Contact: Andrew Smith Ext: 7826

Ian Howell Ext: 7540

With the concurrence of the Leader under section 100(B) (4) (b) of the Local Government Act 1972 this matter is included on the agenda to update the Cabinet on progress and issues associated with Public Private Partnerships (PPP) and the Private Finance Initiative (PFI).

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Contact: Andrew Smith Ext: 7826

Ian Howell Ext: 7540

1. Introduction

1.1 The purpose of the report is to update Cabinet on progress and issues surrounding Public Private Partnerships (PPP) and the Private Finance Initiative (PFI), review the comments of consultants and contractors involved in local discussions and to suggest where these initiatives could play a part in the procurement of County Council building projects. PFI as a procurement route has also been used as a vehicle to establish new partnerships in most areas of public service provision going well beyond specific construction projects. This paper concentrates on future capital projects.

1.2 The County Council has already embarked on a potential major PFI project for the South Hampshire Rapid Transit (SHRT) project at a cost of £190m. This would be one of the largest PFI projects in the Country. While Project Integra, involving capital investment of about £200m, predated the PFI initiative and is therefore not eligible for PFI credits in revenue terms, at a significant cost to the Council, it is one of the largest partnership projects in local government terms. The County Council has also built up partnerships on a range of the building projects and more recently for professional services to build further capacity to implement the capital programme. The County Council's experience in these areas is therefore significant and at the leading edge of much of what is being done around the country. Our `partnership working' is a central theme of our application for Beacon Status for construction activity.

2.0 Public Private Partnerships and the Private Finance Initiative

2.1 There is no agreed definition on what form Public Private Partnerships can take. Indeed the Government has encouraged councils to be innovative in how they use the private sector to provide services. In terms of partnerships the

following would be current examples of County Council partnership initiatives:


IT & e-government

· Seven year partnership with Unisys for the provision of a replacement voice and data network (£23m)


Building Maintenance

· the new five year term contract for building maintenance with four private sector companies at a value of £25m


New School Provision*

· the (recently completed) new school at John Hanson, Andover, designed and constructed on a partnership basis for £14m


Highways Maintenance*

· County-wide Highways Term Maintenance contact worth £200m

The Government's sponsored M4i Initiative and the LGA task force on procurement have recognised two of the *above as national demonstration projects, for wider application within local government. In each of the above the procurement arrangements differ but the contracts developed to meet the needs of the County Council.

2.2 Private Finance Initiative (PFI)

PFI is significantly different to the above partnerships in that under PFI the asset is provided (usually) by a consortium (often a bank, contractor and service provider) and made available to the Council through a long term contract - usually 25 years. In practice this device ensures that the asset is not on the balance sheet of the authority and it pays an "access or services charge" over the length of the agreement. In this case the risk of financing, designing, building and maintaining the asset is transferred to the consortium. The Government provides support for approved PFI projects as revenue grants over the life of the project by way of "PFI credits". For many authorities without access to capital receipts, normal credit approvals, revenue contributions or other credit arrangements, PFI may be the only way to access the level of Government support for the capital investment they need to improve their services. This may force them to set aside their concerns about the costs and other issues associated with very long term and somewhat inflexible agreements.

3.0 Opportunities for PFI

3.1 So far, for PFI, attention has focused on the potential opportunities that could exist in Social Services and Education.

3.2 Social Services

3.2.1 The Cabinet has been advised recently of the initiative being developed with the NHS and Social Services for nursing care capacity. Within that initiative there were proposals for several PFI funded nursing homes on NHS owned land to a value of £20 million.

3.2.2 The idea of developing PFI sponsored capacity on County Council land was considered but ruled out because of the Council's desire to directly manage this capacity and to leave its capital assets and land unencumbered by any long term contract. The proposal for the County Council sites would however be developed along the lines of a partnership model for key services in long term agreements. It is envisaged that a long term agreement between the NHS and the County Council would be required, particularly to safeguard the NHS who would in effect be giving to the County Council a capital grant to create the capacity, (interestingly, this in effect would be PFI in reverse with the risk transfer moving from the NHS to the County Council).

3.2.3 Should this initiative have failed then the question has been raised as to how the County Council would fund the refurbishment and repair of its elderly persons' homes. With restricted local resources and no credit approvals available, then it would more likely be most cost effective to dispose of a small number of sites to generate capital receipts and to reprovide the capacity on other sites. The risk and management would remain with the County Council. Beyond this example PFI may have a role to play should new capacity be needed in the future.

