ࡱ> Root EntryFiles\Common Files\Microsoft Shared\Textco F`_hToоWindWordDocumentH Files\Microsoft Shared\Textconv\WPFZRFTDCA, RFT-DCA, C:\Program Filee FilCompObjd\Textconv\RFTDCA32.CNV, rftnMSWorksWin3Windows , C:\ProgramjosofSummaryInformationpHLH(iGT"G  4%&'()*+,-G/95678>:;<=F?@.HIJKOPRSRoot EntryFiles\Common Files\Microsoft Shared\Textco F`_hToоWindWordDocumentH Files\Microsoft Shared\Textconv\WPFZRFTDCA, RFT-DCA, C:\Program Filetg FilCompObjd\Textconv\RFTDCA32.CNV, rftnMSWorksWin3Windows , C:\ProgramjosofSummaryInformationpHLH(iGT"G  4!#$0/9123A5678>:;<=F?@.BCDEL"MNQTUVG@RHA(A(A>AHA(@(@(@(A(A(A(ASHA(@(@(@(@(@41Times New Roman Symbol &Arial"h0bƏbFLb 14 iX!$LPFI - A Risk Too FarPreferred CustomerPreferred Customerܥhc e(tg'0lPOOOOOOQBPlQQQQQQf1QQ(RRRRRR{R}R}R}R=RTTUfX(gL VORRRRR V4ROORQܥhc e(e'0lNPOPOPOPOPOQOlQQQQ2QQd1HQHQ(pQpQpQpQpQpQQQQQ=RS:U,eXeLXUPOpQpQpQpQpQXUQPOPOpQHQQQQpQPOpQPOpQQ eξdOxO"POPOPOPOpQQQGQPFI - A Risk Too Far It is often stated that risk transfer, from the public sector to the private sector, is at the heart of PFI. In this article, we argue that sloppy thinking about why risks might be transferred to the private sector, and what risks she under the second principle. It has also meant that PFI schemes tend to be developed as large individual projects, qualifying on the first principle on the basis of a few risk elements within the package, but without considering whether appropriate risk transfer under the second principle has actually been achieved for each of the individual components of theproject. In other words, the way the risk transfer principles have been interpreted has tended to result in large individual PFI projects, incorporating potentially inappropriate risk transfers. A classic example of such a project is the Royal Infirmary of Edinburgh scheme. The contract for this 180 million project for the replacement of one of Edinburghs main hospitals was signed in 199 . According to the Business Plan the total risk transferred to the private sector was estimated at 50 million, of which no less than 46 million represented interest rate risk. We have argued above that interest rate risk is a completely inappropriate form of risk to be transferred to the private sector. The amount of non-interest rate risk transferred under this project, at 10 million seems small for a project of this magnitude. There are a number of other adverse consequences of the types of large PFI project which typify the governments current interpretation of the risk transfer principles: paradoxically, the very existence of a large PFI project tends to defeat the basic intention to transfer risk to the private sector. Ultimately, with large projects, the risk rests with the public sector, or with the service recipient - usually the public. This is because the potential costs to the public sector, in terms of the consequences of disruption to service provision, are usually much more severe than the potential financial cost to the private sector, if a large project were to fail. As an example of this, witness the recent bail out of the public private partnership air traffic control system. large PFI contracts weaken the operation of a competitive market. This is because large contracts can only be undertakern by large firms or organisations: hence, such contracts will typically attract bids from a very small number of large firms or consortia. The small number of bidders in itself weakens the competitive process and reduces the chances of obtaining value for money. It also opens up the danger that bidders might choose to operate as a cartel. it is also difficult for the public sector, when dealing with the kind of large and very experienced bidders who are attracted to significant PFI projects, to avoid sub optimal aspects being negotiated into the original contract. This can result in either modifications of the project specification, designed to suit the bider rather than recipient of the service: or in the incorporation of deals, for example in the disposal of surplus land, which may be vet favourable to the bidder. It is estimated, for example, by Allyson Pollock, that the arrangements for the disposal of land incorporated in the Royal Infirmary for Edinburgh were worth about x million to the successful consortium. finally, because all these factors including the transfer of inappropriate risk, increase the cost of large PFI deals, they can commonly only be made affordable by reducing the basic specification of the service to be provided. It is commonly claimed, for example, that a typical PFI hospital project involves something like an x% reduction in the provision of bed spaces. Is there a solution to all of these problems: the answer is surely yes - and it is to do with better unbundling of PFI projects into smaller constituent projects, where the risk transfer in each contract is firmly rooted in the second principle outlined above. Unbundling provides a potential solution to each of the identified problems. First of all, it means that only risks which the private sector is demonstrably better at handling need be transferred. Second, it is much easier with smaller contracts, either to take the activity back into the public sector, or to transfer it to aor Windows 95@n@p{4@@Sh@JϾ14 ՜.