose vehicle—Metronet in particular—was a very unsatisfactory business structure. We really should have seen that. We were trading with an enterprise that was owned by its suppliers, and its suppliers were making their profits between them and the enterprise, not through a share of the profits of the enterprise. Whenever you bring a consortium together, you must make sure that the owners make their profits in the consortium, not in the supply arrangements. Secondly, the Treasury guarantees were probably reasonable in the circumstances, but the Treasury did not have the right tools of transparency so that it could monitor the risk of those guarantees being called in. The conclusion I draw from this is not that we should not do big complex private deals—they may, in fact, be the right vehicle—but that public sector teams of extremely high quality are necessary to do such deals.
I would like an assurance—the noble Lord, Lord MacGregor, touched on this—that if the Government contemplate such a deal in the future, they will first make sure that they have a team of the weight, the intellectual horsepower, the experience and the breadth necessary not just to look at the lines of the deal, as lawyers do, but to see behind the deal and address how people are going to behave with the various incentives. I ask the Government not necessarily to be deterred by the LU experience but to learn from it. I hope that the Minister will take account of that.
The one area in which, from my experience, I thought the report was weak—I have a slight difficulty with this, because I have nothing to add to it—is the problem of the preferred bidder. The complexity of PFP deals means that they take a long time to put together and are quite costly. The private sector has this device of saying, “You have to come to a preferred bidder status with someone, otherwise we cannot afford to continue”.
It is a real dilemma. The case for having a preferred bidder makes sense, but the problem is that the reality of having an alternative goes out the window. I do not know how, in future, the public sector will be able to establish value during the preferred bidder stage, but be able to find an escape route. But the report lets the process off lightly by not going more into the trap of the preferred bidder. I hope that the Government will think more on that whole issue.
In conclusion, I welcome the report, which gives valuable input to the debate. I would ask the Minister to respond to the report and to the emphasis that I have made. I encourage him to use the report—I think that the noble Lord, Lord MacGregor, touched on this—as source material in the training of public sector teams involved in this work. This very good document, which covers the past, can help people to learn the skills necessary to ensure that the public sector will get best value out of these schemes.
Lord Sassoon
My Lords, I thank the then members of the Economic Affairs Committee for preparing such a thorough report on the use of private finance to deliver public projects. I extend my gratitude to all those noble Lords, whose contributions to today’s debate I have found invaluable. I spend a lot of my time here answering for things that are not in my direct area of policy responsibility, but I am pleased that on this occasion there were not 50 Members of this House talking about such areas, many of which I know little about, but half a dozen valuable contributions on something on which I know a little. I was a director of Partnerships UK between 1992 and 1996. It is also a pleasure and a daunting challenge to follow one of the world’s great experts on PFI—the noble Lord, Lord Tunnicliffe—and to have this debate kicked off by my noble friend Lord Vallance of Tummel, with whom I worked in a small capacity a number of years back when he was taking one of our biggest pieces of national infrastructure, British Telecom, into the private sector.
At the outset, I should stress that it is clear that public/private partnerships will continue to play an important role in underpinning our country’s future infrastructure. The noble Lord, Lord Lipsey, reminded us how much has been done. A number of times we have been reminded that this effort has gone through several Administrations, which have now been led by the three main parties in this country. We share a commitment to learning the lessons and making such projects better but also to continuing with them, which is what the committee’s report suggests. The report highlights where private finance has brought valuable disciplines to infrastructure planning and implementation.
Many of the questions and comments today have reminded me that there are quite a number of challenges to improve the model going forward. I will do my best to answer a number of those questions now, but I will write on points that I fail to pick up or where, on reflection, I could have given a fuller answer.
