The private finance initiative (PFI) was a United Kingdom government procurement policy aimed at creating "public–private partnerships" (PPPs) where private firms are contracted to complete and manage public projects. Initially launched in 1992 by Prime Minister John Major, and expanded considerably by the Blair government, PFI is part of the wider programme of privatisation and macroeconomic public policy, and presented as a means for increasing accountability and efficiency for public spending.
PFI is controversial in the UK. In 2003, the National Audit Office felt that it provided good value for money overall; according to critics, PFI has been used simply to place a great amount of debt "off-balance-sheet". In 2011, the parliamentary Treasury Select Committee recommended:
In October 2018, the Chancellor Philip Hammond announced that the UK government would no longer use PFI for new infrastructure projects; however, PFI projects would continue to operate for some time to come.
Overview
thumb|right|[[Cumberland Infirmary, one of the first projects funded using the PFI]]
The private finance initiative (PFI) is a procurement method which uses private sector investment in order to deliver public sector infrastructure and/or services according to a specification defined by the public sector. It is owned by a number of private sector investors, usually including a construction company and a service provider, and often a bank as well. During the period of the contract the consortium will provide certain services, which were previously provided by the public sector. The consortium is paid for the work over the course of the contract on a "no service no fee" performance basis.
The public authority will design an "output specification" which is a document setting out what the consortium is expected to achieve. If the consortium fails to meet any of the agreed standards it should lose an element of its payment until standards improve. If standards do not improve after an agreed period, the public sector authority is usually entitled to terminate the contract, compensate the consortium where appropriate, and take ownership of the project.
Termination procedures are highly complex, as most projects are not able to secure private financing without assurances that the debt financing of the project will be repaid in the case of termination. In most termination cases the public sector is required to repay the debt and take ownership of the project. In practice, termination is considered a last resort only.
Whether public interest is at all protected by a particular PFI contract is highly dependent on how well or badly the contract was written and the determination (or not) and capacity of the contracting authority to enforce it. Many steps have been taken over the years to standardise the form of PFI contracts to ensure public interests are better protected.
Structure of providers
The typical PFI provider is organized into three parts or legal entities: a holding company (called "Topco") which is the same as the SPV mentioned above, a capital equipment or infrastructure provision company (called "Capco"), and a services or operating company (called "Opco"). The main contract is between the public sector authority and the Topco. Requirements then 'flow down' from the Topco to the Capco and Opco via secondary contracts. Further requirements then flow down to subcontractors, again with contracts to match. Often the main subcontractors are companies with the same shareholders as the Topco.
Method of funding
Prior to the 2008 financial crisis, large PFI projects were funded through the sale of bonds and/or senior debt. Since the crisis, funding by senior debt has become more common. Smaller PFI projects – the majority by number – have typically always been funded directly by banks in the form of senior debt. Senior debt is generally slightly more expensive than bonds, which the banks would argue is due to their more accurate understanding of the credit-worthiness of PFI deals – they may consider that monoline providers underestimate the risk, especially during the construction stage, and hence can offer a better price than the banks are willing to.
Refinancing of PFI deals is common. Once construction is complete, the risk profile of a project can be lower, so cheaper debt can be obtained. This refinancing might in the future be done via bonds – the construction stage is financed using bank debt, and then bonds for the much longer period of operation.
The banks who fund PFI projects are repaid by the consortium from the money received from the government during the lifespan of the contract. From the point of view of the private sector, PFI borrowing is considered low risk because public sector authorities are very unlikely to default. Indeed, under IMF rules, national governments are not permitted to go bankrupt (although this is sometimes ignored, as when Argentina 'restructured' its foreign debt). Repayment depends entirely on the ability of the consortium to deliver the services in accordance with the output specified in the contract.
Under guidance issued prior to the reform proposals initiated in December 2011, public sector partners were permitted to contribute up to 30% of the construction costs as a capital contribution, generally handed over at the end of the construction period and subject to appropriate risk transfer and performance regimes being in place. The government indicated in its reform consultation that allowance for higher levels of capital contribution was being considered, noting the some international practice also offered examples of higher levels of capital contribution.