3.3 Education

3.3.1 Discussions have been on going with the County Education Officer as to how future pressures on the capital programme could be met from PFI. Three projects have emerged: a new EBD school in the South East (£2 million), the reorganisation of special school provision in the North East (£7 million) and the new secondary school at Popley (up to £20 million). In the case of the latter the current proposal recognises that a significant portion of the funding will come from a capital receipt, developers contribution and potentially Basingstoke and Deane Borough Council, leaving a (relatively small) residual amount to be financed from future receipts. Any PFI initiative would operate on the net costs after these contributions had been taken into account so this would probably not be a significant opportunity. Bearing in mind that the school will be the catalyst for the regeneration of the area and trigger very significant future capital receipts for the County Council then this too would suggest that direct control over timing and implementation by the County Council would be the strongest position, particularly in view of the local planning decisions that require to go in favour of the County Council/

3.3.2 The other two projects are relatively small in scale about, £10 million in total, but could be considered for PFI as part of a wider package. The issue to be resolved in this case is that both projects would be highly specialised in their brief and normally be subject to bespoke design solutions. This has the least best fit with PFI where the risk transfer arrangements establish outcomes rather than solutions. In the design of special schools care needs to be taken to develop a specific brief and ensure that the solutions are a good fit for teacher and child alike. Not impossible to overcome - but perhaps risky where the opportunity to adapt or change is not easily available at late stages in the projects. Consideration is being given as to how to overcome this point. It is probably at this point where a great deal of the PFI argument has attractions: if facilities are so poor in terms of function and standard that any measured improvement, if not ideal, has some appeal, and if there are no other options available, then PFI must seem attractive, provided the schemes meet the Government's priorities for allocating its PFI credits.

3.4 One further project requires mention. Proposals for the redevelopment of Ashburton Court and new office accommodation and library (Discovery Centre) in Winchester will be developed in the coming months. The potential scale of this opportunity would probably require external development finance and the risk to be shared with a developer or other consortium, depending upon the final decision and scale of the project, PFI, or other financing devices, may be appropriate.

4. The 4P's

4.1 The 4P's is the local government agency set up to help local authorities develop and deliver public private partnerships, including PFI schemes.

Following the presentation to Cabinet and the PRC meetings, discussions were held with the one of their advisers as to how the County Council was shaping up to this opportunity. The discussions were very helpful and further advice was provided on specifically how quality and improvements were being achieved in local authority projects given the early criticism of PFI projects. Discussion also took place about how well PFI would fit with a special school design. The 4P's were very complimentary about Hampshire's approach to its built estate and were aware of the ambition the County Council would have if it was to develop some of these initiatives. The 4P's would in fact be the adviser to the County Council before any submission to the government sponsored Project Review Group considered an outline Business case for any proposals.

5. Contractor Discussion

5.1 One of the County Council's partners in its procurement initiatives is a company called Hollandsche Beton Group (HBG), who have been part of a leading consortia in major PFI projects in the health and education sectors.

5.2 While no commitment could be given, the contractor was prepared to discuss their experience and from their knowledge of education projects, suggest how improvements to PFI could be developed. One interesting point, which is discussed further below was that they believed that one step further in improving PFI would be for the appropriate Council (s) to have some form of equity share in the consortia, hence always ensuring that the local authority had a long term position to influence events over a long term contract. One of the options under PFI includes joint ventures - but otherwise there may be conflicts with Local Government and Housing Act 1989 Part V restrictions on LA companies to be overcome.

6. Government Funding for PFI Projects

6.1 The Government has increased its provision for local authority PFI projects in the recent Spending Review 2002, as the table below shows.

		2002/03	2003/04	2004/05	2005/06
		Forecast	Allocation	Allocation	Allocation
		£m	£m	£m	£m
Schools		721	850	1,050	1,200
Transport		145	360	400	500
Housing		163	300	325	360
Waste Management		123	100	125	130
Police		122	75	100	110
Magistrates' Courts		31	70	70	70
Social Services		50	40	65	90
Fire		40	50	50	50
Culture and Sports		35	30	55	65
Transport in London		-	-	25	60
Other		58	65	65	65
		--------	--------	--------	--------
Total		1,488	1,940	2,330	2,700
		--------	--------	--------	--------
Year-on-year increase			+30.3%	+20.1%	+15.9%

6.2 This shows a significant increase in Government support for PFI of about 17% per annum in real terms (after inflation) over the SR2002 period. The Government has not yet published details of its non-PFI allocations for local government in SR2002 but it has said that the total provision including PFI will increase by 10.7% per annum in real terms. This implies that the allocation for PFI will grow much quicker than the non-PFI funding of credit approvals and grants.

6.3 This is therefore a major stream of Government support for local authorities' capital investment which should be explored by the County Council if it is to maximise the opportunities for improving its assets.

6.4 However, even at the increased levels of provision in SR2002, it is likely that demand from local authorities for PFI credits will outstrip supply. It will be necessary to tailor bids for PFI support to those projects that clearly address the Government's policy priorities as they are more likely to be successful. In practical terms developing a PFI based education project would be likely to get approval for 2004/05 at the earliest.

