Public Accounts Committee - Managing PFI expiry
The Public Accounts Committee (PAC) have published their report on PFI expiry and conclude that vital public services such as schools and hospitals face serious disruptions should the government fail to prepare for expiry. We agree. But we would add that the risk is twofold - the seamless operation of these critical assets is at risk AND there is the potential for substantial contract-end financial liabilities, at substantial cost to the taxpayer.
The PAC report is timely and rightly calls for action.
As with the NAO report, this PAC report should be welcomed by the PFI industry as a helpful and pre-emptive review of the approaching challenge in managing the handback of over 700 complex operational PFIs with an estimated lifetime value of £290Bn.
With seven recommendations to be addressed within a three-month deadline, it is clear that the IPA has a lot to do. See our summary of the recommendations and what they need to achieve here.
What jumped out at us?
1. Accurate and complete data is fundamental to central government preparation for PFI expiry
The PAC report identifies - correctly, in the view of CURSHAW, that the data currently collected and published by the IPA is neither accurate nor complete. It highlights that the data presented by the IPA is partial, with the suggestion that some PFI contracts are even missing. It also notes that the data underpinning the IPA’s schedules is already outdated (March 2018) and that what schedules the IPA can provide are neither easily accessible nor user-friendly to analyse. Further, some key data fields, such as critical expiry dates, are missing. These can be imputed, but we would counsel that this is no basis for thorough and professional preparation.
Reflecting the patchy quality of the available data, and the difficulty of usefully interrogating this data to identify the priority actions now needed, CURSHAW have created our own interactive dashboards that we are making available for anyone who needs to draw real insight from the currently available data. Our reasoning was that, without these insights, it will be hard for any party to understand the true priorities, risks and challenges of delivering a seamless expiry transition of these state-critical assets.
2. The jury is out on the value for money case for creating a central repository of contracts.
The NAO recommends that the IPA should assess the costs and benefits of developing an electronic repository of PFI contracts. The PAC report explains that the IPA’s view is that such a repository of knowledge would not be value for money. Our counter-view within CURSHAW is that, without such a repository, it is hard to conceive of how there can be standardised and scaleable contractual due diligence, with the lessons then learned (especially important where there is an absence of, or ambiguous, exit provisions) shared efficiently across contracts.
It is also hard to reconcile the IPA’s value for money argument with the fact that the Ministry of Defence uses an electronic repository for 18 of its PFI projects and the fact that PFI providers are known to use software to manage fully conformed contracts and to keep them up to date.
In the absence of electronic systems that rigorously require contract managers to implement current terms and conditions, contracting authorities will find themselves reliant on the corporate memory of staff members. Where there is inevitable staff churn over time, across contracts of a typical PFI duration and where operational management by retained contracting authority staff is at an oversight level, with expertise often being TUPEd into the delivery providers, this will present challenges.
One can be certain that the PFI providers will have a detailed grip on every element of their financial, commercial and contractual obligations - and opportunities. For the contracting authorities, and indeed the IPA with its oversight responsibility for these £280Bn of taxpayer-funded contracts, to not be on an equal footing, supported by tools such as a central data repository in order to build an incremental knowledge bank, seems counter-intuitive.
3. Current resourcing is insufficient and it is not clear where the resourcing will come from
The report includes the IPA’s judgement that there is “huge demand” for expertise and skills, all of which are described as currently being insufficient. It is clear that the current allocation of £2m of programme funding and 17 FTEs (set to extend to 21) doesn’t go far in the context of 700 approaching expiries. Or, more pragmatically, does less than £3,000 of central support per PFI sound sufficient to optimally govern the expiry of 700 contracts, each with an average lifetime value of over £400M…?
Our view at CURSHAW is that the funding for support should be based, at least in part, on an understanding of the prospective exposure faced by Government. The contract-end financial liabilities arising from assets (that are in poor condition, or are in good condition but beyond their economic life and requiring replacement or in breach of statutory compliance, which if ignored present health and safety risk) have the potential to be huge. This is before considering the contingent costs associated with avoiding operational discontinuity and achieving a seamless transition to a new - and potentially significantly different - post-PFI operating model.
The report cites the view of Local Partnerships that “the more resources the better” and makes reference to the views of Leeds City Council, views that we identify with from our CURSHAW experience of managing the largest PFI expiry successfully concluded to date. The concern of the Council is that managing expiry alongside daily operations can put pressure on already stretched resources. As we explained in our CURSHAW PFI Perspectives publication putting ‘business as usual’ teams under increasing pressure at a time when it is vital that performance standards are maintained carries a high degree of risk. Furthermore the skills required to contract and performance-manage any contract, let alone a PFI contract, are very different from the skills required to effect a PFI demobilisation and mobilisation of a post-PFI operating model i.e. to run and maintain the asset is a very different from changing the asset and the supply chain.
