Labour’s Plans to Nationalise PFI? 5 Steps to drive better value now, while we are all waiting

By Allan Watton on January 9, 2018

pfi nationalisationSince the revelations of the Labour Conference in September, analysts and pundits have been asking some important questions. They include, in this austerity lashed economic climate, where does Labour believe the potentially hundreds of billions will come from to pay for their plans for Britain, and would it benefit the country to go that way? We thought we should pull together some of the research on the subject and what various people ‘in the know’ are saying about it.

PFI

At the Conference, John McDonnell said: “The scandal of the Private Finance Initiative, launched by John Major, has resulted in huge, long-term costs for tax payers, whilst handing out enormous profits for some companies. Profits which are coming out of the budgets of our public services.” His position seems clear on PFIs, and while true that it was a Conservative government that introduced them, it should be remembered that it was the following Labour government under Tony Blair that took this fairly limited Conservative initiative and considerably expanded upon it.

McDonnell went on to say: “We’ll put an end to this scandal and reduce the cost to the taxpayers. How? We have already pledged that there will be no new PFI deals signed by us. But we will go further. I can tell you today, it’s what you’ve been calling for. We’ll bring existing PFI contracts back in-house.”

This seemed quite definitive. Labour’s policy is to buy back all existing PFI contracts so they could be run by the public sector once again. Yet an official Labour press notice on 25 September was slightly more ambiguous, saying: “Labour will review all PFI contracts and, if necessary, take over outstanding contracts and bring them back in-house…”. It’s the ‘if necessary’ part that adds a little muddiness to the water.

According to an article in the Guardian: “Britain’s business groups have reacted with alarm to a pledge by the Shadow Chancellor, John McDonnell, to bring billions of pounds’ worth of PFI projects and their staff back under government control.”

So just how nervous are British businesses about Labour’s plans? The same article quotes Carolyn Fairbairn, CBI Director General, as saying: “Labour’s policies could send investors ‘running for the hills’ just as businesses were fretting about the impact of Brexit. The shadow chancellor’s vision of massive state intervention is the wrong plan at the wrong time. It raises a warning flag over the British economy at a critical time for our country’s future.

Ms Fairbairn is not alone, with Adam Marshall from the British Chambers of Commerce quoted as saying: “With the UK’s departure from the EU on the horizon, businesses will be concerned by the shadow chancellor’s proposals for widespread and deep intervention across the economy. Proposals to nationalise key industries would put business investment in the deep freeze at precisely the time that it is needed most.”

One estimate of the cost of bringing PFI contracts back in house for the NHS alone was over £50bn, but then of course Labour also promised to renationalise the railways, energy and water, and a suggestion that the Royal Mail “would follow”. So that’s a very expensive exercise indeed, on a scale not seen before in my lifetime.

Renationalised Utilities

It would cost tens of billions of pounds for Labour to renationalise these industries. But putting aside this rather uncomfortable fact for one moment, there is also the rather thorny issue of existing shareholders.

Many ordinary people in Britain have purchased shares in these utilities over the years. These are not big corporations or investment houses, these are average people encouraged to do so for ownership, for assets, to better themselves. But, according to a recent report on the BBC: “Shareholders may not be fully compensated under Labour’s nationalisation plans.” So, will millions of shareholders forced to give back their investments at a knocked-down price be appreciative of Labour’s ideological aspirations for Britain?

The reason given for Labour’s wish to nationalise these businesses is to improve efficiency and investment, and to stop the flood of profits going to the private sector that should be reinvested into public sector services. However, the awkward historical fact that those supporters (and there are a lot of them) of Labour’s nationalisation policy forget, or are too young to remember, is that nationalised utilities and services are rarely efficient, invested in and profitable. In fact, that is the very reason they were privatised in the first place.

So, how will Labour’s buy-back plans be funded? Where will the money actually come from?

