Many people find PFIs hard to understand. Most reports in the press are riddled with poor assumptions and inaccuracies. People on the street certainly don't understand them. I regret to say that even many who work in the industry don't really have a firm grasp of how a PFI project is supposed to operate.
Simply put, PFI is a way for the public sector to build and subsequently operate an asset in an arrangement that requires the private sector to invest the upfront capital and results in the public sector paying a Unitary Charge. As its name suggests a Unitary Charge is one payment (made monthly) that encompasses the costs of building the asset, financing it, and operating it for the whole length of the contract. Think of it as a mortgage for your house, maintenance costs, insurance and housekeeping all rolled into one payment. If the lighting doesn’t work in your kitchen or your dining room is unavailable because of lack of maintenance then you don’t need to pay for that portion of your house.
Often in the press you see references to a £100m hospital which will costs many times more than £100m over the life of the contract. Embarrassingly often, the press neglects to tell their readers that the fee also includes the maintenance, cleaning, catering, portering and other services for more than 20 years.
We believe that PFIs should be better understood. In the first instance let's begin by looking at the various players and their relationships to one another:
The Authority - this is the NHS trust, local authority, or government department that is the initiator of the PFI deal. They want a hospital / school / road built and maintained, and certain services delivered.
The Constructor - the company that builds the asset.
The Service Provider - One or more companies that provide hard (maintenance) and soft (cleaning, catering, portering) services through the life of the contract.
The SPC / SPV - Special Purpose Company / Vehicle (both terms are widely used) that is a limited company set up to run and operate the project. The shareholders are normally made up of the private sector parties that are successful in the PFI bidding process. These can include the Constructor, the Service Provider, and a financier or specialist PFI organisation. Often these parties' shares are subsequently sold in the secondary market to other parties. The secondary market, how it works, and its implications will form another article soon.
The Lenders - the banks or bond holders that provide the majority of the financing to construct the asset.
The Manager - Sometimes the SPC is staffed by direct employees, or those seconded from shareholder companies. Often, however, the SPC is managed by one of the private sector parties, or a specialist PFI management organisation.
Below is a simplified diagram that seeks to show the contractual arrangements between the parties in a typical PFI. In practice there are also a number of direct agreements in place between the parties.
Simply put, PFI is a way for the public sector to build and subsequently operate an asset in an arrangement that requires the private sector to invest the upfront capital and results in the public sector paying a Unitary Charge. As its name suggests a Unitary Charge is one payment (made monthly) that encompasses the costs of building the asset, financing it, and operating it for the whole length of the contract. Think of it as a mortgage for your house, maintenance costs, insurance and housekeeping all rolled into one payment. If the lighting doesn’t work in your kitchen or your dining room is unavailable because of lack of maintenance then you don’t need to pay for that portion of your house.
Often in the press you see references to a £100m hospital which will costs many times more than £100m over the life of the contract. Embarrassingly often, the press neglects to tell their readers that the fee also includes the maintenance, cleaning, catering, portering and other services for more than 20 years.
We believe that PFIs should be better understood. In the first instance let's begin by looking at the various players and their relationships to one another:
The Authority - this is the NHS trust, local authority, or government department that is the initiator of the PFI deal. They want a hospital / school / road built and maintained, and certain services delivered.
The Constructor - the company that builds the asset.
The Service Provider - One or more companies that provide hard (maintenance) and soft (cleaning, catering, portering) services through the life of the contract.
The SPC / SPV - Special Purpose Company / Vehicle (both terms are widely used) that is a limited company set up to run and operate the project. The shareholders are normally made up of the private sector parties that are successful in the PFI bidding process. These can include the Constructor, the Service Provider, and a financier or specialist PFI organisation. Often these parties' shares are subsequently sold in the secondary market to other parties. The secondary market, how it works, and its implications will form another article soon.
The Lenders - the banks or bond holders that provide the majority of the financing to construct the asset.
The Manager - Sometimes the SPC is staffed by direct employees, or those seconded from shareholder companies. Often, however, the SPC is managed by one of the private sector parties, or a specialist PFI management organisation.
Below is a simplified diagram that seeks to show the contractual arrangements between the parties in a typical PFI. In practice there are also a number of direct agreements in place between the parties.
Let's look at each of those agreements:
Project Agreement (PA) - this is the fundamental agreement underpinning the PFI. It states what will be built, how it will be operated, and what risks are retained by the Authority or transferred to the SPC. It also governs relations between these two parties, including what happens when things go wrong, or when the parties cannot agree, or when one or other party wants to change the contract. The PA will typically run for a term of 20 - 30 years.
Construction Agreement - This is a contract between the SPC and the Constructor to determine what will be built, by when, and for what sum.
Facilities Management Agreement (FMA) - This is the agreement between the SPC and the organisation that will do the work of maintaining and operating the asset. Hard services will typically run for the entire length of the contract (PA term), whereas for Soft services there may be provisions to benchmark or market test the cost of those services, typically every five years.
Credit Agreement (CA) - This is the loan agreement and is also sometimes referred to as the Facilities Agreement. The SPC will be borrowing a lot of money (typically 90% of the costs) to build the asset and fund the other up front costs required prior to income being received from the public sector. This agreement details the period over which the money must be paid back and what happens if things go wrong. Some PFI assets are financed by private or public placement bond issues. We won't go into the differences here for the moment.
So that’s who’s involved in a PFI deal and what the relationships are between the parties. In future posts we want to tackle:
- the secondary market and how this works
- benchmarking and market testing
- RPI and its implications
- what happens when there are disagreements
- lifecycle
Project Agreement (PA) - this is the fundamental agreement underpinning the PFI. It states what will be built, how it will be operated, and what risks are retained by the Authority or transferred to the SPC. It also governs relations between these two parties, including what happens when things go wrong, or when the parties cannot agree, or when one or other party wants to change the contract. The PA will typically run for a term of 20 - 30 years.
Construction Agreement - This is a contract between the SPC and the Constructor to determine what will be built, by when, and for what sum.
Facilities Management Agreement (FMA) - This is the agreement between the SPC and the organisation that will do the work of maintaining and operating the asset. Hard services will typically run for the entire length of the contract (PA term), whereas for Soft services there may be provisions to benchmark or market test the cost of those services, typically every five years.
Credit Agreement (CA) - This is the loan agreement and is also sometimes referred to as the Facilities Agreement. The SPC will be borrowing a lot of money (typically 90% of the costs) to build the asset and fund the other up front costs required prior to income being received from the public sector. This agreement details the period over which the money must be paid back and what happens if things go wrong. Some PFI assets are financed by private or public placement bond issues. We won't go into the differences here for the moment.
So that’s who’s involved in a PFI deal and what the relationships are between the parties. In future posts we want to tackle:
- the secondary market and how this works
- benchmarking and market testing
- RPI and its implications
- what happens when there are disagreements
- lifecycle
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