Whilst the stated objective of avoiding a “huge payday for expensive consultants” is an admirable sound-bite, it does not however begin to explain how, without bringing in genuinely expert resources to focus on the complex transition of approaching £0.3 Trillion worth of state-funded contracts, best value for money outcomes can be demonstrably and repeatedly achieved. It is essential that this resource conundrum is looked at through a value, and not just a cost, lens. Government has the potential here to set the agenda, and to create the procurement frameworks, by which an expert pool of resources can be efficiently mobilised to rotate through this decades-long programme of PFI expiries, harvesting ever-increasing levels of sector and contract insight, knowledge and processes to benefit each subsequent expiry and, ultimately, the taxpayer. This community of expertise and the acknowledged costs thereof would, compared to the genuine risk of considerable expiry value leakage, seem a wise investment.
4. Provider concentration is seen as a risk but sadly not as an opportunity.
Both the NAO and the PAC report identify provider concentration - with the top 10 investors accounting for 50% of the market. The portfolio approach that will naturally be taken by investors is regarded as something that will put the public sector at a disadvantage. Yet there is no mention of the fact that government could or should talk to these top 10 investors on a strategic basis. In a forthcoming CURSHAW publication we explain that central government is in the unique position of being able to leverage scale by speaking to providers on behalf of all departments. And it can have a structured engagement with PFI providers that, if handled in the correct way, would not cut across or prejudice commercial dialogue with contracting authorities.
This is something the Cabinet Office does with its other ‘Strategic Suppliers’, because, “Strategic suppliers bring many benefits to the delivery of public services, but serious and/or persistent underperformance by strategic suppliers, and/or financial risk to strategic suppliers, are bad for the delivery of public services and the taxpayer.” The relationships with Strategic Suppliers are managed by Crown Representatives who act as a single customer. They work across departments to:
● ensure a single and strategic view of the government’s needs is communicated to the market
● identify areas for cost savings
● act as a point of focus for cross-cutting supplier-related issues
The PFI investors are arguably no less significant nor strategic, given that they are integral to the handback of this state-critical infrastructure. Our perspective here at CURSHAW is that this proactive intervention warrants early consideration and, importantly, will highlight to the PFI market the seriousness and focus with which central Government intends to manage this substantial programme.
5. It is assumed that addressing the data asymmetry will automatically strengthen the positions of contracting authorities.
Much is made of the data asymmetry point, with seemingly limited understanding of a) how and why this has come to be and b) whether putting data in the hands of contracting authorities is both necessary and sufficient to avoid the chief risks of service disruption and contract-end financial liabilities.
The report refers to the NAO survey finding that 35% of survey respondents do not have access to an asset register. Arguably, this is not surprising. Some might say why should contracting authorities be concerned about asset classification and location hierarchies when they have outsourced maintenance under contracts that were designed to fully transfer risk. Others might contend that without asset data it is impossible to be certain of compliance with maintenance regimes that are critical to health and safety. In practice data can, subject to audit rights, be obtained from PFI providers. Alternatively it can be collected by contracting authorities. The key question is what will contracting authorities then actually do with this base asset data? How will contracting authorities store and maintain asset registers? How will they use them to audit planned and preventative maintenance schedules and assure compliance? Obtaining the data is only the beginning. What matters is how contracting authorities make use of it.
6. Starting handback the right way is crucial
The report makes reference to the risk, a view which we fully share, that contract reviews may be seen as an opportunity by both parties to catch one another out in pursuit of short-term savings or profit. The widely accepted view is that the process of handback should begin with a contract review. As we explain here, our CURSHAW experience has robustly demonstrated that there is definitely a right way and a wrong way to go about these reviews. How they are undertaken, how each party contributes to them and how the findings are subsequently actioned, will likely set the tone for the relationship for the remaining years of the contract. With a potential 7-year lead time, a so-called ‘mid-course correction’ which sets mutually agreed objectives for achieving a ‘good’ PFI expiry can only be beneficial to both sides, operationally and financially.
7. Dispute should not be avoided for the sake of it
It is inevitable that there will be disputes. The PAC report identifies that these can be long and expensive to resolve; however our view is that formal dispute should not be avoided for the sake of it. For intractable issues, where negotiations reach an impasse, sometimes arbitration and adjudication to prescribed timescales with clear process are necessary. There is also a lot to be said for recognising which issues are “too hot to handle” and using the formal process to achieve a resolution, so that time and effort can be spent on the other aspects of the expiry process.
What is, however, important is that the adoption of the formal dispute resolution process should be seen as a last resort, failing all other escalation routes that should be in place if contracts are being managed properly, contractually and operationally. It is also important that parties deciding to use the process, especially contracting authorities, decide to use it based on an understanding of the expected payoff, less the legal costs - i.e. the probability of a settlement in their favour multiplied by a robust estimate of the settlement based on data and technical due diligence, minus the total cost of associated administrative and legal costs to complete the process.
Summary
In summary, our view within CURSHAW is that this PAC report is both timely and rightly provocative. It raises some significantly tough issues, which however likely to occur, can, if managed proactively, professionally, centrally and with a laser-focus on delivering optimal and equitable value for all parties, be substantially mitigated.
However, the clock has started and the pace of PFI expiries only accelerates from here. Action on the points raised by the PAC is not optional. Otherwise the next PAC report on this topic may just be a critique of the regrettable consequences of a PFI expiry that failed to heed the advice of their 2021 report.