No matter which forum you corner a Labour MP in, be it a broadsheet interview or a political TV show, they will recite the party line that their manifesto and all their plans in it have been fully independently costed and approved, and no other party could say the same thing. But little in the way of specifics have been released. What we do know is that tens of billions will need to be found to renationalise the industries Labour has talked about bringing back into public control, many tens of billions more would be needed to buy back PFIs. Then there is the £1.8tn in pension liabilities and over £100bn in outstanding student loans (many of which will never be paid off), and national debt running at an estimated 93% of GDP (up from around 37% in 2005). Against this backdrop you have to investigate what real evidence exists for nationalisation of PFIs being a better way forward? In fairness, it may well be, but we haven’t yet seen the fiscal, commercial and operational capability in sufficient volume within central government that would support such an initiative.

When asked repeatedly to give a number on BBC’s Andrew Marr show, Mr McDonnell said: “You don’t need a number because what you do is you swap shares for government bonds and that is covered by the costs of those profitable industries we take over.” This was an answer that did not seem to satisfy the veteran political interviewer. Certainly, government bonds are relatively safe financial vehicles, but business prospects can go down as well as up, so to peg the country’s financial future to that sail has risks associated with it.

Counter-argument; PFI in private hands isn’t covering itself in glory either…

If nationalisation and buying back PFIs sounds a little daunting, the alternative is not without its issues as well. The PFI situation in private sector hands is, to say the least, a little bleak, and to be fair to McDonnell, he does hit this problem square on the head. The private sector is reported as making a significant profit from their interests in PFI contracts. And, while we are always first in the queue to defend the private sector’s right to make a profit so long as they offer significant enough value creation in return, the situation with PFIs seems to have shifted significantly away from the spirit they were created for.

With average annual rate of returns more than twice what’s quoted in their business cases, 28.7% profit seems on the high side considering the balance of value the private sector is providing. And, with many in the offshore secondary market for PFI equity clamouring for 100% ownership of their SPVs, shares are traded again and again for higher prices, all a further and significant drain on the public purse.

Dexter Whitfield from the European Services Strategy Unit has created some very interesting research into this matter, the summary of which I have respectfully borrowed for this article. He states that in a sample of 334 PFI/PPP projects:

  • The average annual rate of return was 28.7% in 1998–2016 more than double the 12%-15% annual rate of return in PFI/PPP Final Business Cases.
  • The updated ESSU PPP Equity Database records 462 transactions between 1998–2016 involving the direct sale of equity of 1,003 projects (including those where equity was sold multiple times) at an estimated cost of £10.3bn.
  • In 2016, 100% of equity transactions were to offshore infrastructure funds in Jersey, Guernsey and Luxembourg, based on the ESSU sample of 334 projects. The percentage in 2011 and 2014 was 70% for both years and 60% and 61% in 2015 and 2013 respectively.
  • Nine offshore secondary market infrastructure funds owned 50%–100% of the equity in 334 PFI/PPP projects or 45.4% of PPP projects in the UK in 2016 (Whitfield, 2016).
  • The evidence for the average annual rate of return is based on a sample of 334 projects, a third of the total number of PPP projects involved in the sale of equity in 118 transactions, a quarter of the transactions between 1998–2016. It is a significant sample reflecting different sectors, size, geography and a spread of vendors and purchasers of PPP equity.
  • Education and health PPP projects account for 62.7% of projects in equity transactions, followed by transport with 10.4% and criminal justice with 8.4%.
  • There has been little change in the average time of a 6.47-year gap between the date of financial closure of projects and the sale of equity. This is consistent with other findings.
  • An average of 43.4% of project equity was sold in each transaction in the sample.
  • The £18,387m cost of PPP equity transactions and mergers/takeovers of secondary market infrastructure funds is a further additional cost of PPPs. It is money extracted from PPP projects once they have reached financial close, and in effect, an indirect public cost. Financial institutions, aided by construction companies and FM contractors, extract the increased value once construction of PPP projects is completed, risk is significantly reduced, repayments government guaranteed and a secondary market ramps up the value of SPV equity.
  • The direct public costs of PPPs are even higher. The total public cost of PPP buyouts, bailouts, terminations and major problem contracts was estimated to be £7,567m (Table 10, Whitfield, 2017). Further additional costs of PPPs were estimated to be £20,335m based on the additional cost of private finance compared to public investment, additional PPP transaction costs and interest rate swap liabilities in many PPP projects. The combined additional cost of PPP projects was £27,902m (ibid).

