It's PFI, Jim, but not as we know it

Less than two months ago the public finance initiative was on the ropes leading up to the Comprehensive Spending Review. But it appears to have ridden out the storm. Despite this year’s change in government and a new chancellor known to be at best luke-warm about PFI, we expect to see a resurgence in 2011. There will be more deals worth more money including the Sheffield City Council Highways PFI, the South London Waste Partnership and the Nottingham Express Transit phase II. But does this really mean PFI is here to stay?

In 2010 we saw a rise in the number of deals closed; including significant ones such as the £2.7bn Birmingham highway’s maintenance project, Staffordshire waste management project worth £1bn and the Belmarsh prison PFI worth £415m. However, there have been concerns on all sides that the public has been paying too much for some projects and that PFI deals need to be re-thought to reduce the burden on the public purse.

If PFI is to continue, and all the signs are that it will, well into this year and beyond, something will have to give. Inevitably, value for money will have to rise up the agenda. With less money, public bodies will have to make what they have go further. To bring down costs, they will need to examine how much of the risk they can afford to ask their PFI partners to continue to take. Almost certainly, we will see a shift in risk allocation with the party best able to manage the risk actually taking it. And there may be a role for PFI rebates such as the one led by Jesse Norman MP, which seeks to persuade the beneficiaries of PFI to hand 0.05% of their PFI payments back, raising an extra £500m a year which could be ploughed back into local services such as schools and hospitals.

It also seems likely the public sector will have to raise more of its own funding to procure infrastructure and services. We will see a number of different models - for example, the regulatory asset based model - a number of central and local government bodies have substantial assets they can use to raise funds.  TIF will have a role to play and there may be increased Prudential borrowing. The public sector will, however, need to consider carefully the funding model it uses in order to maintain the “off balance” sheet status of deals it enters into. We also think private equity will play a greater role next year. Will the bond market make a comeback?

Twelve months ago, the then shadow chancellor George Osborne said: “Labour’s PFI model is flawed and must be replaced,” but there have been no credible alternative ideas to replace it and support current commitments to infrastructure projects in particular. What does this mean? Is it a case of better the devil you know, albeit with some tweaks?

This is surely a big opportunity for the private sector to shape the funding model. Investors can also influence the procurement of deals in terms of size, scope and risk allocation. It’s an investor’s market and all of this has its biggest knock-on effect locally. With the removal of PFI credits, the impact on local authorities is enormous. It represents a major shift in how local project funding is planned and decentralises the decision making on infrastructure, which will undoubtedly lead to a bun fight over which projects take priority.

The capital expenditure versus services conundrum will ring through town halls across the UK as planners are faced with reducing capital on the one hand but making service promises on the other.This will surely put them at the mercy of private investors. Their alternative is to raise funds from the sale of buildings, land and other assets which has merit but may be an expensive way forward.

While the infrastructure plan was in itself ambitious and optimistic, the devil is always in the detail. Private investors are hovering like angels to help underwrite essential project costs and that’s a good thing both locally and nationally. We can only hope the chancellor sticks to his guns on commitment to infrastructure deals and is not firing blanks. If PFI is to go, it will need replacing and there would have to be transition. All the signs are that the coalition has resisted any temptation for a knee-jerk, short-term reaction.
Shapna Roy is head of projects at Wedlake Bell

Shapna Roy is Head of Projects at Wedlake Bell