One rule fits all?
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5 July 2013
When the Government unveiled its proposals to standardise and improve the PFI procurement process in December last year, it knew there would be a fiery reaction from the private sector. And so it was the case.
The debate centres on some arcane technical issues that might appear dull to the outside world, but to PFI practitioners the new clauses contained in the draft update to the Standardisation of PFI Contracts are matters of grave concern.
Four coordinated private sector groups and their lawyers are fighting the proposals. The groups comprise: a syndicate of around 25 banks, advised by Altheimer & Grey; the British Banking Association, advised by Lovells; the PPP Forum, a lobbying group led by Clifford Chance; and a Confederation of British Industry (CBI)-led consortium, including the Major Contractors Group and the Business Services Association (BSA).
The new draft guidance sets the procurement framework for all future deals. It determines how much risk should be transferred to the private sector and the level of profit firms can make from the schemes. The private sector was furious with the new clauses, believing the proposals to be unfairly biased in favour of the public sector.
Altheimer partner Ashok Ghosh said: "Standardisation is there to maintain the balance between the public and private sectors. In light of the Railtrack fiasco, you'd think the Government would have more sensitivity to the market."
On the public sector side, Partnerships UK (PUK), the Treasury agency which authored the guidance, is leading the consultation process. It has faced a barrage of criticism for its handling of the issue.
The first problem was the timing. The draft proposals were published on 21 December with a deadline for responses of 23 January. That gave practitioners little more than four weeks (two of which were eaten up by the Christmas break) to draw up responses. Many felt the Government was trying to sneak the proposals through before the private sector had time to review them.
Norman Rose, director of BSA, which represents 18 major PFI contractors, says: "The public sector had six months to decide what it wanted. We were excluded until last December, when 324 pages of draft guidance suddenly appeared. I'm not 100 per cent happy with the way it's been dealt with."
After taking a severe earbashing, the Treasury agreed to alter the deadline to 15 February, but discussions have been no less heated. Even though many say that getting a consensus on some issues has been easier than expected, the feeling in the private sector remains that PUK is taking things too far in favour of the client side.
"Standardisation is a fundamental issue," says Rose. "If we don't get it right, we might as well forget PFI. The Government is moving towards a more realistic picture, but it's still trying to push too much risk onto the private sector."
PUK has agreed to amendments and changes of position in a number of key areas of disagreement, including compensation on authority default, contractor default, certainty of compensation payment amounts, change in service, insurance and indemnities. It has also promised to add an introduction section to the standardisation that makes it clear that it should be used as guidance rather than unalterable law - a key industry concern.
But the private sector has not been overwhelmed by the generosity of the amendments. In a submission to PUK, the CBI argues that the revised clauses were poorly drafted, failed to give effect to the principles the private sector had agreed with the Government and included proposals that used a sledgehammer to crack a nut. Suspicion remains that the Government has already made up its mind on some of the key issues.
Clifford Chance partner Andrew Rolfe says: "There's an inevitable dynamic in the process of reflecting consensus between the public and private sector participants on important subjects and stating decided public policy in those areas. That was always going to be a challenge."
Countless meetings, discussions and lobbying are still taking place - three such meetings took place last week alone - but lawyers are in the dark about what will finally emerge. However, participants in the discussions are beginning to get a sense of where the Government is willing to budge and where it is not.
One such area of difficulty is the controversial issue of refinancing. The industry is unhappy with what it sees as PUK's dishonest defininition of refinancing. The guidance states that the majority of refinancing gains, through which companies stand to benefit from hefty windfalls, are a result of market conditions; and as these conditions are created by the Government, it should share the benefit.
Most of those in the private sector, in contrast, understand refinancing to be a renegotiation of the main project finance, either by changing to another lender or by changing the terms of the deal with the original lender. They believe that if a PFI produces higher profits than expected through private sector risk-taking, innovation and efficiencies, these profits should remain with the private sector.
A 50-50 share of refinancing gains has been Government policy for almost a year, since a disapproving report from the National Audit Office (NAO) on a refinancing of the Altcourse prison PFI scheme, which landed a consortium a massive £10m windfall. Alerted by the auditors, the Commons' infamous public accounts committee suggested a rethink, but it is unlikely that PUK will budge from its current position. This continues to be a sore point.
"The NAO's report endorsed a 20 per cent gain for the public sector," said Ghosh. "PUK's jump from 20 to 50 per cent has not been adequately explained. If the gain is due to the efficiency and success of the private consortium, how can the public sector claim they have a right to this amount?"
Others are less critical. Stephen Matthew, head of Eversheds' projects group, which represents public and private sector clients in PFIs, says: "The private sector will see this as the public sector trying to have its cake and eat it, but there should be protection for the public purse. It needs to protect itself from the added risks around windfall gains."
Accordingly, most contractors have accepted the 50-50 split as an unfortunate but necessary political concession. "We'll have a 50-50 split - that's it. It's a Treasury-led decision and it won't be changed," says Rose.
An area on which agreement looks more likely is that of funding competitions, under which the public sector would force preferred bidders to run a competitive process for all finance, including third party equity. So far this has only happened on a handful of deals, such as the £500m PFI refurbishment of the Treasury Headquarters.
The private sector is not keen on this, arguing that bidders arrange their finance at very competitive rates already and that more formal procedures could slow down an already overly bureaucratic PFI procurement process. "It inserts another step into the process and I'm not sure that the savings will be sufficient to offset the extra costs associated with the time taken to run these competitions," says Matthew. "The test will be whether or not the margins on finance are lower as a result."
Many leading industry figures feared that its inclusion in the main guidance indicated it would be standard practice, rather than a reaction to the needs of an individual project, unnecessarily delaying the process across the board.
It appears the Treasury has now accepted that competitions are going to be the exception rather than the rule, and will make this explicit in the final draft. "It is not in the public sector's interest to widely enforce funding competitions in the latter stages of projects, because all that will do is encourage people to do less work in the early stages," explains a source at PUK.
Perhaps the main issue for lawyers, who have been among the most vociferous of the consultation protagonists, is how their status will be affected by the new standard terms. Might a newly standardised PFI process lead to a downgrading in the status of lawyers? Might they be forced off the gravy train altogether? Not according to the industry. It points out that standardisation has been around for five years, with no noticeable effect on lawyers' interests. Business will continue to boom as public and private sectors pick the best and the brightest to guarantee successful 30-year contracts.
"Every contract is going to have to be changed according to the specific circumstances of that project," says Rose. "Standardisation should be seen as guidance rather than a set of rules. I would estimate that, for about 40 per cent of the contract, it will still be up to the project negotiators and their advisers to find ways through project-specific problems."
Meanwhile, the final discussions continue. There is much at stake. The Government wants to inject £25bn of private sector finance into the UK's public infrastructure in the next three years. It knows the private sector will have to be on board to realise its plans for a sea change in the quality of public services. But equally, the private sector knows that this is a profitable area of business that it would be unwise to ignore. The next few days will see public and private sectors coming together and finding a solution that the contractors, the banks and their lawyers can live with. It is take it or leave it time.
Mark Hellowell is news editor of The PFI Report