Insurance
PFI contracts generally allocate risks to the private sector contractor, who takes out appropriate insurance to cover these risks and includes anticipated insurance costs in its PFI charges. However, it has been recognised that levels of insurance premium are variable following cyclical economic changes, and difficult to predict over the lifetime of a PFI project. PFI terms were amended in 2002 and standardised in 2006 to allow for insurance cost sharing mechanisms, whereby the client and contractor could share the risk of market fluctuation in insurance premium costs.
History
Development
PFI was implemented in the UK by the Conservative Government led by John Major in 1992. It was introduced against the backdrop of the Maastricht Treaty which provided for European Economic and Monetary Union (EMU). To participate in EMU, EU member states were required to keep public debt below a certain threshold, and PFI was a mechanism to take debt off the government balance sheet and so meet the Maastricht convergence criteria. PFI immediately proved controversial, and was attacked by Labour critics such as the Shadow Chief Secretary to the Treasury Harriet Harman, who said that PFI was really a back-door form of privatisation (House of Commons, 7 December 1993), and the future Chancellor of the Exchequer, Alistair Darling, warned that "apparent savings now could be countered by the formidable commitment on revenue expenditure in years to come".
Initially, the private sector was unenthusiastic about PFI, and the public sector was opposed to its implementation. In 1993, the Chancellor of the Exchequer described its progress as "disappointingly slow". To help promote and implement the policy, he created the Private Finance Office within the Treasury, with a Private Finance Panel headed by Alastair Morton. These institutions were staffed with people linked with the City of London, and accountancy and consultancy firms who had a vested interest in the success of PFI. The largest of the early PFI projects was Pathway, announced by Peter Lilley in 1995, which was to automate the handling of benefit payments at post offices.
Two months after Tony Blair's Labour Party took office, the Health Secretary, Alan Milburn, announced that "when there is a limited amount of public-sector capital available, as there is, it's PFI or bust". resulting in criticism from many trade unions, elements of the Labour Party, the Scottish National Party (SNP), and the Green Party, as well as commentators such as George Monbiot. Proponents of the PFI include the World Bank, the IMF and the Confederation of British Industry.
Both Conservative and Labour governments sought to justify PFI on the practical grounds that the private sector is better at delivering services than the public sector. This position has been supported by the UK National Audit Office with regard to certain projects. However, critics claim that many uses of PFI are ideological rather than practical; Dr. Allyson Pollock recalls a meeting with the then Chancellor of the Exchequer Gordon Brown who could not provide a rationale for PFI other than to "declare repeatedly that the public sector is bad at management, and that only the private sector is efficient and can manage services well."
thumb|Sign on the door of Central Manchester University Hospitals NHS Foundation Trust
To better promote PFI, the Labour government appointed Malcolm Bates to chair the efforts to review the policy with a number of Arthur Andersen staffers. They recommended the creation of a Treasury Task Force (TTF) to train public servants into PFI practice and to coordinate the implementation of PFI. In 1998, the TTF was renamed to "Partnership UK" (PUK) and sold 51% of its share to the private sector. PUK was then chaired by Sir Derek Higgs, director of Prudential Insurance and chairman of British Land plc. These changes meant that the government transferred the responsibility of managing PFI to a corporation closely related with the owners, financiers, consultants, and subcontractors that stood to benefit from this policy. This created a strong appearance of conflict of interest. In 2005/2006 the Labour Government introduced Building Schools for the Future, a scheme introduced for improving the infrastructure of Britain's schools. Of the £2.2 billion funding that the Labour government committed to BSF, £1.2 billion (55.5%) was to be covered by PFI credits. Some local authorities were persuaded to accept Academies in order to secure BSF funding in their area.
