Food for thought for social infrastructure PPPs

By Stuart Cosgriff.

Key Points:
Flexibility for the public sector and improving the value for money test for "soft services" are two issues identified by the new reports.

A recent review of operating United Kingdom Private Finance Initiative ("PFI") projects by Partnerships UK, together with a revised policy document issued by Her Majesty's Treasury following on from that review, provides food for thought in considering the various social infrastructure projects proposed for the Australian Public-Private Partnership ("PPP") market.

The Partnerships UK Report

During March 2006, Partnerships UK released a "Report on Operational PFI Projects". The Report claims to cover "a wide range of operational issues impacting on all projects from all sectors that were known to be in their operational phase as the end of March 2005."

Partnerships UK gathered information for the Report from three principal sources:

• a "literature review" of a number of reports on specific PFI and PPP projects and upon specific issues arising in PFI and PPP projects;
• a review of responses to an online survey of public sector contract managers covering a range of operational (as opposed to "construction phase") issues across a range of PFI and PPF projects; and
• an in-depth review of 12 of the projects in respect of which survey responses were received, which involved interviews with the relevant public sector contract managers.

The Report concluded that, while public sector contract managers are generally satisfied with the manner in which PFI contracts govern the operating phase of projects, two key areas were identified as areas for improvement:

• change mechanisms in some PFI contracts lack the flexibility to enable the public sector to negotiate what the public sector views as minor changes to the specified services to be provided to address changes in operating requirements; and
• where benchmarking / market testing provisions exist in contracts, some public sector managers have concerns about the operation of procedures, in particular concerns that disputes may arise out of the differences between the "original" contract pricing and benchmarked pricing.

The Treasury Paper

The findings of the Report have been considered by HM Treasury and analysed in "PFI: Strengthening long-term partnerships", also issued in March 2006. Picking up on the themes set out in the Report, the Treasury Paper has identified two areas where changes in policy are required:

• improvements in operational flexibility within PFI contracts to ensure that the public sector's requirements continue to be met in the future; and
• refining the PFI model so as to improve "long-term value for money".

Greater flexibility for the public sector

HM Treasury proposes to increase operational flexibility by refining payment mechanisms, to create a mechanism more closely linking payment with user satisfaction. It has also indicated that it wishes to increase the long-term flexibility of PFI projects to ensure that PFI contracts do not "unduly constrain the public sector's choice of asset base". HM Treasury will do this by reviewing the financial structures for projects which will be acceptable for delivery under the PFI model; in particular the revised policy will focus on the area of the termination payments to be made if the public sector wishes to terminate a PFI contract.

Soft services and value for money

As in most Australian jurisdictions, the key concept which underpins the UK Government's commitment to PFI style procurement is that it is adopted where it will, in the Government's view, provide "value for money". The definition of value for money used by HM Treasury is "the optimum combination of whole of life cost and quality (or fitness for purpose) to meet the user's requirement".

The Treasury Paper is intended to respond to concerns that, in certain circumstances, the PFI procurement model does not deliver value for money as defined. In particular the Treasury Paper evidences a concern that the public sector is not receiving value for money from PFI contracts which, in their operating phase, primarily involve the delivery of "soft services".

One of the risks which the Treasury Paper recognises will be retained by a public authority in a PFI arrangement is the risk that "the service specified in the contract is required and adequate to meet public demand and expectations". In PFI contracts, changes in services specifications will generally involve a cost to the public authority (or a reduction in service without a reduction in cost). The Treasury Paper recognises that the PFI procurement model is unlikely to deliver value for money where authorities require short term flexibility because of fast-changing service requirements. The Treasury Paper also notes research which indicates that what public sector managers perceive to be relatively minor changes in service requirements to respond to end user needs lead to significant increases in cost to public authorities.

In response, the Treasury Paper indicates that the value for money test will be strengthened to require authorities to "rigorously prove the case" when putting forward a project which involves "soft services" for delivery under the PFI model. The Treasury Paper does not offer a definition of "soft services", stating instead that the services which are categorised as "soft services" vary by sector. To the extent that soft services are included in PFI procurements, the Treasury Paper recommends stricter benchmarking procedures which are subject to a higher degree of public sector control than has previously been the case.

Relevance to the Australian market

The Australian PPP market is showing signs of expansion in the delivery of what may be described as "social infrastructure". In particular the advent of what is seen by all sides of the market as the successful PFP delivery of schools in New South Wales, together with a number of recent hospital projects, has given rise to a pipeline of proposals for similar projects. The Report and the Treasury Paper are timely as they coincide not only with this growth in the market but also with the recent launch of a project by the University of Sydney School of Business to review the operating performance of Australian PPPs. That review will consider in particular whether the public sector is properly assessing and accounting for the "whole of life" costs and benefits of the PPP mode of procurement.

It seems likely that value for money in the delivery of soft services will shortly be in the forefront of the minds of public authorities responsible for procurement of social infrastructure projects in Australia. The Report and the Treasury Paper may offer some indication of the issues which will be exercising those minds.

For further information, please contact Stuart Cosgriff.