Rob Hann assesses new guidance from the National Audit Office for public bodies as PFI contracts start coming to an end, and looks at what the future holds for local authority investment.
The National Audit Office (‘NAO’) recently published some helpful guidance to flag up the fact that many major PFI contracts across the public sector spectrum, are reaching the end of their respective contract terms over the next five-ten years. That guidance can be accessed here. PFI contracts usually (but not always) provide for the assets to be transferred to public sector ownership when contracts expire. There are currently more than 700 PFI contracts across the public sector estate, the bulk of which will start to term expire from 2025.
As someone who had a fair bit to do with the PFI programme as it was rolled out across local government between 1996 and 2016, I was interested to explore what this guidance had to say. It also got me wondering what the future might hold for investment in assets and services which have been effectively outsourced for the past two and a half decades?
No-one these days has a good word to say about the PFI. Usually, lips curl in disgust if the dreaded acronym is ever mentioned in polite society. Politically, there has been unprecedented consensus between the (now extinct) Jeremy Corbyn led labour opposition and the (equally extinct) Theresa May led conservative government - that PFI was a disaster and a busted flush. The ex-Chancellor Phillip Hammond pulled the shroud over the PFI corpse in October 2018, but the body continues to twitch as these legacy PFI contracts reach the end of their natural lives. The reasons for the opprobrium poured over the PFI are many and varied and I don’t doubt some of the objections and concerns laid at its door are justified. But merely because some projects and some PFI providers (most notably Carillion in recent memory) have failed, that doesn’t mean everything linked or associated with the PFI is necessarily all bad.
Reading the NAO report and looking at the breadth and depth of major infrastructure projects financed through PFI, I was reminded about that fabulous sketch from ‘The Life of Brian’ where Reg (John Cleese) asks his assembled disciples: ‘ What did the Romans ever do for us?”. The answer comes back: ‘Er Roads? Aqueducts? Education? public health?” (Look it up on youtube!)
Instead of “Romans” ask the same question of the PFI and there might be something approaching a similar response? Trams? Roads? Housing? Street Lighting? Schools? Waste Management facilities and much, much more was delivered by local government using the PFI over a 15 year period. I would also ask: Since the funding for new PFI projects effectively ended as a source of investment more than 7 years ago (under the coalition government) where has the funding gone to help local government promote and procure new investment in the public estate and infrastructure? What are local authorities going to do once their existing PFI projects terminate about planning and paying for the delivery of new services they will need to replace defunct PFI services?
Is it time, perhaps, for central government to announce a new major investment and funding programme for local government which builds on the firm foundations laid by the processes which were put in place under the PFI for local government, to address the many challenges posed to the economy in a the post pandemic, post Brexit environment?
Any new funding programme would not be faced with the myriad of difficulties the PFI faced and had to overcome when it was first introduced.
Take the legislative regime for example:
When I first became involved in 1996, it was nigh impossible to find any local authority willing to consider long term, pay-for-service contracts as an investment option. Opposition to the PFI as a methodology was strong and widespread. There were no PFI schemes and no prospect of any and not just because of politics. The biggest problem back then, was that banks and funding institutions who would be needed to provide the up-front funding for such projects, regarded local government as a very bad credit risk. The reason for this was the seemingly endless tranche of case law arising from the Hammersmith and Fulham swaps litigation and other ultra vires court decisions (Allerdale v Credit Suisse, Waltham Forest v Credit Suisse and so on) which impacted on market confidence. Potential funders were worried that certain high value contracts which local authorities had entered into willingly and enthusiastically, could later be deemed by the courts to be void and unenforceable. Whilst these ‘contracts’ might have been viewed by the lucky few local authorities involved as the best example of ‘risk transfer’ ever achieved, for the remainder of the local government sector, these rulings were very damaging and the ‘kiss of death’ to any PFI.
The other major problem was a lack of financial incentive for local authorities to pursue a PFI solution given the complexity, time and cost of procurement and inflexible nature of such arrangements over a long period of time.
In 1997, the incoming Labour Government under Prime Minister Tony Blair dealt with both these barriers almost immediately after taking power by 1. announcing a significant tranche of additional funding to be made available to local authorities to promote PFI and 2. by introducing the Local Government (Contracts) Act 1997 which effectively provided a statutory ‘fix’ to the vires difficulties. At a stroke, local government was both encouraged and enthused to develop and deliver business cases seeking £Ms for much needed investment in the local government asset base through the allocation of PFI credits (later PFI grant). That source of funding for local government was boosted during the decade to 2010 by successive comprehensive funding review increases. Many local authorities were incentivised to explore the PFI approach, with some councils coming back time and time again to secure PFI credits for different service needs and requirements.