I turn first to some of the balance sheet questions—I ask noble Lords to forgive me if I do not refer to them by name each time on points that they have raised—which were brought up by my noble friend Lord MacGregor of Pulham Market and the noble Lord, Lord Tunnicliffe. We are constrained here because we are bound by European accounting requirements that set the framework for how each project is recorded in the national accounts. However, I recognise that these requirements can make it difficult to get a clear picture of the public sector’s commitments, which is something that we must remedy. It is the Government’s policy to ensure that future liabilities are made obvious to the public and that complex financial instruments, such as PFI, should not hide the true cost of investments that the Government have made. Such practices are completely out of step with our strong transparency agenda but also risk the endorsement of projects that do not represent good value to the taxpayer.
For that reason, we have already taken action to bring greater transparency to PPPs. It has been a long time coming, but I can confidently say that next year we will publish, for the first time, whole of government accounts, which will be prepared according to international accounting standards. This will ensure that the vast majority of PFI transactions will appear on balance sheet. In future, we will also publish details of all new government contracts valued at more than £25,000, including PPP agreements. This will enable members of the public to assess the ongoing costs of long-term commitments, and will complement the existing reporting of PFI commitments disclosed on the Treasury’s website.
A second area of concern to us and to speakers in this debate has been funding for local government and government departments. There were questions around ring-fencing, bias and so on. Ring-fencing, in particular, meant that government departments and local authorities could use PFI as a means to increase their budgets, with potential for diverting funds away from more beneficial areas—those which offered greater value for money. In answer to the question asked by the noble Lord, Lord Tunnicliffe, I stress that, in this regard as well as in other dimensions, the Government absolutely want to do whatever they can to remove any bias over alternative ways of public procurement, including over public versus private financing. We have already taken action to address the particular problem of ring-fencing by removing the existing ring-fence and transferring financial responsibility for the grants back to the relevant government department. This will place all procurement options on a level playing field and ensure that merit rather than increased budgets determine which projects should go ahead.
That leads me on to the impact of PFPs on departments. In answer to my noble friend Lord MacGregor’s concern, we will continue to monitor all PFI contracts and information on the flow of payments under those contracts. Of course it is the case that, following the spending review, the budgets for departments will be constrained. Our initial analysis, which we did in conjunction with the spending review, suggests that this should not cause any department a significant problem. However, we will continue to monitor the level of commitments that are being made.
Some speakers have stressed the need for a national infrastructure bank, while others have questioned it and I think that my noble friend Lord Newby offered some mixed messages. My noble friend reminded us of the strong private sector appetite for investment in infrastructure and drew particular attention to sovereign wealth funds. Certainly, my discussions with sovereign wealth funds—both here and on a recent trip to the Gulf—and my discussions with long-term investors, insurance companies and others suggest that there is a strong, latent demand. I can assure my noble friend that we are taking new steps across government to make sure that we co-ordinate our contacts with sovereign wealth funds and with a range of the largest actual or prospective inward investors into the UK. His point is well taken. He challenged me to say whether this has translated into action yet. Of course, it is early days, but we are certainly starting with the co-ordination so that we can understand what investors want and channel their appetite—in so far as it is in the Government’s gift to do that—appropriately. When I was in the Gulf, I had a couple of discussions with Islamic finance specialist houses, particularly in Kuwait, so I am well aware of their possible involvement in this area.
Against that background, we have to be careful—the noble Lord, Lord Lipsey, drew attention to this—that Government-backed loans, if and when they are necessary, which is still open to question, do not increase the incentives for the private sector to deliver value for money by transferring risk away from the private provider to the public sector. We must ensure that there is no crowding out of private investors by the Government reducing competition and stepping in where there is not a market failure. For that reason, it is our policy for the Government to make loans only where they do not risk undermining the wider market, or where such loan or construction of a particular financial instrument helps to address a specific market failure. In that spirit, we will look to target the green investment bank—which will initially have £1 billion of government capital and the possibility of proceeds from government asset sales but will not have a mega balance sheet—on helping to relieve particularly challenging areas of risk on projects, particularly at the front end or where new technology is involved. We will come forward with the design of the green investment bank by spring 2011.
