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The Monthly Report

7/10/2019

The principle of all PFI projects is that Project Co (and their subcontractors) should self-report against their own performance and declare to the Authority any areas of underperformance against the Service standards. The Monthly Report is where they should do this.

It is perhaps naive to believe that this is going to work. How many times have you sped down the motorway and then called the police at the end of your journey in the knowledge that you will be fined and awarded penalty points? It just isn’t human nature and, certainly, it isn’t typical for commercial organisations to create a culture that expects their staff to purposefully diminish their returns on a contract in order to be contractually compliant.

On this basis alone, it is important for any public sector organisation to actively read and question the Monthly Report and to ensure that it properly addresses all of the requirements under the contract.

The minimum requirements for the Monthly Report are typically set out in both Schedules 14 and 18 of standard form contracts and will include the following:

Incidences reported to the helpdesk, including the target Response Times and/or Rectification Times and those achieved;
Maintenance and other task based activities carried out in the month;
Maintenance and other task based activities planned for the next month;
A summary of all Failure Events and Quality Failures (or equivalent);
The effects of these Failures;
A time frame, in hours, of any event not Rectified on time;
The deductions to be made from the Service Payment in respect of Failure Events; and
The number of Service Failure Points awarded in respect of each Service for that Contract Month.

However, for each Service that is covered by the Project Agreement, it is important to go back to the Service Level Specification and look at the requirements.

On most standard form contracts the Key Performance Indicators (KPI’s) or Service Parameters (SP’s) for each Service are typically well defined and stipulate what should be measured to demonstrate compliance. There can be up to 45 KPI’s per Service on a typical contract, so if there are say 11 Services (General, Estates, Helpdesk, Cleaning, Catering, Portering, Security, Telecoms, Pest Control, Waste and Energy Management) that could easily amount to in excess of 350 individual scores that need to be reviewed and critiqued each and every month.

What is not always well defined, though, is the method of monitoring and the source data that will be utilised.

For Reactive tasks, the method of monitoring is invariably measured using the Helpdesk, provided that Project Co (and their Service Providers) are properly reporting all reactive tasks using the Helpdesk (see our ‘Follow on tasks’ post). What is often missing, however, is clarity around the method of measurement for qualitative or planned tasks. It is therefore important to sit down with the Project Co and Service providers to check whether the contents of the monthly report do in fact evidence compliance with each of the KPI’s or SP’s.

Typically, the Authority will have a defined time frame to raise any issues with the self-declared scoring. This is typically two months, although in order to get any issues properly credited in the current month’s invoice, you may have as little as 5 days. Once two months have passed, the Monthly Report and the data it contains become the sole record for the period, with no challenges able to be raised except in cases of deliberate misrepresentation, gross incompetence, gross negligence, or fraud.

P2G actively monitor the performance and monthly reporting on a number of NHS PFI projects and our experiences to date suggest that there is a large divergence between reported and actual performance when measured against the contract. If you are interested in checking whether you are receiving the Services for which you are paying, please feel free to get in touch.

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PFI Code of Conduct revisited

8/8/2014

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Two months ago we took a look at who had signed up to HM Treasury’s PFI Code of Conduct and what this might tell us.

As we showed, although the Code has largely been seen as “modest” and “toothless”, it does at least require signatories to engage in a constructive and timely manner to discuss savings and operational efficiencies.

The public sector is under pressure to reduce expenditure, whilst PFI’s provide the private sector with built-in annual RPI increases. This really matters.

When we last looked at this, there had been 159 signatories. This has now risen to 205. The make-up of those signatories has changed little, however.

New signatories have included no further investors, sponsors, or lenders. With the exception of two advisors (including P2G), new signatories are all Public Sector bodies or SPCs (and over 92% of SPCs have still not signed).

Through our work, we are aware of investors and lenders that have refused to sign up. Perhaps, as we suggested on our last visit to the subject, it’s time to name and shame.

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How flexible is a PFI contract?

8/7/2014

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HM Treasury’s 2013 Code of Conduct for PFI contracts placed commitments on the signatories that are pertinent to the ability of the public sector to make meaningful savings on their existing contracts. These include:

Engage responsively when considering the type and price of variations, waivers, changes or approvals. Not unreasonably refuse to consent to these or make unreasonable charges for such consents.
Engage constructively and in a timely manner when approached by public sector bodies to make savings on a specific PFI/PPP contract or across their portfolio of PFI/PPP contracts, including but not limited to exploring the potential cost savings measures set out in the July 2011 guidance entitled “Making savings in operational PFI contracts”. This approach should be flowed down from senior management to contract managers to support effective engagement.