+,0HPt|  Dell Computer Corporation@ PFI - A Risk Too Far FMicrosoft Word Document MSWordDocWord.Document.69qOh+'0 ,8 ` l x PFI - A Risk Too FarAPreferred CustomerDdNormalPreferred Customer13Microsoft Word fould be transferred, is indeed at the heart of a number of the major weaknesses of PFI schemes as implemented to date. We also argue that greater clarity on these issues offers the potential for radical improvement in the operation of PFI. There are two basic principles which underlie the operation of risk transfer in PFI. A primary consideration when PFI was introduced by the Conservatives, at a time of considerable public sector constraint, was to remove the acquisition of capital assets off the governments balance sheet: that is, out of the PSBR. The acid test here relates to risk: has sufficient risk been transferred to the private sector. If there is a limited transfer of risk, then, under the governments accounting standards, the transaction should be regarded as a disguised form of borrowing, and hence should score against the PSBR. Hence the first principle relating to risk transfer and PFI: namely, is there sufficient risk transfer to ensure that the public sector is not simply acquiring a capital asset which needs to be shown on its balance sheet. The second principle of risk transfer in PFI relates to value for money: it states that risks should be allocated between the public and p[rivate sectors to the party best able to manage them to ensure best value for money. It is, perhaps, slightly odd that this second principle is expressed in terms of risk at all: after all, why not just state that functions should be delivered by the private or public sectors depending on which is better able to deliver value for money. Clouding the statement in terms of risk could be seen as an attempt to cloud the issue of the most appropriate division between the sectors of the surplus which potentially arises if the private sector is able to deliver more cheaply. Leaving this quibble aside, however, the idea that risks should be transferred to the sector best able to manage them seems unexceptionable. It is also quite clear that, in terms of this principle, certain types of risk should never be transferred from the ublic sector to the private sector. There is no point in transferring to the private sector any risk which the private sector can do nothing about: in this case, such a transfer cannot be value for money, since it merely involves the public sector paying a premium to the private sector over and above the unaltered cost of the original risk. In particular, since the private sector can only borrow at a premium relative tothe public sector, there is no pont in transferring interest rrate risk to the private sector under the second principle. The problem with the way PFI has been implemented in Britain is that these two principles of risk transfer have not been clearly enough distinguished: and the requirements of the first principle have in practice tended to be dominant. This has led to a situation where the emphasis has been on claiming a sufficient quantum of risk transfer within a given scheme to satisfy the first principle, without considering whether the nature of the risks transferred is appropriat4R4R4RROROR{RToо P P"OOOOR{R4RG4RPFI - A Risk Too Far It is often stated that risk transfer, from the public sector to the private sector, is at the heart of PFI. In this article, we argue that sloppy thinking about why risks might be transferred to the private sector, and what risks should be transferred, is indeed at the heart of a number of the major weaknesses of PFI schemes as implemented to date. We also argue that greater clarity on these issues offers the potential for radical improvement in the operation of PFI. There are two basic principles which underlie the operation of risk transfer in PFI. A primary consideration when PFI was introduced by the Conservatives, at a time of considerable public sector constraint, was to remove the acquisition of capital assets off the governments balance sheet: that is, out of the PSBR. The acid test