Private finance initiative

The private finance initiative (PFI) was a United Kingdom government procurement policy aimed at creating " public–private partnerships" (PPPs) where private firms are contracted to complete and manage public projects. Initially launched in 1992 by Prime Minister John Major, and expanded considerably by the Blair government, PFI is part of the wider programme of privatisation and financialisation, and presented as a means for increasing accountability and efficiency for public spending.

PFI was controversial in the UK. In 2003, the National Audit Office felt that it provided good value for money overall; according to critics, PFI has been used simply to place a great amount of debt " off-balance-sheet". In 2011, the parliamentary Treasury Select Committee recommended:

In October 2018, the then-chancellor Philip Hammond announced that the UK government would no longer use PFI; however, PFI projects will continue to operate for some time to come. In 2021, Robert Naylor warned that NHS trusts risked sleepwalking into costly disputes with PFI providers as the contracts started expiring.

Overview

The private finance initiative (PFI) is a procurement method which uses private sector investment in order to deliver public sector infrastructure and/or services according to a specification defined by the public sector. It is a sub-set of a broader procurement approach termed public-private partnership (PPP), with the main defining characteristic being the use of project finance (using private sector debt and equity, underwritten by the public) in order to deliver the public services. Beyond developing the infrastructure and providing finance, private sector companies operate the public facilities, sometimes using former public sector staff who have had their employment contracts transferred to the private sector through the TUPE process which applies to all staff in a company whose ownership changes.

Mechanics

Contracts

A public sector authority signs a contract with a private sector consortium, technically known as a special-purpose vehicle (SPV). This consortium is typically formed for the specific purpose of providing the PFI. It is owned by a number of private sector investors, usually including a construction company and a service provider, and often a bank as well. The consortium's funding will be used to build the facility and to undertake maintenance and capital replacement during the life-cycle of the contract. Once the contract is operational, the SPV may be used as a conduit for contract amendment discussions between the customer and the facility operator. SPVs often charge fees for this go-between 'service'.

PFI contracts are typically for 25–30 years (depending on the type of project); although contracts less than 20 years or more than 40 years exist, they are considerably less common. During the period of the contract the consortium will provide certain services, which were previously provided by the public sector. The consortium is paid for the work over the course of the contract on a "no service no fee" performance basis.

The public authority will design an "output specification" which is a document setting out what the consortium is expected to achieve. If the consortium fails to meet any of the agreed standards it should lose an element of its payment until standards improve. If standards do not improve after an agreed period, the public sector authority is usually entitled to terminate the contract, compensate the consortium where appropriate, and take ownership of the project.

Termination procedures are highly complex, as most projects are not able to secure private financing without assurances that the debt financing of the project will be repaid in the case of termination. In most termination cases the public sector is required to repay the debt and take ownership of the project. In practice, termination is considered a last resort only.

Whether public interest is at all protected by a particular PFI contract is highly dependent on how well or badly the contract was written and the determination (or not) and capacity of the contracting authority to enforce it. Many steps have been taken over the years to standardise the form of PFI contracts to ensure public interests are better protected.

Structure of providers

The typical PFI provider is organized into three parts or legal entities: a holding company (called "Topco") which is the same as the SPV mentioned above, a capital equipment or infrastructure provision company (called "Capco"), and a services or operating company (called "Opco"). The main contract is between the public sector authority and the Topco. Requirements then 'flow down' from the Topco to the Capco and Opco via secondary contracts. Further requirements then flow down to subcontractors, again with contracts to match. Often the main subcontractors are companies with the same shareholders as the Topco.

Method of funding

Prior to the financial crisis of 2007–2010, large PFI projects were funded through the sale of bonds and/or senior debt. Since the crisis, funding by senior debt has become more common. Smaller PFI projects – the majority by number – have typically always been funded directly by banks in the form of senior debt. Senior debt is generally slightly more expensive than bonds, which the banks would argue is due to their more accurate understanding of the credit-worthiness of PFI deals – they may consider that monoline providers underestimate the risk, especially during the construction stage, and hence can offer a better price than the banks are willing to.

Refinancing of PFI deals is common. Once construction is complete, the risk profile of a project can be lower, so cheaper debt can be obtained. This refinancing might in the future be done via bonds – the construction stage is financed using bank debt, and then bonds for the much longer period of operation.

The banks who fund PFI projects are repaid by the consortium from the money received from the government during the lifespan of the contract. From the point of view of the private sector, PFI borrowing is considered low risk because public sector authorities are very unlikely to default. Indeed, under IMF rules, national governments are not permitted to go bankrupt (although this is sometimes ignored, as when Argentina 'restructured' its foreign debt). Repayment depends entirely on the ability of the consortium to deliver the services in accordance with the output specified in the contract.

History

Development

In 1992 PFI was implemented for the first time in the UK by the Conservative Government led by John Major. It was introduced against the backdrop of the Maastricht Treaty which provided for European Economic and Monetary Union (EMU). To participate in EMU, EU member states were required to keep public debt below a certain threshold, and PFI was a mechanism to take debt off the government balance sheet and so meet the Maastricht Convergence Criteria. PFI immediately proved controversial, and was attacked by Labour critics such as the Shadow Chief Secretary to the Treasury Harriet Harman, who said that PFI was really a back-door form of privatisation (House of Commons, 7 December 1993), and the future Chancellor of the Exchequer, Alistair Darling, warned that "apparent savings now could be countered by the formidable commitment on revenue expenditure in years to come".

Initially, the private sector was unenthusiastic about PFI, and the public sector was opposed to its implementation. In 1993, the Chancellor of the Exchequer described its progress as "disappointingly slow". To help promote and implement the policy, he created the Private Finance Office within the Treasury, with a Private Finance Panel headed by Alastair Morton. These institutions were staffed with people linked with the City of London, and accountancy and consultancy firms who had a vested interest in the success of PFI.

Two months after Tony Blair's Labour Party took office, the Health Secretary, Alan Milburn, announced that "when there is a limited amount of public-sector capital available, as there is, it's PFI or bust". PFI expanded considerably in 1996 and then expanded much further under Labour with the NHS (Private Finance) Act 1997, resulting in criticism from many trade unions, elements of the Labour Party, the Scottish National Party (SNP), and the Green Party, as well as commentators such as George Monbiot. Proponents of the PFI include the World Bank, the IMF and the