What next for the PFI?

The private finance initiative's 'special status' has all but been abolished by the comprehensive spending review and it will now have to compete with other sources of government funding. Will it still appeal, wonders Paul Jarvis
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Birmingham's first new hospital for 70 years was built by the Private Finance Initiative

The comprehensive spending review has effectively abolished the use of PFI credits in future public building projects, but the announcement could have even greater implications for existing deals.

A single line in the review quietly but fundamentally changed the relationship between local councils and PFI funding.

"The government is … transferring responsibility for the revenue costs of local government Private Finance Initiative (PFI) projects from local government to the sponsoring department," it said, "to remove perverse incentives for projects to be delivered through PFI."

In essence, this ends the ring-fencing of PFI credits, which had previously been handed to local authorities from the Treasury, outside of the relevant department's budget. For future deals, it will make it a far less attractive option for councils.

One source close to government insists PFI "remains a valid procurement route", but it will now be competing on a level playing field with other sources of government funding. "It won't have the special place it did under previous administrations," he adds.

Criticisms of PFI

In part, it might be good to place some limitations on PFI. "It's going back to first principles in a sense," explains Dickinson Dees lawyer Tim Care. "One of the criticisms of PFI was the way it was devolved out and delivered in thousands of different ways by thousands of different authorities."

Jamie Kerr, of developer John Laing, says he's yet to see a significant flight from PFI among councils. He suggests central government financing will remain the first port of call for most public bodies, whether that be in the form of PFI credits or some other arrangement. "I think [councils] will always see if they can get some money from central government," he says.

Nevertheless, alternative funding routes are being sought. "Generally, the approach has been negative towards PFI from this government," says Ken Jones, strategic housing adviser at London's Barking and Dagenham council. "Local authorities have got to consider other ways to take things forward in partnership."

That might mean using more innovative methods, such as joint ventures where the public sector puts in the land, while the developer brings private cash to get new projects off the ground. And it might mean more borrowing by local authorities – through new approaches like tax increment financing.

But if the impact on future projects is fairly clear-cut, the way ahead for existing PFI projects is far less certain.

Laughlan Waterston, from bank SMBC, suggests funders might be pleased to see the burden of paying the annual unitary charges given to central government departments. "From a credit point of view, to see central government as the counter-party is probably better," he explains. "At least then you're dealing with central government and not an arm of government."

Operational side

On the operational side, though, there's concern the move will create a disconnect between the user of the building (for example, the hospital trust) and the body paying for that structure. Tony Reeves, chief executive of Bradford metropolitan district council, warns the change could cause some confusion. "It would need a complex, tri-partite legal arrangement," he says. "That will cause added complexity to contracts, which are already pretty intricate."

There is also the threat councils will not be interested in squeezing out the best value from PFI contracts, because it's no longer their money. But Clare McConnell, of lawyers Stephenson Harwood, argues the coalition government's localism agenda will force councils to take an active role.

"I would think, because of the competing agenda to empower local authorities, it would be very difficult for [them] to abdicate responsibility."

One serious problem central government may now face is funding the so-called affordability gap. For a number of reasons, PFI projects often end up costing more to the public purse than central government has allocated in credits – something the local council has always had to plug in the past.

As the government seeks to cut spending, this could provide an opportunity to clamp down on the private sector, using the collective bargaining power of central government to pressurise firms into renegotiating and reducing the cost of PFI contracts.

It won't make happy reading for the private sector – apart from the lawyers tasked with renegotiating the contracts – but the change may be a way to squeeze out even more value on existing PFI deals.

Paul Jarvis is editor of Partnerships Bulletin

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