Investing in major infrastructure: the proposed public sector stake in PF2


A version of this article was published in Partnerships Bulletin on 1 October 2013.

The Government has just published its response to the consultation on public sector equity investment as part of PF2. It is helpful to reflect on the debate about PFI and whether this approach to public sector investment helps us address key issues emerging from that debate.

Against the backdrop of sharp critique of the value for money of PFI by the House of Commons Public Accounts Committee and the National Audit Office, it seems the Government wants to assuage public concerns about:

  • a lack of transparency in private finance and the potential for unethical conduct; and
  • the ability of private investors to make significant returns whilst not taking a true measure of risk on underperforming projects.

In addition, the Government wishes to promote:

  • the ability of the public sector to make a return on its investments in major projects as well as obtaining high quality outcomes from the projects themselves; and
  • learning from past projects in order to move forward with confidence in procuring a pipeline of major infrastructure projects necessary for our economy to thrive.

Turning to the investment opportunity for the public sector, the consultation paper is keen to obtain views on separating the investment decision from the procurement process.

Making good use of the procurement timetable

We know that the Government wishes to see procurements of future projects concluded under the appropriate public procurement process within 18 months. It is proposing to hold a funding competition and allow the Treasury’s PF2 Equity Unit to make a final decision on the public sector’s equity stake at the end of the process. It apparently intends to separate the type of information gleaned from the procurement process (through competitive dialogue in most procurement scenarios) from a different information source for the investment decision (which may better reflect the outcome of dialogue), that of a due diligence report supported by letters of reliance from professional advisers. But will this approach result in delays to achieving financial close as investors use independent sources to verify the due diligence information provided? Might a hard edged separation of the investment decision from the procurement process lead to all the investors (private and public sector) being kept at arm’s length from the intended outcomes of the project? Would the procurement be poorer for the removal of the check and challenge that can come from the vantage point of the equity investors? And ultimately might such a separation engender uncertainty about the ability of the project to enlist the most cost effective balance of funding from debt finance and equity?

One advantage of adopting a sophisticated procurement regime (despite costs and the time it takes) is that the prospects for success can be analysed from multiple perspectives. Omitting the participation of investors until so late in the day could be seen as leaving the procurement process uncontaminated by pressures from would-be investors. It is worth considering whether this might also be to the detriment of the quality of the project itself. Once the Preferred Bidder is selected using PF2, there is no prospect of the project being re-negotiated as this would be against all the principles of a fair public procurement process. Could there be a risk of more projects failing after selection of the Preferred Bidder because no equity investors can be found to back the financial assumptions underlying the project?

The aim should be to create a genuine opportunity for the equity investors to engage with the detail of the project, understand how it has evolved through negotiations in dialogue, so that equity investors may be comforted by the knowledge that the essential ingredients of a potentially successful project have come together over time. This, of course, needs to be consistent with the technical detail of a due diligence report, supported by letters of reliance from professional advisers. As the opportunity presents itself to attract new investors (both public and private sector) into the market in support of PF2, presenting appropriate, high quality information as the basis for such investment decisions is likely to be essential.

Addressing the public interest through transparency

A new feature of PF2 will be the annual supply of headline data on internal rates of return, shareholder dividends and the like for all live projects. This will be welcome. However, public expectations on transparency will need to be managed. Even when such data is made available each year (and taking account of any consequential effects on the behaviour of shareholders), the commercial and sensitive decisions taken by shareholders cannot be subject to public scrutiny/consultation at the time the decisions were taken. Such decisions, once they reach the public domain, could be reviewed some considerable time after they have been taken. Public judgements about projects will continue to be made with the benefit of considerable hindsight, therefore. Part of the learning from UK PFI projects must be that the criticisms of some of the features of early PFI projects did not hold true for later projects and yet public perception has not caught up with the changes. PF2 will want to be subject to a fairer public assessment of the reasonableness of commercial decisions made during the lifetime of a project.

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