NAO demands reviews of future PFI projects, with stricter criteria adopted

The National Audit Office has called for a project-by-project review of future private finance initiative contracts, with stricter criteria being employed than in the last two years.

In its report Financing PFI projects in the credit crisis and the Treasury’s response, the NAO praised the Treasury for its role in reactivating the PFI market at a time (late 2008) when debt finance became increasingly unavailable and no sizeable contract could be let.

One of the Treasury’s responses was to set up an Infrastructure Finance Unit in March 2009 to address the scarcity of debt finance. The Treasury and other departments also gave priority to closing deals at prevailing market rates, even if that meant the public sector paying more and the private sector taking on less risk.

The NAO’s report revealed that higher financing costs added 6-7% to the annual charge of PFI projects. Between £500m and £1bn in higher cost has been built in over 30 years, it added, although this has been partly offset by an increased public sector share in refinancing gains. In October 2008 the Treasury increased the public sector share of most such gains from 50% to 70%.

The spending watchdog suggested that the then government was justified in its decision to reactivate the market rather than reconsider business cases, which could have seen projects cancelled or stalled. The Treasury’s willingness to lend had improved market confidence, it said.

However, the NAO warned that while the extra finance costs for projects in 2009 were value for money in the short term to achieve the government’s objective of stimulating the economy, “the Treasury should not presume that continuing the use of private finance at current rates will be value for money”.

The NAO recommended that there now be a thorough project-by-project review of the forward programme to “apply more exacting and narrower criteria than applied to projects at the height of the crisis”. It also said the Treasury should:

• Analyse the lessons of the last two years and prepare a contingency plan for how government departments should handle future market disruption affecting procurement plans
• Where there are material changes, such as project costs increasing by 15%, require the department to re-evaluate the project. Such a re-evaluation would “assess all the benefits, and potential loss of benefits, of continuing the project in its current form, compared to other available options, including other forms of procurement”
• Continue to consider how a greater mix of finance sources, with less emphasis on the use of commercial bank loans, can be used to finance infrastructure projects.

The report recommended that the Treasury adopt a portfolio approach to refinancing, so that individual authorities do not exercise any right to a refinancing on a piecemeal basis. Such an approach would enhance the public sector bargaining position, reduce transaction costs and increase potential gains, the NAO said.

The spending watchdog added that increased finance costs and some reduction risk borne by banks meant that PFI was less likely to be a value for money solution going forwards.

Government departments therefore should – in line with Treasury guidance – not presume that a wholly privately financed project offers a solution likely to secure good value for money, it suggested. “During procurement, and in drafting notices for the Official Journal of the European Union, departments should assess a range of financing options, including all public finance or part public and part private finance,” it said.

The NAO also suggested that government departments should make greater use of sensitivity analysis to inform their decision-making when negotiating small changes in finance rates or considering requests to take on additional project risk.

NAO head Amyas Morse said: “By introducing an Infrastructure Finance Unit, the Treasury helped reactivate the market and prevent the stalling of many government projects. During 2009, the cost of finance built into the PFI programme at that time was value for money, but there is no guarantee that it will remain that way.

“Now that the market is providing finance again, a project by project review should be carried out using stricter criteria, to establish the most appropriate funding methods.”