“Making savings in operational PFI contracts” included a number of recommendations that would necessitate the amendment of the original scope of the project through the variation mechanism contained within the PFI Project Agreement. These include for example, removal of Hard FM and lifecycle risk (para 3.48), removal of Soft FM Services from the scope (para 3.49) and removal of change in law risk (para 3.68).

Every signatory to the Code of Conduct, therefore, must accept that the public sector should be entitled to vary or omit work from a PFI/ PPP contract in order to make savings.

However, even since the introduction of the Code of Conduct, we are seeing a tendency on the part of the private sector (including signatories to the Code of Conduct) to defend the original scope of the Project Agreement in contradiction to this principle.

Variations are an important facet of PFI contracts. The terms of these agreements are typically from 25 to 50 years in length and, given the rate of change in how public services are delivered, flexibility in respect of how and what services are required has always been a key component. To that end, PFI Agreements have detailed drafting contained within them to allow variations to occur.

The first defence that we see the private sector deploying is the principle that variation clauses do not cover a situation where the employer wishes to omit work and give it to others. Put another way, absent clear words in a contract, the right to omit works from the contract does not include the ability to omit work and have it done by someone else. This is not a contract provision of PFI Agreements but a principle of law.

This is the swings-and-roundabouts principle. The legal premise is that a contractor, when pricing the contract, has struck an overall bargain and in doing so recognises that it will gain on some elements and lose on others. Allowing an employer to cherry-pick individual elements to vary and in particular omit from the contract would therefore, in the absence of clear agreement, be unjust as it would deprive the contractor of his bargain.

Where the courts have previously adjudged work to be wrongfully omitted, most often in relation to construction contracts, then they have had to assess the contractor’s loss. Generally, this is the loss of profit on the omitted work.

However, unlike traditional construction contracts in which this principle has been applied, PFI variation provisions keep the contracting counterparty to the public sector, the Special Purpose Company (SPC), whole, i.e. in a no better / no worse position. In such a case there will be no loss on the part of the SPC as a result of the variation.

The contract terms in a PFI arrangement look back to the position that the parties agreed on at the point the contract was signed. Within the Financial Model, there is expressed an Internal Rate of Return (IRR) for the SPC, on which the private sector will bid, and which is measured against the funds they invested. It is this that is protected by the ‘no better/no worse’ provision.

This is fair and reasonable for two reasons. Firstly, all bidding parties were required to openly declare the IRR they expected to receive on the project. Secondly, there was never an expectation, by the public or private sector, that SPCs would make a profit on the underlying provision of services. The profit element on service provision was contained either within the Construction Agreement or the Facilities Management Agreement. This position was also driven by project lenders who did not want SPCs (which, by their very nature, are thinly capitalised companies) taking risk on PFI projects, given that this could lead to loan default.

The private sector agreed to the principle that, when valuing variations, as long as the SPC was left in a no better / no worse position when measured against the Project IRR, they were content and the variation had to be implemented.

Time has moved on. The original shareholders in SPCs have often sold out, at high levels of return, and the new shareholders from the secondary market are attempting to squeeze out as much profit as they can, often in order to justify large fund management fees. In doing so, they have sought to make a return on the underlying service delivery, rather than just on the capital they invested. They are therefore incentivised to fight against the removal of elements of the underlying service delivery, even when the mechanics of the contract leave them in a no better/ no worse position, and where the public sector can perform these services at a lower cost.

The second common defence is to argue that the contract limits variations to the statement of requirement for the services in question and do not extend to, for instance, changes to the price and the payment mechanism. Mechanically, this is because many PFI projects define Variations as a change to the Works or Services and Works and Services are defined in turn by reference to a specific Schedule to the PFI Agreement.

The argument runs that, unless the proposed variation is limited to matters contained within the Schedule that defines the Works or Services, then the changes the public sector are seeking fall outside the scope of the variation procedure.