I turn briefly to the question of project failures and guarantees, which was raised several times. It is important to note that PPP, including PFI, critically allows us to transfer substantially more risks to our partners than conventional procurement. As has been said, we should not shy away from taking on challenging and complex projects. However, I absolutely take the point made by the noble Lord, Lord Tunnicliffe, that we need appropriate expertise in government when we come to such projects. At the moment, there is nothing on the scale and complexity of Metronet in the pipeline, but when we contemplate such projects, yes, we absolutely need the expertise. That is why it was absolutely right of the previous Government to centralise the expertise in Infrastructure UK as an infrastructure financing unit within the Treasury, especially given the particular circumstances of the past couple of years. My right honourable friend the Chancellor confirmed at the time of the Budget that Infrastructure UK remains central to how we take our efforts forward. That is the best answer that I can give to the question about expertise, which we recognise.
My noble friend Lord Newby picked up on a point in the national infrastructure plan about risk transfer and the possibility of reducing costs. I point him to one area discussed in the report, which is whether we can expand the use of the regulated asset-based model as a way of attributing risk in a different way and bringing down the cost of capital. That is very much work in hand.
On the question of preferred bidders, PPPs are now sufficiently complex contracts that they have to be procured under the so-called competitive dialogue procedure. This prohibits any discussion of the scope or cost of the contract with the preferred bidder and was designed to stop the so-called deal creep that has been seen in the past. The Treasury will publish a review of the competitive dialogue procedure—that addresses part of the point made by the noble Lord—later this month.
The committee's report also highlighted the value that private sector expertise and due diligence bring to PPP. In that context, one specific point that was drawn to our attention was bid costs. That issue has arisen again, particularly in the re-review of projects that we conducted following the election and ahead of the spending review. Although government policy remains that bid costs should not be paid unless in exceptional circumstances, the Treasury review of competitive dialogue—which, as I said, is scheduled for publication in November—will set out details of our review of policy in that area.
To wrap up, I emphasise that public/private partnerships, including PFI, will continue to make a valuable and important contribution to our future infrastructure needs. There are more than 670 signed PFI contracts, and the spending review confirmed further new projects, including three maintenance projects and the Nottingham tram extension. However, I think that we all agree that PPP should be used only where it offers real value for money. In pursuit of that objective, we have taken steps, as I have described, to improve how we assess those partnerships. We have removed the financial incentives that unfairly encouraged the use of PFI over other delivery structures. I mentioned the steps that we have taken to drive forward transparency. We have set out the broader challenges facing our infrastructure in the first national infrastructure plan, to which my noble friend Lord Newby drew attention.
In conclusion, the Government absolutely acknowledge the points raised in the Economic Affairs Committee report about both the benefits that private finance projects bring and the drawbacks of the current system. We will continue to look at options to improve the way PPPs perform, building on the work that we are already taking forward. In the current climate, there is a particular need to get the best possible deal for the taxpayer, and we are completely committed to that. I welcome the conclusion of the committee's report. I thank my noble friend Lord Vallance of Tummel and the other members of the committee for it. I absolutely take on board the valuable suggestion of the noble Lord, Lord Tunnicliffe, that it should be used as source material for training people in government.
Lord Vallance of Tummel
My Lords, PFPs clearly present a complex set of financing and procurement issues, and it is relatively easy for them to become politicised—although not, of course, in your Lordships' House. The very adjectives “public” and “private” can produce knee-jerk reactions—a point to which the noble Lord, Lord Lipsey, alluded. As someone who has spent half of his career in the public sector and half in the private, I know that neither has all the answers. What matters in public procurement is to keep learning the lessons of the past, to keep experimenting with new ideas and, critically, to build up real procurement expertise in the public sector—a point made strongly by the noble Lord, Lord Tunnicliffe, and acknowledged by the Minister.
I am very grateful to the Minister for his thoughtful and positive response to our committee's report, and trust that he will keep it high on his agenda.