here relates to risk: has sufficient risk been transferred to the private sector. If there is a limited transfer of risk, then, under the governments accounting standards, the transaction should be regarded as a disguised form of borrowing, and hence should score against the PSBR. Hence the first principle relating to risk transfer and PFI: namely, is there sufficient risk transfer to ensure that the public sector is not simply acquiring a capital asset which needs to be shown on its balance sheet. The second principle of risk transfer in PFI relates to value for money: it states that risks should be allocated between the public and p[rivate sectors to the party best able to manage them to ensure best value for money. It is, perhaps, slightly odd that this second principle is expressed in terms of risk at all: after all, why not just state that functions should be delivered by the private or public sectors depending on which is better able to deliver value for money. Clouding the statement in terms of risk could be seen as an attempt to cloud the issue of the most appropriate division between the sectors of the surplus which potentially arises if the private sector is able to deliver more cheaply. Leaving this quibble aside, however, the idea that risks should be transferred to the sector best able to manage them seems unexceptionable. It is also quite clear that, in terms of this principle, certain types of risk should never be transferred from the ublic sector to the private sector. There is no point in transferring to the private sector any risk which the private sector can do nothing about: in this case, such a transfer cannot be value for money, since it merely involves the public sector paying a premium to the private sector over and above the unaltered cost of the original risk. In particular, since the private sector can only borrow at a premium relative tothe public sector, there is no pont in transferring interest rrate risk to the priva 9r )@ Page Number 3 Jim CuthbertMargaret Cuthbert 26th February 2002 However, i, to get projects off the governments books,bundle together a number of different components, for example design, build, and facilities management, to form large individual projects. Such projectsThe drive towards large PFI projects itself leads to Large contracts, bundling together design and build with an operational stream, also tend to be long contracts, commonly lasting for 30 years. There may in prac!DocumentSummaryInformation8 te sector under the second principle. The problem with the way PFI has been implemented in Britain is that these two principles of risk transfer have not been clearly enough distinguished: and the requirements of the first principle have in practice tended to be dominant. This has led to a situation where the emphasis has been on claiming a sufficient quantum of risk transfer within a given scheme to satisfy the first principle, without considering whether the nature of the risks transferred is appropriat9r )@ Page Number 3 Jim CuthbertMargaret Cuthbert 26th February 2002 However, i, to get projects off the governments books,bundle together a number of different components, for example design, build, and facilities management, to form large individual projects. Such projectsThe drive towards large PFI projects itself leads to Large contracts, bundling together design and build with an operational stream, also tend to be long contracts, commonly lasting for 30 years. There may in prac!%@&@'@(@,@-@4@E@F@H@J@K@Z@c@d@@@@@@@@@@@A)A-AHAQARASA]A^AjAAAAAAAAAAAADDDDDDDDDDEEE*E+E,E4E9E:EEEEEEEF8FBFRFFFFFFFFFF4G5G6G[G\G]GGGGGGGGVuhUPa`K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Numbertice be insufficient flexibility in the specification of such contracts to cater for the changing demand for services through time. complexthese These adverse consequences have tended in practice to far outweigh the claimed benefits of bundled projects - namely, that such projects would enable sufficient synergy between design and operation,%@&@'@(@,@-@4@E@F@H@J@K@Z@c@d@@@@@@@@@@@A)A-AHAQARASA]A^AjAAAAAAAAAAAADDDDDDDDDDEEE*E+E,E4E9E:EEEEEEEF8FBFRFFFFFFFFFF4G5G6G[G\G]GGGGGGGGVuhUPa`K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Numbertice be insufficient flexibility in the specification of such contracts to cater for the changing demand for services through time. complexthese These adverse consequences have tended in practice to far outweigh the claimed benefits of bundled projects - namely, that such projects would enable sufficient synergy between design and operation, and also encourage the development of innovative solutions for service provision. In fact, examination of PFI schemes to date suggests that such synergies have not been achieved. We suggest that there is a solution via the mechanism of unbundling, facilitated by the establishment of public service trusts. Pollock, Shaoul, Rowland and Player, Public Services and the Private Sector: A Response to the IPPR, November, 2001. Building Better Public Partnerships, Institute of Public Policy Research, 2001. 