Were this truly to be the case then no variation would have ever been allowed under PFI Agreements and as such it is, in our view, an extremely narrow interpretation of the contract. PFI Agreements are a complex suite of documents where, for instance, the price and payment mechanism are often contained within a different Schedule of the Agreement to the definition of Works or Services. By their nature, almost all variations will require changes to more than just the statement of requirement, not least because of the financial element of any change.

For instance it is logical that almost every variation to a PFI Agreement will affect the amount the SPC is paid and the basis of that payment. As such it is difficult to envisage any change that could comply with this wholly unrealistic construction. The private sector is basically arguing that, unless they agree, no changes can occur.

The intention of the Variation procedure for PFI contracts was never to restrict Trusts from adding or removing services or obligations from the scope of the Agreement, so long as the public sector did so in a manner that left the SPC in a no better / no worse position with regard to both profitability and risk. Indeed, where Trusts have added scope into PFI contracts, the private sector have never raised such arguments.

To spell it out clearly, the variation mechanism in a PFI contract allows for change and protects the equity return on which the contract was bid. In order to make savings the public sector now needs to enact changes, Rather than fight each change, the private sector, as outlined in the Code of Conduct, should assist knowing that the agreed equity returns are assured.

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PFI, the baby, and the bathwater. Why it’s important to take stock of where we are.

10/6/2014

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Hexham Hospital is about to go through a voluntary termination. Reportedly, this involves Northumbria NHS Trust paying compensation to the private sector Special Purpose Company (SPC) of £114m. As a result, the Trust will regain ownership and management of the facility in all aspects and save £3.5m per year (£67m over the original life of the PFI contract).

What does this mean?

It means that, for this particular deal, the Trust was able to borrow sufficient funds (in this case from the Local Authority). It means that the cost to the Trust in re-procuring the services to run the hospital for the remaining years of the PFI, together with paying off the private sector for their contractual loss of profit, was £67m less than the cost of continuing to pay the PFI unitary charge.

To put all this in context, according to HM Treasury, the capital cost of the hospital was originally £54.1m.

The Trust Chief Executive called the hospital a “fantastic facility” that could never have been built without PFI. Nevertheless, the PFI was not seen as offering value for money in the current climate. Northumbria NHS Trust are to be congratulated for assessing their options and to have negotiated their way into a significant saving. It has taken them two years to do so.

Is this a model that other NHS Trusts and Local Authorities can follow? Unfortunately not all PFI contracts allow for voluntary termination. In addition, the compensation provisions vary, making termination more or less attractive.

And, crucially, not all PFI contracts are a bad deal for the public sector.

It is true that many PFI contracts have proved expensive, particularly the earlier deals. However, over time, the Treasury refined the standard form of PFI contracts. Mistakes were rectified, the imbalance between amount paid and the risks transferred was addressed.

The later PFI deals were a vast improvement on the earlier incarnations. If we look at later deals, in particular those done in Scotland, PFI was cut down to design, build and maintain. The provision of soft services (cleaning, equipment, catering, portering etc.) was generally outside the PFI. In our desire to rectify the wrongs of early deals we should not be blind to the fact that later deals provided a competitive procurement avenue. We should not throw out the baby with the bathwater.

What should a Trust (or Local Authority) do?

An Authority should be aware of the the difference between the costs of the PFI to the contract term, and the costs of running the facility under self-procurement. An Authority should also assess whether the contract can be terminated, and the amount of compensation payable. If the procurement saving is greater than the compensation payable, then the Authority should seriously consider its options.

Importantly, however, PFI contracts contain variation provisions. This means that the Authority has rights to change the contract. In many cases, significant savings can be made in this way. In assessing value for money, therefore, Authorities need to conduct a full review of their PFI contracts.

PFI contracts are complex and, to date, much of the experience and expertise has sat on the other side of the table. It’s different now. We would urge Authorities to seek expert advice and develop a plan for their PFIs. If value is already being achieved, that’s great. If not, then there is work to be done.

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PFI Code of Conduct - Progress?

2/6/2014

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On the 14th June 2013, HM Treasury published its Code of Conduct for Operational PFI / PPP contracts with the intent of driving better behaviours, particularly amongst PFI providers, in support of its aim of making savings.

It is fair to say that the Code of Conduct’s reception has been lukewarm. It has been variously described as “a modest attempt to influence behaviour” and as “toothless”. It’s basic commitments include each party:

agreeing a single point of contact for each project;
engaging in a constructive and timely manner;
meeting on a regular basis to discuss savings and operational efficiencies; and
working together to identify operational improvements and develop joint strategies.