Dexter’s five recommendations for reducing the PFI burden

Mr Whitfield also listed a number of recommendations weighted towards Labour’s manifesto perspective:

  1. New controls to restrict offshoring public assets

He would like to see regulations created to prevent the transfer of ownership of PFI/PPP assets to offshore infrastructure funds, whether through contractual or legal changes, and he’d like to see pressure exerted on such offshore funds to transfer ownership back to British shores.

  1. Termination of the PPP programme

He believes the PFI/PPP model to be broken, unable to deliver on its promises of value, savings and social benefits, so it should be ended.

  1. Nationalisation of SPVs

He would like to see the buoyant secondary market for shares in PFI contracts closed down by the nationalisation of the businesses that run the contracts, essentially bringing PFI back in-house

  1. New radical public management

Whitfield goes one step further, with a suggestion that nationalisation alone is not enough, that the public sector has been so degraded by a loss of talent into the private sector that a ‘new investment infrastructure model’ and ‘radical public management’ was needed to reset the capabilities of the public sector to effectively plan for, manage and innovate on their own projects.

  1. Increased public investment

Finally he would like to see greater investment in making these in-house run projects work more effectively.

Conclusion – our own five steps to drive better value in PFIs now, while waiting for the possibility of nationalisation…

So, is your view that Labour’s plans are more ‘ideology’ than realistic practicality, and is the status quo too costly to maintain? We’ll leave that for you to decide. But, the more pressing question, with Labour potentially having to wait another few years before fighting for their right to put their ideology into practice, is what can we do now, in the meantime to drive better value in our existing arrangements? A Conservative government is unlikely to be changing the privatised status of PFIs any time soon, so our experience – nearly two decades of working on hundreds of complex relationships in the public and private sector – evidences that there are five ways in which the current situation can be improved upon, right now:

  1. Banish funding rigidity

The agility of PFI funding can be one road to a more efficient system. If approached in the wrong way, many contractors baulk at the perceived complexity of flexible allocation of funds. However, a needs-based allocation can be negotiated and these often provide much greater value.

  1. Timely life cycle replacement

Efficiency can be impaired by asset replacement delay. As contractors carry the cost of assets that ‘expire’ sooner than planned, there is often a reluctance to replace them, leading to efficiency issues. Contract knowledge, good project management and domain expertise will ensure that all measures are brought to bear to ensure timely asset replacement.

  1. Unlike for like replacement

If there are assets that could do a better job for longer, why replace an expired asset with like for like? Evidence from previous relationships we have dealt with is that all provide cost savings, recognition for innovation, and longer between necessary replacements as a way of improving value through some lateral thinking.

  1. Logic over contractual obligation

There are many examples of budget waste where unnecessary work is carried out simply because it is a requirement of a PFI contract. Redecoration is one. A rigid schedule for redecoration is often stipulated within agreements, and no matter whether it is required or not, it is often carried out. Realigning/reshaping the contract (a common occurrence if handled correctly) that allows for flexibility to employ common sense, does save a considerable amount of time and money.

  1. Life cycle review and refinement

On complex service delivery contracts we’re regular advocates of a periodic review and refinement process being built into agreements at the outset to ensure that as the needs of the project/relationship change over time, the agreement that binds and guides the parties can also be adapted. PFIs are no different, and we would recommend a biannual review of life cycle expectancies, replacement strategies and innovation research that often improve value for money strategies.

PFI has become a large and complex issue, too big to tear down, too costly to leave alone. Our experience in dealing with hundreds of these complex relationships evidences that there is a third path, a middle ground where PFI is steered back to its origins, where efficiencies are improved, value optimised and expertise from the best and most competitively priced talent can be utilised. But then we’re not running an election campaign…

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