UK: "PF2" - A New Approach To Public Private Partnerships In England?

Last Updated: 31 December 2012
Article by Lillian Mackenzie

The Chancellor of the Exchequer's Autumn Statement, published on 5 December 2012, included the conclusions of the governmental review of PFI and their new proposals for delivering public and private sector partnerships. This new approach, called "PF2", is intended to replace the traditional PFI delivery model.

Although there are some key changes to note, the latest reforms are founded on the PFI model and could possibly be classed as another re-branding and re-packaging exercise, though this time, south of the border.

So, what has actually changed?

This briefing sets out some of the key changes to the traditional PFI model, introduced by PF2. The key themes can be summarised as follows:

  • Equity structure and credit enhancement
  • Acceleration of delivery
  • Service provision
  • More appropriate risk transfer
  • Greater transparency

Equity structure and credit enhancement

Through additional equity injection (in the form of both shares and sub-debt), PF2 aims to reduce the gearing for projects from the traditional 90:10 debt to equity ratio, to between 75:25 and 80:20.

Although equity is the most expensive form of finance, the driver behind this new approach is to achieve the investment-grade ratings required to address current market constraints and to secure finance from a wider source of long-term debt providers, including institutional investors such as life insurance providers. With long-term bank debt still only available from a minority, the Government is keen to avoid the budgetary uncertainty created by the public sector underpinning refinancing risk.

The public sector will now have the right to contribute equity at minority shareholder levels (anticipated to be around 30-49% of the overall equity requirements). The Government hopes that the introduction of public sector investment will strengthen partnerships between the public and private sectors, as well as mitigate the cost of increasing the overall equity requirements.

It is anticipated that public sector equity will be priced at a market rate and will be invested on essentially the same terms as the private sector. However, there will be a number of matters (called Reserved Matters) which cannot be carried out without the consent of each class of shareholder (e.g. approval of dividends, and increasing debt). The procuring authority will not inject any equity into the project but is intended to have observer status at board meetings. This concept is not entirely new in the market and many sponsor directors will have experience of working with authority observers.

One development which could certainly be described as new is the Government's intention to introduce a further tranche of 'third party' equity to sit alongside public sector equity and developer equity. It is anticipated that this tranche of equity will be introduced through a funding competition on a portion of private sector equity at preferred bidder stage. It is not currently clear what "portion" this will comprise and what consequences this might have for the sponsors taking the risk on bid costs. The Government's justifications for funding competitions are:

  • to provide a transparent market price for the project equity;
  • to widen access to different types of investor, with the likes of pension funds having historically been deterred from getting involved in projects at early stages due to lack of resource and high bid costs; and
  • to reduce the number and size of secondary market transactions, which have historically attracted criticism because of excessive financial gains achieved by sponsors.

Acceleration of delivery

Possibly one of the biggest criticisms of PFI has been procurement costs and delays, hence the Government's commitment to ensuring PF2 procurement is faster and cheaper than its predecessor. The Government intends to achieve this by:

  • improving the public sector's procurement capability by strengthening the mandate of Infrastructure UK and supporting departmental centralised procurement units;
  • streamlining procurement by introducing a standardised procurement protocol and a comprehensive suite of procurement documentation, albeit this is not an entirely new concept;
  • limiting the competitive tendering phase of PF2 projects to 18 months, unless exceptional circumstances are agreed by the Chief Secretary;
  • requiring authorities to give due consideration to their design requirements to ensure they are appropriate and reduce the amount of design carried out in competition. For example, in respect of a batch of schools put out to procurement, bidders will be asked to produce a design for a secondary and primary school and explain how these designs could be replicated across all the schools in the batch; and
  • strengthening scrutiny of PF2 project preparation by introducing additional Treasury checks in the business case approval process, to ensure projects have undertaken a sufficient level of project preparation prior to OJEU.

The new standard documentation will include:

  • new draft guidance titled Standardisation of PF2 Contracts (which follows the same format as SOPC with required and recommended drafting);
  • a standard facilities management output specification for PF2 accommodation projects;
  • a standard payment mechanism for PF2 accommodation projects; and
  • new PF2 Lean Sourcing procurement guidance.

Service provision

In order to improve the flexibility of service provision, the range of services included in PF2 projects will be reduced. As has happened under NPD in Scotland, soft services, such as cleaning, catering portering, laundry, security, mail and waste have been removed from the scope of contracts (other than where, by exception, there are integration benefits).

Again in a similar vein to the Scottish model, procuring authorities will also now have discretion over the inclusion of certain minor maintenance activities, such as re-decoration of the interior, replacement of floor coverings, replacement of lighting consumables, mini washroom repairs and graffiti removal.

There will be certain "elective" services defined at the outset (such as snow clearance and window cleaning) at a pre-agreed prices, so that they can be added or removed without the need to re-run the model.

The approach to lifecycle has also changed, meaning there will now be:

  • an open book approach to lifecycle costs; and
  • a gain share mechanism for surplus lifecycle provision to ensure that any surplus lifecycle funding is shared with the public sector at the end of the contract.

There will also now be periodic efficiency reviews of the service provision, with any savings being shared between the authority and the contractor: 75% of savings going to the authority and 25% to the contractor.

More appropriate risk transfer

Some changes have also been made to the traditional risk allocation model, albeit some of the changes are not necessarily new to those familiar with the NPD model in Scotland. The effect of the changes is to place a greater retention of risk with the public sector, where doing so will offer value for money. For example:

  • the risk of additional capital expenditure arising from an unforeseeable general change in law during the operational phase will be taken by the public sector;
  • utilities consumption risk will be taken by the public sector, subject to a two-year handover test (the contractor will retain responsibility for the efficiency of the design of the building);
  • the risk of the site being contaminated by offsite sources will be taken by the public sector where it has provided the site;
  • procuring authorities will be required to undertake adequate investigations into legal title for
  • sites made available to bidders, and provide a warranty to the contractor;
  • where the procuring authority provides the site for the project, the authority will also be required to procure ground condition surveys and make them available to all bidders, with the benefit of a warranty; and
  • the procuring authority will take a bigger share of insurance premium risk, and reduce the contractor's need to build up reserves against market movements.

Greater transparency

The Government is also aiming to introduce a number of measures to increase transparency. These include:

  • publishing an annual report detailing full project and financial information on all projects where the Government is a shareholder;
  • introducing a business case approval tracker on the Treasury website;
  • publishing information on future PF2 projects and the infrastructure and construction pipeline;
  • ensuring that failure to provide information forms part of the service and will constitute poor performance, resulting in financial deductions, with the possibility of contract termination for persistent breach; and
  • the contractor being required to provide a contract summary following signature, to aid public sector contract management.

What's next?

One of the first projects to be procured under the new PF2 will be the £1.75 billion privately financed element of the Priority Schools Building Programme, which will act as a pilot for the scheme. In the health sector, Sandwell and West Birmingham Hospitals NHS Trust is working with the Department of Health to assess the suitability of PF2, and roads and MOD projects have also been quoted as potential candidates. It is not yet clear what other projects the Government has lined up for PF2, or when these might appear. However, an Infrastructure Procurement Routemap is to be issued for consultation in January 2013.

One final note on the reforms. You will see we headed this Briefing "A new approach to public private partnerships in England?" The Scottish Futures Trust have confirmed the Scottish NPD model will remain unchanged by the recent publications.

© MacRoberts 2012

Disclaimer

The material contained in this article is of the nature of general comment only and does not give advice on any particular matter. Recipients should not act on the basis of the information in this e-update without taking appropriate professional advice upon their own particular circumstances.

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