In addition, the private sector must not unreasonably refuse consent to variations suggested by the public sector and must provide clear and transparent information regarding a project’s consumables, energy and utility usage and costs. In return, the public sector must give reasonable and prompt consideration to any efficiency opportunities identified by the private sector.

Despite the mixed views, almost one year on from the Code of Conduct’s release, we examine the uptake.

To date, there have been 159 signatories to the Code. They are made up as follows:

Unsurprisingly, the largest percentage of signatories are the public sector themselves. It would, after all, be difficult to lecture the private sector if you haven’t signed up yourself.

Turning to the main private sector investors / sponsors, there are currently 40 signatories. The HMT Current Projects List (last updated in March 2012) lists over 130 different investors in the UK’s PFI projects; meaning that almost 70% of the investors have yet to sign up. Is it not time for a complete name and shame list? A few well known names, who are notable by their absence, are:

3i Group Plc
Babcock International Group Plc
BAE Systems Plc
Biffa
BT Plc
Dalmore Capital Limited
E.ON
FCC Construction
G4S Plc (other than in respect of one project)
Lend Lease Investment Management
Lend Lease PFI/PPP Infrastructure Fund
Macquarie
Morgan Sindall Group Plc
Veolia

The next group of signatories are the funding institutions and monolines who provide the majority of the debt or bond finance and, importantly, can often either block savings measures from being implemented completely, or seek to charge disproportionate fee levels for agreeing to them.

The HMT Current Projects List does not list funders on projects (perhaps it should) but notable absentees include:

Ambac
Assured Guaranty Municipal
AXA Group
Bayern LB
Commerzebank
European Investment Bank
Financial Guaranty Insurance Company (FGIC)
Heleba Landesbank
Municipal Bond Insurance Association (MBIA)
Prudential

Finally, there are currently 717 operational PFI contracts covered by the Code of Conduct, each one with a separate project company. Yet only 28 of these have signed up, a miserly 4%. Well done to those who have.

From the above figures, it is clear that there is a long way to go to have a private sector that is committed to the Code of Conduct. And yet many of the companies and institutions who have not signed up continue to benefit from new contracts with UK plc. Is this the right message to send?

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Renegotiating PFI contracts

3/7/2013

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One of the most common questions we are asked is whether our involvement on a PFI project will have a detrimental effect on relationships with the private sector provider and ultimately will lower performance. The short answer is that it will not.

If you have a PFI contract, deciding to renegotiate elements of it is a complicated affair fraught with potential pitfalls. However the private sector expect it to happen and are often astounded that it doesn’t happen more frequently. PFI contracts are not as inflexible as many people choose to believe.

It is possible to cut costs in a successful PFI partnership. It certainly isn’t always easy, but with the correct approach and buy-in from key stakeholders, one can reach an agreement that benefits all parties in the long term.

Before you do anything you need to gain a better grasp of exactly what you hope to achieve through renegotiation. “Cutting costs” is all well and good, but you need to consider how costs will be cut. Renegotiating a contract under such circumstances is a delicate enough process as it is, so it is important that you equip yourself with an understanding of your intended outcomes before you approach your partner.

Most PFI providers have a large exposure to the public sector and many will have signed up to the new Treasury Code of Conduct, so it is important to use these levers to help bring pressure to bear on them to assist. However, far more important is your approach to them as an organisation.

All PFI contracts are “owned” by Special Purpose Companies (SPC’s). Their raison d'etre is to deliver long term sustainable returns for their shareholders. Given the length of PFI contracts, it is not in their interests to maintain their margins to a point where their public sector partner is put in serious financial jeopardy; but ultimately they are there to make a profit for their shareholders and weaving a path between these positions is a balancing act that requires finesse to deliver.

If you operate a traditional buyer/supplier relationship, this will make delivery harder as your private sector partner is likely to take a short-term and solely profit-driven approach to the contract. You may find that renegotiation or re-shaping is more adversarial in these circumstances.

If, on the other hand, you do have a true partnership/alliance operating model, your partner will understand your financial challenges and they are far more likely to work with you on potential solutions that can appeal to both their sense of partnership and moral obligation to work together for the public good.