A pipeline of projects was eventually developed with local authorities in different service areas bidding in competition (with each other) for Government funding in the form of a 70% (effective) funding guarantee from HM Treasury of the capital intensive revenue costs over the 25 year term of the average PFI contract. Never before (or since) was such a copper-bottomed funding promise made to individual local authorities by government departments and HM Treasury. Never before or since has there been an effective nation-wide interest and close collaboration between central government funding bodies and individual local authorities, all focussed on locally based investment priorities. Ring-fenced PFI funding provided through the revenue support mechanism helped (and still helps) to pay for and maintain these serviced assets over the long life of each PFI contract. And (in theory at least), the authority maintains the ability to hit the contractor in the pocket if it is not getting the service it contracted to receive?
Other legal and financial barriers were identified and dealt with to improve deal flow, such as difficulties with the procurement regime (the negotiated process and then the EU competitive dialogue process). The difficulties with procuring PFI contracts through competitive dialogue led directly to central government prioritising effort to input changes to the wider EU procurement regime, which culminated in the 2015 public contracts regulations.
Any new investment programme will benefit from these changes if it were to be introduced today.
Most beneficial of all though, was the contract standardisation programme for PFI contracts which was rolled out across all sectors including local government and which included for the first time, a tranche of high quality, standardised commercial terms to be mandated and applied pan-public sector and ‘enforced’ via a ‘non-derogation’ system ‘policed’ by HM Treasury and the various central government departmental funding departments (CLG, dept health, education and so on). This gave local government, for the first time, a sound platform on which to procure and engage service suppliers. After all that work centrally and locally to arrive at a set of standard commercial clauses for local government what has happened, I wonder, to SOPC 4 now? Is it still being used on fresh projects by local government or does it lay fallow on shelves gathering dust?
This standardisation exercise (or SOPC as it became known) was a huge undertaking which could only begin once financial close of several projects in various sectors had been reached. This meant SOPC was iterative process with early schemes in the programme not having the benefit the later projects had of learning lessons from those pilot projects. The new NAO guidance recognises this as a difficulty now when lawyers are called upon to advise on PFI contracts which are heading for termination due to effluxion of time. Those contracts nearest termination are likely to not be covered by SOPC at all or may be governed by earlier versions of the SOPC guidance. SOPC had 4 iterations as issues such as refinancing, change of law, best value and contract variation protocols were identified, developed and designed on the hoof and as the knowhow base improved.
At central government level an unprecedented collaboration between leading civil servants drawn from each PFI funding department and assisted by bodies like 4ps and PUK and chaired by HM Treasury (known as the project review group) were able to sift through applications for financial support and then decide which LA’s would be provided with funding if the project reached the end of the long EU procurement process. This was crucial to getting the private sector market interested and confident in bidding and (more importantly) staying the course of a competitive dialogue process.
Unfortunately, the support provided by the central bodies to individual local authorities was always limited in terms of resource but also was entirely ‘front ended” – i.e. pre-procurement phase and during procurement but (crucially) never during implementation and operation stage of these contracts. Local authorities were (effectively) on their own from financial close. Many local authority officers have gained significant experience of dealing with the commercial market but, sadly, that experience too is in danger of being lost as that generation of officers and advisers reach a certain age and retire.
In retrospect, more should have been done by the central support bodies to help individual councils with the major task of driving value for money and effective, efficient service delivery through the PFI contract mechanisms that took so much time to sort during procurement. Contract management of PFI legacy contracts has been a big problem for many individual local authorities as each grapples with the complexities in terms of resourcing, experience and understanding of what was procured, what remedies are available for incentivising performance, what flexibilities there are in effecting variations and change and so on.
However, in today’s local government environment we now have Combined Authorities in many regions which could take the lead with the constituent authorities in that region to marshall expertise to help individual councils to, not only bring existing PFI contracts to a cost effective end, but also to help plan regionally for necessary services to replace them going forward.
Think what could be achieved if a street lighting project was not limited by traditional geographical LA boundaries? Or if waste collection services were procured and/or funded regionally through a combined authority who could contract directly )on behalf of constituent LA’s) with service providers and then resource centrally to manage such contracts? Combining carbon reduction initiatives (CO2) to waste collection fleet procurement would also be a great way to boost local economies, join up policies and stimulate jobs to help combat the feared post-pandemic recession.
In summary, the NAO guidance is a timely reminder of what will be happening soon for many PFI contracts but with the challenges we all face going forward as the lockdown is eased, substantial financial incentives to actively promote bids for new investment funding are urgently needed. There is perhaps a final opportunity to thoroughly review what we can take from the PFI experience that was beneficial and could be recycled for the next generation? We should be ‘harvesting’ what worked well to stimulate and kick start a major new local government investment programme as these old contracts expire. Local authorities should be given incentives now to come forward with ideas and proposals which identifies their needs to take on serviced assets directly and/or to outsource those services once again, perhaps in a different way going forward and which takes in hard learned lessons of the past.
Rob Hann is a local government lawyer, author and consultant and who between 1996-2016 was head of legal at 4ps (the local government body set up by the LGA in 1996 to roll out the PFI across local government) and former Head of Legal at Local Partnerships (the successor body to 4ps owned by the LGA and HM Treasury).
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