In 2003 the Labour Government used public-private partnership (PPP) schemes for the privatisation of London Underground's infrastructure and rolling stock. The two private companies created under the PPP, Metronet and Tube Lines were later taken into public ownership.
By October 2007 the total capital value of PFI contracts signed throughout the UK was £68bn, over the life of the contracts. The 2008 financial crisis presented PFI with difficulties because many sources of private capital had dried up. Nevertheless, PFI remained the UK government's preferred method for public sector procurement under Labour. In January 2009 the Labour Secretary of State for Health, Alan Johnson, reaffirmed this commitment with regard to the health sector, stating that "PFIs have always been the NHS’s 'plan A' for building new hospitals … There was never a 'plan B'". However, because of banks' unwillingness to lend money for PFI projects, the UK government now had to fund the so-called 'private' finance initiative itself. In March 2009 it was announced that the Treasury would lend £2bn of public money to private firms building schools and other projects under PFI. Labour's Chief Secretary to the Treasury, Yvette Cooper, claimed the loans should ensure that projects worth £13bn – including waste treatment projects, environmental schemes and schools – would not be delayed or cancelled. She also promised that the loans would be temporary and would be repaid at a commercial rate. But, at the time, Vince Cable of the Liberal Democrats, subsequently Secretary of State for Business in the coalition, argued in favour of traditional public financing structures instead of propping up PFI with public money:
thumb|right|The Skye Bridge
While it is a catchy term, it is unclear what "value-for-money" means in practice and technical detail. A Scottish auditor once called it "technocratic mumbo-jumbo". A number of PFI projects have cost considerably more than originally anticipated. The duplication of design costs when each bidder in the latter stages of project procurement is preparing its own design was the subject of some criticism: the Royal Institute of British Architects (RIBA) put forward a model known as "Smart PFI" in 2005, under which a traditionally appointed design team would prepare "example plans" which would be finalised and costed by PFI bidders.
More recent reports indicate that PFI represents poor value for money. A treasury select committee stated that 'PFI was no more efficient than other forms of borrowing and it was "illusory" that it shielded the taxpayer from risk'.
One key criticism of PFI, when it comes to value for money, is the lack of transparency surrounding individual projects. This means that independent attempts, such as that by the Association for Consultancy and Engineering, to assess PFI data across government departments have been able to find significant variations in the costs to the taxpayer.
Tax
Some PFI deals have also been associated with tax avoidance, including a deal to sell properties belonging to the UK government's own tax authority. The House of Commons Public Accounts Committee criticised HM Revenue and Customs over the PFI STEPS deal to sell about 600 properties to a company called Mapeley, based in the tax haven of Bermuda. The committee said it was "a very serious blow indeed" for the government's own tax-collecting services to have entered into the contract with Mapeley, whom they described as "tax avoiders". Conservative MP Edward Leigh said there were "significant weaknesses" in the way the contract was negotiated. The government agencies had failed to clarify Mapeley's tax plans until a late stage in the negotiations. Leigh said: "It is incredible that the Inland Revenue, of all departments, did not, during contract negotiations, find out more about Mapeley's structure".
Complexity
Critics claim that the complexity of many PFI projects is a barrier to accountability. For example, a report by the Trade Union UNISON entitled "What is Wrong with PFI in Schools?" says:
Malcolm Trobe, the President of the Association of School and College Leaders has said that the idea that contracting out the school building process via PFI would free up head teachers to concentrate on education has turned out to be a myth. In many cases it has in fact increased the workload on already stretched staff.
Waste
A BBC Radio 4 investigation into PFI noted the case of Balmoral High School in Northern Ireland which cost £17m to build in 2002. In 2007 the decision was made to close the school because of lack of pupils. But the PFI contract is due to run for another 20 years, so the taxpayer will be paying millions of pounds for an unused facility.
With regard to hospitals, Prof. Nick Bosanquet of Imperial College London has argued that the government commissioned some PFI hospitals without a proper understanding of their costs, resulting in a number of hospitals which are too expensive to be used. He said: