Private Finance Initiative

David Mowat Excerpts

Thursday 23rd June 2011 Westminster Hall

[Andrea Leadsom]

I am sure that, privately, you might be interested Mrs Main, but thank you for keeping me in order.

What you—[Hon. Members: “One!”]—or rather not you, Mrs Main, but an LEA wanting to build a school, would need would be to have the entire specification for the school for the subsequent 25 years up front. That is clearly impossible, and the banks make their money by charging enormous arrangement fees and ongoing charges as schools change their requirements. That is how the money continues to come in from those projects.

[David Mowat (Warrington South) (Con)]

The point that I believe is at issue is procurement failure. To take the example of the hockey pitch, if it is built 2 feet too short, that is a procurement failure. It is not necessarily a specification issue—there are such words as “fit for purpose”. The real issue with all the stuff we are talking about is that the public sector is incapable of procuring projects of such complexity. That is what happens, and that is why so much money is made in change requests. It is not principally to do with financing.

[Andrea Leadsom]

My hon. Friend makes a good point, and many of the problems arising from PFI have happened because the private sector saw the public sector coming. There have been all sorts of issues with poor public procurement, and where two PCTs in neighbouring counties have both commissioned a hospital, one has not learned the lessons of the other. Everyone comes at the thing afresh, and they all have the same problems and run into the same weaknesses. Nevertheless, there is an inherent lack of flexibility built into the projects, which cannot be overcome. It is therefore incredibly important to consider that the PFI on its own, even if it were the cheapest option, and even though it does not at the moment have an impact on our national debt picture, has an inherent weakness in its structure.

The other massive weakness in the structure, which has been exacerbated since the financial crisis, is the cost. As my hon. Friend the Member for Hereford and South Herefordshire said, the reality now, with Government gilts at about 3% to 4% long term, is that direct Government procurement would be much cheaper than a bank trying to fund a project itself over five to 25 years and make a profit, where the net cost to the taxpayer ends up at 8% or 9%. There is an enormous difference between the costs of direct procurement and PFI procurement. That is exacerbated by the financial crisis, and makes things almost unaffordable. We must begin to look at alternatives.

I want to float an idea that I have been trying to put to Ministers—and will be doing in the near future. That is the possibility that the green investment bank could provide some necessary competition to the PFI market. As I said earlier, there is a serious lack of competition. The Treasury Committee heard from PFI providers that often they bid only for perhaps one in three deals. Since there are only six or seven major PFI providers, that means there are probably only two, or at most three, serious bidders for any deal; that suggests an enormous lack of competition.

However, we are now thinking about the green investment bank—a brand new idea for this country, whose time has come. That bank will be looking to fund many of the low-carbon, high-tech and potentially economic infrastructure projects of the future, such as offshore wind farms—I shall not talk about railways, but others might; hon. Members will appreciate my personal sensitivity there. Offshore wind farms, roads and all the rest require long-term financing. That is a big challenge, and the green investment bank could address it.

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[Anne Marie Morris]

I agree. My argument is that that is part of the problem, rather than the totality of the problem. My second request is that we find a way of delivering transparency and better management of the contracts. One hospital was charged £333 to change a light bulb. I dare say that that changes the hospital’s decision about whether it will change many light bulbs. One school was charged £300 just to install an electrical socket. How many times will the school install a socket on that basis? One Army official was charged £103 for a 1-inch Land Rover screw that actually cost just over £2. That is not the right way of doing things.

[David Mowat]

The three examples that my hon. Friend has cited are powerful, but they represent procurement failures by the public sector procurement people involved and structural failures in the nature of the contract, because the contract did not have to specify, for example, exactly how light bulbs would be maintained. We have examples of multiple procurement failures. PFI is being used as a proxy for that. Those procurement failures can happen with any technique or contract.

[Anne Marie Morris]

My hon. Friend makes a valid point, which is why the issue is far more complicated than a rebate.