Ultimately, a wise private sector partner will understand the long term benefits of working in true partnership with a public sector organisation, be it a local authority, NHS trust, police force or the like.

Partnership also extends to the way the contract fundamentals are handled. Knowing exactly what you should be getting and holding the private sector to account for failure to deliver are key components of successful contract management. Doing so will, in the long term, improve your ability to successfully renegotiate elements of the contract to deliver savings. However the way you conduct yourselves and your ability to think through the issues that your ‘partner’ will face, as a result of the changes, is vital.

There is nothing simple about the process of renegotiating a PFI contract. However, a healthy dose of common sense (including pro-actively helping the provider open new doors so it can address new opportunities) and a willingness to work in true partnership with your provider will take them and you a very long way towards achieving a positive outcome.

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The PFI Secondary Market

13/5/2013

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Traditionally companies, who invest in PFI/ PPP transactions, do so though a Special Purpose Company. This Company borrows using either traditional bank debt, or through bond issues, around 80-85% of the capital needed to construct the facility and pay back the winning consortium the costs associated with bidding and closing the transaction.

The remaining 15 – 20% of the required capital comes from the investors in the project, traditionally structured as a split between nominal equity and subordinated debt, in order to provide a tax shield for investors.

When PFI/PPP transactions complete construction and pass into their operational phases, the original equity (and subordinated-debt) investors often look to recycle their capital in order to re-invest in new primary transactions or to realise a return on their investment. Alongside this maturing market, new investors in PFI/PPP projects have emerged such as infrastructure investment funds and, indirectly, pension funds. These investors are attracted by the reduced risk profile of PFI/ PPP infrastructure assets and by the long term, stable profile of investment returns generated, which are often index linked. As a result there is now an active trading market for equity and investment products within the sector, whether by disposal, acquisition, or portfolio creation.

Private Finance Initiative equity is an attractive and growing asset class. PFI equity, post construction completion, historically offers income generation at low risk. Long duration, inflation adjusted, concession payments by the UK government provide index-linked bond-like characteristics, with clear attractions for matching against pension fund liabilities.

There are two main types of secondary deal in the market presently, a true arms length acquisition by 3rd parties, or disposal by a related entity to a fund or portfolio. Valuation methodologies are similar in each, although in the case of investment funds buying secondary assets from a related primary origination team, the actual return that investors in the fund may see can be diluted by fund management fees and highly overpriced subcontract arrangements, again with related entities, in order to suppress the headline IRR.

For the Public Sector a change in ownership is not necessarily a bad thing, although with bidding levels for secondary assets often delivering around a 6-7% yield; whilst many investors are seeking actual yields of 8-9%, many management teams are highly incentivised to enhance the cash flows of the project, a process often referred to as value enhancement.

Value enhancement is a process whereby private sector management, on behalf of the investors, will seek to analyse the base returns of the project, as evidenced within the Financial Model, and then look to increase these through the actions they take.

These can often take the form of just good management actions, such as better management of the supply chain, competitive tendering of things like insurance, or reduction of overhead. In these cases the private sector should be actively encouraged; as these will lead to better-run public assets with lower termination liabilities for the public sector. Unfortunately, all too often it can also engender a more commercial and claims orientated mind set amongst private sector managers that has, in many cases, created the bad publicity for this method of procurement as a whole.

For many commentators the term secondary market in PFI has been painted as intrinsically bad for both the public sector and us, as a tax paying public. Like most things in life, the truth is somewhat more complex.

On the plus side the secondary market has both sharpened costings within the industry, leading to better value primary deals and lower cost of infrastructure; and allowed the recycling of capital so that primary players can continue to support this method of procurement; where government feel it is still appropriate to pursue.

Unfortunately it has also effectively diluted many of the plus points of PFI in terms of having long term contracts supported by long term relationships; allowing some primary investors to do some very bad deals with the public sector and then exit these projects with massive windfall profits.

A January 2011 report by the European Services Strategy Unit found that there had been more than 240 secondary deals, with profits averaging over 50%. The report also found that government recording of these transactions is inadequate and grossly under-estimates the scale of the transactions.

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The Monthly Report

PFI Code of Conduct revisited

How flexible is a PFI contract?

PFI, the baby, and the bathwater. Why it’s important to take stock of where we are.

PFI Code of Conduct - Progress?

Renegotiating PFI contracts

The PFI Secondary Market

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