Lords Committee reports on Private Finance Project liabilities

• Report: Private Finance Projects and Off Balance Sheet Debt
• House of Lords Economic Affairs Committee

With critics of PFPs often claiming that they are a device to place public sector spending 'off balance sheet', the Committee wants to see PFP spending accounted for more clearly. It recommends that the Government should publish figures for total PFP liabilities as a separate item alongside figures for public sector net debt.

The Committee calls for more monitoring and control of Private Finance Project (PFPs) commitments to ensure that contractual payments do not crowd out other departmental and local authority expenditure as overall public spending is constrained over the coming years.

The Committee believes that PFPs’ whole life approach to projects, in which the private contractor is responsible for long-term maintenance as well as construction, can have benefits and could be adopted more widely in public procurement.

The Committee also suggests that PFPs’ scope could be broadened to include the transfer of further risks to the private sector, including those of some mainstream services (for example, in the health and education sectors), rather than just ancillary services as at present.

The report also deals with the growth in the secondary market for PFPs where investors sell on their stake in a project, in many cases once the construction period of that project has been completed.

The Committee is concerned that the ability of construction companies to do this might negate one of the key advantages of PFPs over traditional procurement – that the developers have an ongoing responsibility for maintenance and are therefore motivated to use high quality materials and construction processes. The Committee calls on the National Audit Office to undertake detailed studies of the effects of secondary markets on the quality of PFP builds.

The Committee queried some aspects of the value for money tests public authorities are required to undertake when comparing estimates of costs for PFPs with traditional procurement. They are critical of the practice of adding an 'optimism bias', (a way of accounting for assumed unwarranted optimism in cost estimates under traditional procurement), solely to the Public Sector Comparator (PSC) and not PFP estimates.

The Committee points out that the projected costs of private finance projects may also be subject to optimism and that some of this may fall on the public sector. Adding the optimism bias costs solely to calculations of conventional public sector procurement tilts the balance unfairly in favour of PFI financing. The Committee recommend that an appropriate uplift for optimism bias should also be applied to the Net Present Value of the PFP option.

The report concludes that where PFPs are ‘efficient and value for money they should not need the support of any institutional bias in their favour’. Subject to the need to maintain control over public spending, public authorities should have greater freedom to choose the procurement route, PFP or another, which offers best value for money.

The Committee also considers whether any new source of debt finance is needed to provide loans to public organisations who may struggle to finance public sector procurement in a period of restricted credit, though they came to no conclusions on this one way or the other.

The Committee however asks the Government to consider the pros and cons of establishing a National Infrastructure Bank which would be able to borrow and lend money on Government terms.

Commenting Lord Vallance, Chairman of the House of Lords Economic Affairs Committee, said:

"The Private Finance Initiative has not been looked at in the round by a Parliamentary Committee for ten years. It clearly remains a controversial subject and we have found both strengths and weaknesses in its use when compared to traditional public sector procurement.

"The risk transfer Private Finance Projects provide has been beneficial in ensuring projects are completed on time and on budget. But experience has shown that PFP is not always well suited to very large and complex schemes and that value for money tests need to be improved.

"We recommend that the Government learns from these lessons of the past and, in addition, considers for the future where risk transfer to the private sector might be extended (for example in the health and education sectors). It should then draw up comprehensive new policy guidelines

"In the meantime, the Government must carefully monitor PFP contractual commitments to ensure they do not mean other spending priorities are sidelined at a time when public expenditure is constrained.

"Finally, PFP should not be used as a means of getting public sector debt 'off balance sheet'. We recommend that the Government should publish figures for PFP liabilities alongside figures for public sector net debt. This would help alleviate suspicions that PFPs are favoured because they misrepresent and underestimate the level of public sector indebtedness."