7. Value for Money

7.1 The Government argues that its prime motive for pursuing PFI procurement is that it provides better value for money for certain projects. It says that this overrides any concerns about keeping capital projects off the Government's balance sheet.

7.2 Value for money should also be the key issue for the County Council. Accessing additional Government support for PFI schemes is not, in itself, sufficient justification for adopting a PFI approach if the project offers poor value for money even after allowing for PFI credits. Viewed from a wider perspective of public spending as a whole, it could be argued further that PFI credits should not be taken into account in assessing whether a project is value for money: it should stand alone as value for money in its own right. But that narrower approach could deny the County Council access to the Government's significant pot of PFI support.

7.3 It is essential, however, that any potential PFI project is successful in attracting Government support towards the capital cost through PFI credits. Otherwise, a PFI or PPP project that fails to gain Government support would have to met from the County Council's existing capital resources in competition with traditionally procured projects. The Government has established conditions that schemes must meet to be eligible for such support and this may limit the scope for adopting more innovative partnering approaches. Project Integra is an example of a PPP approach that does not qualify for PFI support.

7.4 Value for money comparisons for PFI projects are far from straightforward and have been criticised by the National Audit Office as `pseudo-scientific mumbo-jumbo' that not even the experts really understand. The comparisons should include all costs of the project over its lifetime including preparatory work and take into account the risks associated with a long-term contract. They should also reflect the risks not transferred to the PFI contractor and retained instead by the local authority.

7.5 It can also be difficult for those involved from all sides - public and private - in developing a potential PFI project to retain a rigorous scrutiny of value for money issues as the project gathers momentum. The focus of those involved becomes increasingly diverted to making the proposal succeed come what may.

7.6 Some aspects of the value for money test applied prior to the approval of a PFI project are inevitably subjective. The real evidence of whether the local authority has received good value for the transfer of risk to the contractor will only emerge over the period of the contract.

8. A Planned Approach

8.1 PFI is often only considered when other options have failed. PFI projects need to be large enough to be worthwhile for both public and private sectors to invest in the significant preparation costs. That can require packages of schemes to be put together, but it is important that PFI projects should not cut across or queue-jump priorities already established through the Council's capital strategy and asset management plan processes.

9. PFI Procurement and Management Skills

9.1 PFI projects require specialist skills in procurement, legal and finance. There is a high risk of abortive costs if the bid for Government support is unsuccessful or the project fails to attract backing from the private sector. Rigorous sieving of potential projects is essential at an early stage before too much has been invested in their development.

9.2 Specialist skills also needed to manage PFI contracts. Almost 60% of public sector bodies with PFI schemes have had to make deductions from their annual payments to their PFI contractors for failure to deliver the required service, which suggests that many are not getting the service from PFI projects they would have expected. These are early days for PFI projects and a full picture of whether PFI projects have been a success will only emerge after 10 to 15 years and, again, when contracts have completed their full term. Only then will it be possible to judge whether the price paid to transfer risks to the private sector has been value for money.

10. Length of PFI Contracts

10.1 Concerns have been raised about whether local authorities have been committing themselves to overly rigid patterns of service delivery for long periods of 20 to 25 years, to make PFI contracts more attractive to bidders. It is difficult to predict service delivery requirements over that length of time. But that argument equally applies to traditionally procured capital schemes particularly those for specialist assets that may not readily marketable, such as a school. If such an asset turns out to have a shorter operational life than originally envisaged, there are abortive capital financing costs under the traditional option, though they are less transparent than under PFI. However, if an asset is redundant in the medium term, the absence of a long term contract allows the County Council to dispose of it.

10.2 Some have argued that it is telling that PFI is not widely adopted by private sector organisations for their own procurement. It would be too much of a straitjacket for them as their operational requirements will inevitably change over time. However, although the private sector may not have had to adopt aspects of the PFI package that are driven by the public procurement requirements, there are parallels in the private sector.

10.3 Councils adopting PFI need to keep a balance to the way that they procure their services so that not too much of the revenue budget is committed to long-term contracts. There are risks that too many large PFI projects could silt-up the revenue budgets of some councils or - at lower level - individual schools or establishments.

11. Accounting Standards and PFI

11.1 There has also been some concern that PFI accounting is all about smoke and mirrors to get projects off the public sector's balance sheet. The application of more rigorous accounting standards to PFI projects could depress the profits from projects by requiring more genuine transfer of risk, as evidenced by the recent falls in the stock market price of Amey, one of the major PFI contractors, who recently adjusted the presentation of their accounts in anticipation of new accounting standards. This may increase the cost of PFI projects to public sector bodies.