43 .A 33 ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1GGGGGGGGGGGHHHHHHHuPaV(@F@Y@Z@^A:EF5G6GHHz z z z z z z z  4!  4 K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page NumberK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Number'H!!! P'j#56IJK=>R S fu]^Qu"%%''''z z z z z z z z z z  z z  z z z z z z z z z {z z `z z z z z  z z  z z z z z  4%@GH!%((@H& !!''GPreferred Customer1C:\My Documents\PFI\PFI A Risk too far 230202.doc@HP DeskJet 870C SeriesLPT1:HPRDJC03HP DeskJet 870C SeriesHP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,HP DeskJet 870C Series7 d,,K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page NumberK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Number A fundamental part of both of these objectives relates to the idea of transfer of risk from the public sector to the private sector. In this article, we argue that confusion about risk transfer is responsible for major weaknesses in PFI schemes: greatewr clarity on risk transfer offers the potential On reading the governments published explanations of the PFI process, it is clear that t out of the governments borrowing requirement.U, ifis the assets do not count against the governments borrowing requirement:ifonly so the assets do count against the governments borrowing requirementT is, therefore, that must bep 1K@Normala c and also encourage the development of innovative solutions for service provision. In fact, examination of PFI schemes to date suggests that such synergies have not been achieved. We suggest that there is a solution via the mechanism of unbundling, facilitated by the establishment of public service trusts. Pollock, Shaoul, Rowland and Player, Public Services and the Private Sector: A Response to the IPPR, November, 2001. Building Better Public Partnerships, Institute of Public Policy Research, 2001. 43 .A 33fks, leAs a result,becomes, or indeed public sector, 3 ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1GGGGGGGGGGGHHHHHHHH!H"H#H$H%H&H(H1H8HRHSHTHuPaV(@F@Y@Z@^A:EF5G6GHH#HSHz z z z z z z z z  4!  4 nother private sector provider, in the event of failure. Hence the risk transfer to the private sector is genuine. Thirdly, with smaller contracts there is likely to be genuine market, with more potential suppliers, including smaller local firms: this has the added advantage of potentially providing greater help to the local economy. Fourthly, it is much easier for the public sector to maintain control of the overall project specification. Finally, the greater value for money achievable should ensure that there is less pressure for reduction in the level of service provided. There are, however, two potential problems with going down this unbundling route. Will the capital expenditure in the unbundled projects indeed be off the books as regards the governments borrowing requirement, and are local public sector agencies sufficiently expert to successfully co-ordinate the large number of unbundled contracts which would be involved in the building and running of, say, a hospital. In fact, the first of these problems is something of a red herring. With the improvement in the public finances over the last five years, there has been little requirement to get capital expenditure off the government's books. Further, changes in accounting standards, and in particular, the introduction of xxx, mean that conventional PFI schemes are anyway likely to come back on to the governments books. In other words, it appears that PFI has latterly been driven by another agenda than the requirement to get capital expenditure out of the PSBR. As regards the second problem, there is a potential solution in the creation of specialised not-for-profit trusts. Such a trust, for example, might be responsible for the design, build, and operation of a number of hospitals across Scotland. As a specialist agency with a national scale of operation, such a trust would have the ex[ertise to unbundle each individual hospital project into constituent components, which it would then let to private sector contractors. This solution, of the creation of public sector trusts was originally proposed by the SNP. But it is interesting that the recent IPPR report recommended the creation of similar vehicles in certain circumstances. .A PAGE  PAGE 1 Successive governments have had two main objectives in promoting PFI: first, to keep capital expenditure out of the governments borrowing requirement, and secondly, claiming that PFI will produce a significant improvement in value for money."A@"Default Paragraph Font @ Footer 9r )@ Page Number This principle in itself In terms of this principle, tnot handle any more cheaplyi, . In fact, the expression of thisis not particularly helpful.A clearer statement would be to require Phrasing the principle diverts attention from an important issue: that is, how should any surplus arising from private sector involvement be divided between the private and public sectors. 