The risk is overestimated. Projects are not monitored, partly because there is no transparency. As has been said, the size of the debt has been hidden because it is off balance sheet. If we looked at the real national debt figure, then rather than £910 billion, we would probably be looking at £1.12 trillion.

I can perhaps best illustrate the distortion in the way in which public services are used by explaining what is happening in my constituency. There is a wonderful new build hospital in Newton Abbot. It was the winner of the 2007 HealthInvestor PFI deal of the year award. But what has happened? In that hospital, we are finding considerable underuse of facilities. Beds and consulting rooms are not being used as they might be. Why? The reason, as I understand it from individuals who have come to me to raise this concern, is that it is just too expensive to use those facilities rather than the cheaper facilities in neighbouring hospitals. I am pleased to say that the primary care trust has taken the matter up and is considering how better use of the facilities at Newton Abbot hospital can be made. However, it is an example of how behaviour can be changed.

The challenge, therefore, is not only to get the cost down. Reference has been made to what the Government are already doing. I am pleased that we have a PFI hit squad, which has already taken £4 billion out of the project list. I am minded to look very favourably on the concept of a rebate, but as I said, a rebate will not be enough. There are two aspects to trying to sort out the financial mess. One is the issue of maintenance. Clearly, there are ways of reducing maintenance costs under the contracts, and whatever saving comes out of any renegotiation needs to be shared with the taxpayer and the local community. The second aspect is the payback rates. We have heard many examples of the payback rates in this context being well above the payback rates for similar risks in the market. Those two issues need to be considered.

To return to where I started, one issue that we need to consider is the impact on what happens in other parts of Government. We need to consider our health care reforms, because many of the PFI contracts are currently held by the primary care trusts. Those PCTs will cease to exist in the not-too-distant future. As and when we see their demise, what will happen to those contracts? Is that an opportunity or a threat? That is a serious issue, which my right hon. Friend the Secretary of State for Health will need to consider in conjunction with the Treasury. We have heard about the examples of schools and the challenges for some of negotiating academy status because of existing PFI contracts. To conclude, this is a complex issue. It is not something that the Treasury can deal with alone. Some joined-up thinking needs to be applied to it across a number of Departments.

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[Neil Carmichael]

I thank my hon. Friend for that. I do not like any mistakes; I do not like small ones, but I especially dislike big ones. We need a system that allows fewer of both, but particularly large ones.

[David Mowat]

It is about accountability and procurement. Much of what has been said this afternoon is about procurement failures rather than the failure of the PFI technique. I do not agree that people cannot be held to account for big procurement errors. Many organisations succeed in holding others to account, but the Government do not. I would be interested to know whether people in any of the procuring organisations involved in these awful contracts have been held to account—how many jobs have been lost and how many promotions have been missed—but my guess is not many on either count.

[Neil Carmichael]

I think that you are absolutely right if you agree with me that we need more accountability in the procurement and specification systems.

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[Mark Garnier (Wyre Forest) (Con)]

It is a great pleasure to speak under one’s chairmanship, Mrs Main. [Laughter.] I also add my name to the chorus of congratulations for my near neighbour and hon. Friend the Member for Hereford and South Herefordshire (Jesse Norman), who has not only secured this debate but worked so hard on the thorny issue of the PFI. His work includes his PFI rebate campaign, which I have enthusiastically signed up to. He has also managed to secure a Treasury Committee investigation into the future of PFI. It is good to see that four members of the Select Committee have come along this afternoon.

The PFI does not directly affect my constituency—there is only a magistrates court there under a PFI contract. However, it indirectly affects my constituents because they are served by the Worcestershire Royal hospital. Famously, Kidderminster hospital was downscaled to help pay for it. When my constituents hear that we have overspent on those contracts to the tune of half a billion pounds, they will be rightly even more furious than they were when the Government wound down Kidderminster hospital.

