Big squeeze as the credit crunch hits home

As a result of the credit crunch, funding has tightened in the private sector. PFI funding requires the private sector to source funding from private sector banks. The credit crunch and PFI delivery has become a cause for concern, even if it is only a temporary one.

The credit crunch means that financial institutes have become more selective in terms of what they will fund. PFI is regarded as a government-backed contract and in that regard, is a good bet for investment as markets tighten. However, the underlying risk transfer within a contract will attract more attention from the banks and their credit committees.

In the Comprehensive Spending Review 2007, HM Treasury made available to Defra £2B of funding through PFI credits to assist local authorities with waste management infrastructure investment. However, the history of PFI in the waste sector has not had a smooth start, being typified by long procurements and difficulty with waste projections.

The lack of certainty over waste flow predictions has delayed projects and places public sector procurers under pressure to close deals by reaching compromises potentially biased to the public sector. The additional focus on the risk arising from the credit crunch will lead to an additional drag on waste deals closure, and a shift in risk back to the public sector that will lessen the value for money achieved by the schemes.

The local authority perspective is quite interesting in terms of the attractiveness of PFI. At the higher level of HM Treasury, there is a push to say PFI must be seen to stand on its own two feet as a value for money solution for public sector procurement. At the local level, PFI support is grant. In value for money terms, the comparison is simply – waste project with grant or waste project without grant. PFI is popular with local authorities because it ‘is’ grant.

Test for value

There is a simple value for money test that can be applied to PFI. How many infrastructure investment projects, not supported by PFI credits, have been delivered through PFI methodologies? The answer is virtually none. The early PFI rounds saw Defra offering a level of PFI credit support that was longer than that provided to such other schemes as education.

The local authority procurers responded to this by assessing whether enough grant was being made available to make it worth their while. An increasing number of authorities were coming to the conclusion that the level of PFI credit support was not tempting enough.

In 2008-9 the level of support per scheme was increased, making the efficacy of PFI more obvious. Defra also released procurement guidance stating that even non-PFI capital investment should be conducted under PFI methodologies. No evidence was put out to validate or justify the advice. Promotion of PFI means the implications of the credit crunch will impact on the fundability of schemes.

So, what are the alternatives? The regeneration market for local government has seen the resurrection of certain ideas around securing borrowing into the special purpose vehicle on the back of assets transformed to it by local government, commonly known as ‘local asset backed vehicles’.

There is no reason why such vehicles cannot form the effective basis of partnership between the public and private sectors to progress waste infrastructure. The basis of these vehicles is a sharing of the risks. This solution also relies on the raising of private finance and so the credit crunch will have an impact. However, the sharing of risks may present a solution more readily fundable than the PFI root.

Back to balance

Changes in international accounting standards mean that PFI has been brought back on local government balance sheets. This does not impact on PFI arrangements as it is simple the ‘accounting’ of the scheme. But PFI was originally designed to be off balance sheet. By bringing it on balance sheet, it affords the opportunity to re-examine PFI and to redesign it to improve its value for money credentials.

PFI has brought some procurement disciplines to public sector procurement and these need to be captured. The PFI structure presumes private finance and risk transfer as key elements of the off balance sheet structure. Local authorities could consider utilising their own funding for the vehicle and adjusting the risk transfer to make it more appropriate.

Such ideas can be piloted in the local authority sector, but would need to have grant support as encouragement. The credit crunch has not significantly impacted on local authority liquidity and this solution would be insulated from global market fluctuations.

The credit crunch does impact on public sector procurement and PFI in all sectors has seen additional rigor on investment decisions. The future of PFI remains bright so long as it is the only way for local authorities to access grant. Some may argue PFI is due for a little reinvention to help it keep pace with the changing world.

John Southgate is managing director, and Simon Johnson is executive director – sector projects, at Capita Symonds.