1!! .AA major in the implementation of PFIthe aboveamountPFI project, that is, ensuring value for money 8652, d,such dealsAs noted in Pollock et al, the first 14 PFI hospitals involved bed reductions averaging 33% from the outline business case stage.value for money aby the Accountancy Standards Board of amendments to accounting standard FRS5governments borrowing requirement of managing many smaller contracts,pservice, by the Institute of Public Policy ResearchHP DeskJet 870C Seri44444444444455+585B5t5555556!6=6F6L6W6z6{6|6~6666666667777k7u7v7777777:::::;;;;;;;;<<<<(<*<s<z<|<}<~<<<<<I=K===W>>>>>>>>{?|?%@ uDPuPa`K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Numbernot for profit trusts to handle certain public/private partnership schemes 3 .AK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Numberwithin large complex PFI projects, there is a danger that land deals and other issues can be swept up, without their financial and operational aspects being given the due attention that they deserve. 3 .AK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Numbergreater After ten years of PFI, the controversy still rages about whether or not PFI gives value for money, and whether it should be extended into further areas of public sector provision. (((((((((((((((((((( ))))&)2)O)l)m))))P1u1w112!262=2k2~22222222222223 3 3 3 3333>3?3@3A3V3W3Y3^3w3333333333333m4v44444444444PaP uDPuU_67    '(./T=G"H"##&&((z z  z z z z z z z z  4!  4!((((((((((2234444445::<<J=K=>{?%@'@(@z z z z z z z z z  z z ` z z z z !  4`% 4K@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page NumberK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page NumberK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Number'H!   9'#56IJK*+; < Op^EF9i!'%(%''''z z z z z z z z z z  z z  z z z z z z z z z z {z `z z z z z  z z  z z z z z  4%@GTH!%((@SH& !!##''GPreferred Customer1C:\My Documents\PFI\PFI A Risk too far 230202.doc@HP DeskJet 870C SeriesLPT1:HPRDJC03HP DeskJet 870C SeriesHP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,####  U : 4 <"#4568:;JKgklv =bd#*4;Wj<`klmn()@BCw  "#:CDWe have argued here that there has been confusion on the risk transfer process, and that this has largely contributed to some of the more controversial features of past PFI schemes. 33 .AK@Normala c"A@"Default Paragraph Font @ Footer 9r )@ Page Number 3K@Normala c"A@"Default Paragraph Font @ Footer HP DeskJet 870C SeriesLPT1 ,,''''  U : 4 L"#4568:;JKgklv =bd#*4;Wj+-Os~'1;<SUV&56MVWY\krs> ? 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" ) * ` 9 H P < = -/QR&'(2M`B~opq| %-.01eh RY[\]^IUb&+7=>bc:E&546Q !!!!":"g#h###3$:$A$B$$$$$%%&%(%%%4&}&&&&&&&&'''9':';'`'a'd'e'p'x'y'z''''''''''''''''''''''''''''''A@&@@'@A(@A,@A-@@A4@@@E@AF@AH@AJ@@K@@A(A )A)A)A)A&)A2)AO)Al)Am)A)A)AP1Au1Aw1A1A2A!2A62A=2AB=AO2Ak2A@~2@2A2A2A2A2A2A2AA2AAA2AHA2A2A2A2AHA3A.A3AA 3A 3A 3AVA 3AkA3A33AA4A) A4A A A A4A A A4A Ak A4A A4@&A6A,A!6AYA=6ArAd@A@A@A@AAF6AkAL6AAW6AA@A@A@A@A@A@A@AAAsA~Az6@jA{6AA|6A[A~6A~@A)AA-AAHAAQAARAASAA@RA%A6A6AfAFA@]AA^AAjAAAAAAAAAAAAAAAAAAAAAADADADADADADADADADADAEAEAEA*EA+E@A,EAA4EA@2A;A;A;A;A;A;A;A;A<A<A<A<A(<A*<As<Az<A|<A}<@~<A=A6A_A6AA6A6A6A7>3A?3A@3AA3AV3AAW3AAY3AAA^3Aw3A3A3A3AVA3A_A3A3A3AA3@AAl4Am4Av4A4Ay AZ@Ac@A4A4A4A4A4A) A4A4A A A A4A A A4A Ak A4A A4@&A6A,A!6AYA=6ArAd@A@A@A@A@@9EA:EAEAEAEAEAEAEAFA8FABFARFAF@F@A7@A7A @ A7A%Ak7Au7Av7@&A7A1&A7A_'A7A(A7A(Am(A7As(A:A(@I=AK=A=A=AW>A>AFAFAFAFAFAFAF@4G@5GA6GA[GA\GA]GAGAGAGAGAGAGAGAGAGAG@:AGAGAGAGAGAG@HA(A(A>AHA(@(@(@(A(A(A(AHA(@(@(@(@(@41Times New Roman Symbol &Arial"1h0bƅbFLb /( iX!!LPFI - A Risk Too FarPreferred CustomerPreferred CustomerAAz6@jA{6AA|6AF6AkAL6AAW6AA@A@A@A@A@A@A@AAAsA~Az6@jA{6AA!HAA|6A[A~6A~@A)AA-AAHAAQAARAASAA@RA%A6A6AfAFA@]AAA,EAA4EAA2@"HA#HA_AAjAAAAAAAAAAAAAAAAAAAAAADADADADADADADADADADAEAEAEA*EA+E@A;A;A;A;A;A;A;A;A<A<A<A<A(<A*<As<Az<A|<A}<@~<A=A6A_A6AA6A6A6A7@@9EA:EAEAEAEAEAEA$HAEAEAFA8FABFARFAF@F@A7@A%HA&HA(HA> A1HAi A7A @ A7A%Ak7Au7Av7@&A7A1&A7A_'A8HA'A7A(A7A(Am(A7As(A:A(@I=AK=A=A=AW>A>AFAFAFAFAFAFAF@4G@5GA6GA[GA\GA]GAGAGAGAGAGAGAGAGAGAG@:AGAGAGAGAGA