The Slow Burn of PF2

Tiffany Cloynes, Geldards, Derby

PF2 was introduced in 2011 by the Government, heralded as providing a more sensible risk allocation supported by a new standard form of contract and ancillary documents together with revised guidance which replaced SoPC4.

The key differences between PF2 and PFI comprise:

  • Centralised procurement aimed initially at education, health and the armed forces.
  • Competitive tendering process was to last no more than 18 months or funding was at risk.
  • The Government expects to invest between 30-49% equity and take a “true” profit share.
  • There is to be greater third party investment.
  • Removal of soft facilities management from the scope, to be replaced by short term contracts procured by the public sector.

The NHS for example could use PF2 on large capital investment projects as a means of enhancing market power.

As one of the distinctive features of PF2 is that construction companies invest a substantial amount of their own money as equity, this in effect has been seen as leading to an increase in the cost of private finance.

The Government stated that one of the key elements was that “government will sit side by side with private investors as a real partner in PF2 projects sharing some of the risk and the profits too…”. Despite revised documentation and a revised approach to project risk, with greater risk sharing, take up to date has been slow although that should be seen in the context of the economy and the slowdown in PFI projects prior to the introduction of PF2.

One area where PF2 has been used successfully is education.

The Education Funding Agency issued new standard form equity documents in the privately financed element of the Priority Schools Building Programme (“PSBP”).

PSBP is a programme introduced to address the needs of schools most in need of urgent repair. Through the programme 260 schools will be either rebuilt or refurbished by funding from the Education Funding Agency.

The EFA will deliver five batches of 46 schools through private funding which will have funding requirements of approximately £700 million

The first three batches (Hertfordshire, Luton and Reading, the north east and north west) have reached contract close

In order to deliver PF2 the EFA developed and procured the aggregator financing model which aggregated funding across the five batches

This has enabled cheaper finance to be accessed and procurement to be streamlined by using standardised finance documents.

In March this year International Public Partnership Limited announced that the Amber Consortium of which it was part had reached financial close on the third privately financed batch of five batches of schools delivered through PSBP. It cited one of the key features of the aggregator as the ability to warehouse loans and thereby aggregate total financing requirements across the batches.

The third funding tranche supports the development of five secondary schools and seven primary schools on existing sites in the north west over a 25 year period. Total capital expenditure in this batch is £123 million with the aggregator providing £111 million of which International Public Partnerships Limited will fund £8.4 million with EIB and Aviva providing the residual. Project sponsors provide equity and subordinated debt including Morgan Sindall Investment Limited and the private equity unit set up to invest in Government infrastructure under PF2. Senior debt is also provided by the European Investment Bank

One recent criticism from the Treasury has been that although the introduction of total control limiting payment from PFI to contracts to £70 billion over the five years from 2015-16 onwards, allowing £1 billion of new PF2 projects a year, sounds positive there is a danger that the aggregate control total will not remove the budgetary incentive for individual departments to choose PF2 over traditional procurement. Instead the control total will create an incentive for the government departments to bring forward investment decisions under PF2 as soon as possible in order to include projects within the £70 billion cap. Some in the Treasury believe that this may reduce the quality of decision making on investment projects with less consideration given as to whether PF2 offers best value for money. However the Treasury to date has seen no evidence that the control total has influenced departments to bring forward decisions. Indeed the plans to undertake PF2 projects are currently those within the PSBP Scheme and the Midland Metropolitan Hospital projects in procurement and notwithstanding the control total there is still a duty to ensure value for money for the tax payer in investment decisions.

The Treasury’s analysis of PF2 to date is that the aggregator model drives further efficiencies in due diligence. While it remains as detailed as if it were done at batch level, the due diligence can also be “aggregated” at programme level as each batch project agreement is essentially identical. The approach of systemising documentation in this way has in the Treasury’s view been instrumental in “attracting finance from the European Investment Bank who would otherwise consider individual batches too small to warrant the resource requirements for due diligence”

Although slow burn, PF2 is developing and attracting investment