The PFI is something that we all love to hate. It has come to signify the inability of the public sector to write proper contracts and it is a symbol of trying to hide capital investments on the country’s balance sheet. However, is that a fair summary of what is a reasonably legitimate way of financing part of the supply side of the economy? I have certainly argued in the past that the public sector will always negotiate bad contracts for the simple reason that there is an asymmetry in negotiating skills. I am certainly not here to criticise the knowledge of public sector employees in terms of how to go about writing a contract. However, when it comes to a contract between the public sector and the private sector, we have, on one side of the table, a well-read and well-intentioned civil servant who is doing his best and possibly looking forward to his retirement, while on the other side we have a hardened businessman who is motivated by profit and return on equity and quite probably incentivised by direct equity in his business and a bonus for concessions won. A civil servant will certainly be very well educated in negotiating, but the hardened PFI negotiator from the private sector will have the concept of return on equity, risk evaluation and profitability etched into his DNA. There is no doubt that there is plenty of money to be made out of PFI for the astute negotiator.

Dexter Whitfield, director of the European services strategy unit, in his submission to the recent Treasury Committee investigation, highlighted the profitability of PFI equity sales—that is where a PFI contract is sold and the profit made is in addition to the profit that is gained on an ongoing basis. He pointed out that although there is little readily available information on PFI sales, the ESSU database holds 63 transactions covering 154 PFI projects, and he has looked at how much they have made. Average equity profit has been 50.6% on the 63 transactions. What is interesting is how they fare by sector. Health has been given a profit of 66%, housing 80% and leisure 86%. However, the truly eye-watering winner by miles goes to the defence sector, which has been giving PFI providers a whopping 134% profit on their equity sales. The Treasury Committee inquiry was lucky enough to have a representative from the PFI industry, one of the directors of Balfour Beatty, and he was surprisingly evasive in his reply to my questions, implying that that profit may have included the annual premium returns and therefore was not a fair judgment. But my interpretation is that PFI providers that have sold their investments have already made an annual return on the projects—that is perfectly reasonable, given the way that the projects are structured—but that the sale profit is in addition to that annual return.

What does that mean in terms of the contracts that have been negotiated? It seems that the valuation of risk, which is a key part of a contract, has been miscalculated in favour of the provider and it is that premium, in favour of the provider, that gives the opportunity for the sizeable equity sale profit. Indeed, the fact that there is someone out there to buy the equity stake with their own measure of risk and expectation of return means that there is still more to be made by the subsequent buyer, implying even further mispricing of risk.

That is the point. PFI projects do two things: first, they provide a so-called off-balance sheet way of financing a vital piece of investment; and secondly, they devolve the risk element of any project to the private sector. But the private sector will evaluate that risk and charge for it, and the evidence put forward by Mr Whitfield suggests that the PFI provider is making a great deal of that opportunity.

[David Mowat]

I have been listening very closely this afternoon to the points that have been made about the super-profits, the 180% margins and all the rest of it. I have also tried to hear the names of the companies that are making those profits and the only two that I have heard are Balfour Beatty and Bovis. My understanding is that neither of those organisations has a particularly high return on capital employed. So I am a little bit mystified as to where the money is going and I genuinely would like somebody to help me with that point.

[Mark Garnier]

I thank my hon. Friend for that intervention—what a perfect opportunity for me to do so. These are the profits of equity sales by the companies concerned: 41% for Carillion; 59.1% for John Laing; 53.9% for Interserve; 78% for Lend Lease Corporation, so well done to that company; 42.9% for Costain Group; 20% for Serco Group, which was perhaps not the best investment for someone’s money; 71% for Balfour Beatty; and 59% for Kajima Partnership.

[David Mowat]

What are those numbers?

[Mark Garnier]

Those are the equity sale profits. So those companies are PFI providers who have then sold their contracts, and those figures are the profits they have made. Just to be fair, the figure was 56.3% for Kier Group. Those are pretty sizeable returns.

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[David Mowat (Warrington South) (Con)]

I thank my hon. Friend the Member for North East Cambridgeshire (Stephen Barclay) for shortening his speech to let me in—I hope it was worth it. Along with other hon. Members, I commend the hon. Member for Hereford and South Herefordshire (Jesse Norman) for his important initiative.