12. A Model for Hampshire

12.1 The issues surrounding PFI in the context of the County Council are not; let's do it or let's not do it. As a potential major source of funding for capital projects, it must provide an option in certain circumstance. For very large projects (the SHRT is an example) and especially where there is a potential income stream as far as the private sector is concerned, it is probably the only way a Council could embark on a successful funding strategy. One option that emerges is to consider a partnership approach, subject to meeting all the necessary PFI regulations, perhaps with two consortia, to develop `packages of work' as opportunities emerge. Because of the set up costs in PFI projects - even a £10 million project would be considered relatively small. Another approach could be to link together the NHS projects, if approved, and the two education projects mentioned above into one package and develop an outline business case.

12.2 Concentrating on large projects things might be achieved that otherwise just would not happen. In the Education sector many authorities have used PFI to deal with maintenance backlogs, upgradings of facilities and providing new capacity where it is coming to the end of its life. Arguably, Hampshire has maintained its assets in a more appropriate condition, been very successful at achieving credit approvals and grant allocations such as New Deal for Schools and led the field in major in/out and capital receipts. These funding options would have in practical terms been open to only a few authorities in the scale that Hampshire has operated on. Additional Government funding has also been set aside to enhance repair programmes. If the provisions in the new Local Government bill move to a more `prudential borrowing' approach this may open up further avenues, but would not provide any additional cost support, so in effect would be no different to underlying revenue contributions to capital over the medium term. This would suggest that any decisions on PFI should be (re) considered over time as opportunies arise. If it becomes the only `game in town' then it would provide a means by which projects could be developed. In anticipation of this eventuality it would be appropriate to develop Hampshire's approach to cover any new initiatives.

12.3 Any decision to undertake PFI projects should therefore consider:

· the availability of capital from receipts and revenue contributions

· the necessity of credit approvals being given towards the projects

· the level of revenue support (PFI credit) the scheme would receive from central government

· the alternative means of securing the same objectives (e.g. in/out schemes)

· the long term nature of the arrangement that is being entered into

12.4 Any PFI bid for revenue support would also have to meet specific national political and service objectives and demonstrate it represents best value for the resources concerned. Another approach that has relevance is to select projects where there is little likelihood of finding alternative means of funding the work. This could in the future be in relation to:

· buildings coming to the end of their life (for which there is no likely current government support)

· projects that cannot be funded by recycling assets (e.g. in/out schemes and capital receipts)

· projects for which there is no `national stream' for funding but that may mean that PFI credits are unlikely to be awarded by the Government

12.5 There could potentially be several secondary and primary schools that would come into this category over the next 2-3 years. Decisions in this area would almost definitely prompt consideration of reorganisations.

12.6 On the other hand, it could be argued that the most effective and economical use of resources requires not a `one size fits all approach' but the development of the relevant procurement route consistent with the opportunity and the objectives of the project. This argument suggests a more selective approach.

12.7 There is no doubt that the uncertainty of early PFI projects have been improved. Improved standard contract clauses and conditions, more competition in the market, better outcome based specifications, provide means upon which some of the earlier criticisms can be overcome. The loss of direct management and control over the outcome and subsequent levels of service, the risk of abortive preparation costs and the uncertainty of entering into a long term contract agreement remain relevant issues to consider, as does any provision relating to the transfer of staff where any long term service agreement operates.

Postscript

It should be noted that the DfES has recently suspended any further PFI bids pending a review of the bidding process, to make sure that PFI still contributes to the DfES latest priorities, especially transforming secondary school education. This is perhaps another factor as to why a special school bid would fail.

The current Education Bill is also encouraging schools to increase the use of partners for direct service provision. This takes the debate on from capital projects to a wider view of how services and staff are provided to schools.

The level of government support mentioned above will ensure that the PFI market remains. There are however unsettling signs that a number of the larger consortia are withdrawing because of the high bid preparation costs and delays in reaching contract.

Project Selection

Within this report several projects are mentioned:

· special school provisions: the north east of the County

· Ashburton Court redevelopment

· buildings coming to the end of their life

· opportunities with the NHS

Each of the above could be candidates. Packaging the work, hence creating a greater critical mass of work will probably create more commercial interest. In any event, if PFI becomes "the only game in town" then it would be important to position the County Council to maximise its benefits.

Recommendations:

i) that the Cabinet notes the report and continues to endorse PFI as an option


ii) that the next review of the capital programme (probably after the budget when specific capital allocations are known) consider what PFI options could be considered


iii) that the Director of Property, Business & Regulatory Services and County Treasurer consider how PFI could be used to facilitate the `Winchester redevelopments'


iv) that subject to the outcome of final decisions with the NHS, consideration be given to the development of a suitable package of PFI projects, in line with the review mentioned in (ii) above.

Section 100D - Local Government Act 1972 - Background Papers:

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.
Documents which disclose exempt or confidential information as defined in the Act.

File Location

None.

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