It seems to me that the PFI is a procurement technique that has been used over the past decade or so—perhaps for longer. Like any technique, it can be used wisely or poorly. There are certain instances, when a project has certain characteristics, when it is probably a good technique to use—for example, when there is a significant construction phase that is difficult. The private sector is able to do that, and we want to transfer the risk. I heard about the Edinburgh tram system on the radio this morning. That system is an appalling failure, and I do not think that it is a PFI project. PFI is a technique that also works when trying to minimise life-cycle costs, because there are some advantages in looking at the overall operability of a scheme as well as its construction.

The technique works best when the procurement contract is written in such a way that, over its period, it properly aligns the profits of the contractor with the interests of the client, and that is where contracts have gone wrong so frequently. It is a technique that also works best when the market is reasonably deep, so that value for money is achievable, and some of the points about how weak the market is are right. The PFI technique also works when there is reasonable certainty as to the nature of the contract that is needed, which is to say that multiple changes will not be made over a 20 or 30-year period. Again, one issue is that, in certain instances, we have been locked into hospital contracts, which, as health care changes come through, we are unable to alter.

Those reasons are why the PFI technique may be valid. There are instances, however, where we should not use PFI, and the overall reason why it has been a bad thing is that it has the characteristic of off-balance-sheet finance. It is a way of constructing a load of activity and projects without putting it on the public debt. I am sorry to say that—without being too political—the previous Government built many schools and hospitals in that way, and, frankly, those schools and hospitals will be paid for over a long time. That is a poor thing.

PFI also does not work if there are asymmetric negotiating skills, and we have heard much about that this afternoon. Unfortunately, that is the case in the example that my hon. Friend the Member for Wyre Forest (Mark Garnier) gave about the contractor’s interest and expertise. All that is true. It strikes me that the issue is also one of accountability. In an earlier intervention, I made the point that I see no accountability in public sector procurement, which is disappointing.

The consequence of all that is that we get the multiple messes that have been mentioned. I was interested in the example that was given by my hon. Friend the Member for Nuneaton (Mr Jones) of a hospital that is under pressure because work has had to be transferred to a PFI hospital, because exactly the same thing is happening to Warrington hospital due to a large PFI hospital being built just up the road and needing patients to satisfy the contract. That is an example of terrible failure.

I am delighted that the review of contracts is going on, but I want to raise several points that I do not fully understand. We have to be careful about opening up contracts that have been entered into in good faith, and we must be careful about bandying about profit figures. In my previous life, I had some contracts where I made a lot of profit, and I had some where I made so much loss that it could not be counted. It is only reasonable that all such activity is looked at in the round, so we must be careful. Regarding the list of organisations that was read out earlier, I reiterate that, as far as I am aware, none of those companies is making excessive profits in terms of return on capital employed or share price. We need to think through what is happening between the extraordinary profits that everyone is talking about and the fact that those publicly quoted organisations do not seem to making them.

It is worth trying to get some of the money back in the same way that the Cabinet Office has been doing for large consultancy and IT projects. However, what carrot are we giving to such people, who in many instances entered into contracts in good faith? From their point of view, they have carried out the contracts to the best of their ability. In the case of the Cabinet Office initiative, the bribe being used is the threat of not getting further contracts unless they play this game. That is a valid thing, and the directors, who have a fiduciary responsibility to their shareholders, can go back to their boards and say that they have a choice to make: they can either knock some money off or do no more work for the Government. That is their choice. In our discussions in this area, we must enable ourselves to create that choice for such organisations. I am not sure that characterising them all as money-grabbing private sector rogues is necessarily the way forward. I have heard a bit of that this afternoon.

I shall sit down now but, before I do, I again congratulate my hon. Friend the Member for Hereford and South Herefordshire (Jesse Norman) on initiating the debate. The issue is very important and could have significant impacts on all our communities.