The Private Finance Initiative (PFI)

The Private Finance Initiative (PFI) is a type of Public-Private Partnership (PPP) where the local authorities are capable of gaining access to the recent new capital assets and frequently they take the form of buildings but it is not a must that they are buildings they may as well assume other forms. Contrary to the traditional procurement methods, the public sectors doesn’t purchase the assets but it pays for the period it has used the assets combined with other related services like cleaning and security. The private sector makes the capital investment in the assets where it recovers the cost during the contract period which is usually above 25 years (Hill & Collins, 12-25).

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There exists various ways in which the projects of PFI offer a better time value of money than the original traditional option of purchasing the asset and taking the entire responsibility of maintaining the asset. The operator of the private sector takes the fundamental risks which are involved in designing, operating and financing the asset hence the additional costs and damages that may be incurred thus the local authority is less likely to account for these costs. The local authority indirectly finances the depreciation costs of the asset thus the contractor has the capability of repairing and maintaining the asset in a good condition which is a major advantage over the traditional methods of procurement for it increases the efficiency and performance of the local authority (Hill, 88-126).

Since the introduction of the PFIs in the mid-1990s as a tool of funding the private sector it has been very successful and it has most commonly used method to fund health and transportation services. The fundamental principle underlying the operation of the PFIs is the fact that risks and responsibilities that are connected with running the public service are delegated to institutions where they can be well managed. For instance procuring a new building for running a school using the PFI is very different from the traditional procurement method where since the Local Authority enters into an agreement and pays for the accommodation in the school building for a period of time. With reference to the traditional methods, the Local Authority uses funds that have been approved and provided by the central government but the building is designed by architects from the Local Authority however the private sector is limited to the bidding of the contract. The procurement process of the PFI is basically a negotiated process (Allen, 12-62).

One of the major advantages of a PFI is its unique characteristic of time value of money. This factor is based on the idea that even though it is cheaper for the government to borrow the money directly rather than use private finance, the gains from the efficiency of the private sector are more than the gains from the public sector and thus this point nullifies the overheads of borrowing. According to Julian Le Grand “…NHS workers are more interested in forming long lasting relationships within the new internal market and are adverse to competition and it is believed that, through PFIs the NHS will benefit from private sector management and expertise which under pressure of market forces and competition, it will lead to positive, fresh ideas and innovation…” (Addis & Talbot, 84-145).

The PFI transfers the risk from the public to the private sector and the risk involves both the design and completion risks and this is an advantage as the private sector is more efficient and cautious when handling specific risks. Some critics of the PFI projects argue that the interest rate of a loan borrowed by a company reflects the risk level and thus with negligible levels of risk, a company can borrow the loan at almost the base rate which economists refer to as a ‘risk free rate of interest. PFI projects are capable of obtaining loans at low levels of 4-5%, and this shows that the risk associated with the loan is negligible hence there will be no major risk that will be secured from the public sector. Another argument is the fact that for the case of health; the PFI hospitals are very expensive. This is from the fact that the healthcare authorities are supposed to reduce the numbers of beds in their hospitals so as to sustain themselves within their budgets thus the cost of PFIs is believed to be overstretching the budgets of the Health Authorities hence compromising the health facilities. Basically, Le Grand believed that private companies are profit-oriented and will believe in building large hospitals in big towns to accommodate as many patients as possible so as to make huge profits so they will not build small healthcare centers which will be easily accessed by the community (Kibert, 32-67).

The PFI process is a dynamic process especially with regard to large projects where most of the issues are complex and have several alternatives which can be implemented to satisfy the given specifications. The outputs of these specifications are not fixed but are subject to modifications after negotiation with bidders so as to operate at the desired scope. Initial PFI projects relied on the first bidders but of late, the period of completion of the project has become a major factor to consider before choosing the preferred bidder. In the early stages of the bidding process, the client has the liberty to rely on internal advisers so as he/she can gain knowledge and skill to win the procurement. This can be done in case the client has never handled a project of similar scope or perhaps the supporting staff is committed on other projects. There are three types of skills that may be required in the implementation of such projects namely: financial, technical, and financial. The technical team facilitates management disciplines and the procedure of appointing the external consultants depends on the appropriate public procurement processes in the market (Johnson, 142-173).

The bidding team constitutes of several representatives who originate from various organizations so as to achieve the fundamental aim of the scope of the project. The consortium structure is dependent on the type of the project and further who is funding the project. The PFI projects have similar characteristics since the bidding consortia plays an important role for it will have the fundamental responsibility of underwriting the performance level of the service in the course of the contract period. After the contract has been signed, a special company is delegated the duty to monitor and run the contract and will have a sovereign administration which will include representatives from the consortium and funders of the project but this management service provider team will be subject to change with time. A model, which may be regional, has to be adopted where regional sub-contracts are delegated specific functions like maintenance, security and cleaning. The national contracts are implemented if only a substantial amount of money has been approved for the project; the sub-contracts provide potential opportunities for the managers to estimate the costs and quality between two different regions so that they can control the risk that may arise from poorly performing sectors (Grimsey & Graham, 118-166).

It is also essential to determine the feasibility of the PFI project. The client is required to offer support to the proposal for the funding of the project and this has to be accompanies by the relevant feasibility study and, further, he/she has to prove the benefits of the specific type of contract over other similar contracts. At this stage of procurement, both the client and the consortium will continue to scrutinize the evolution of the project. The formation of negotiations and relationships will assist the clients as well as the service providers so as maintain a sustainable production over the long period of the contract. The procurement route and the individual projects which entirely depend on the commitment of the client is significant for the progress of the project towards completion (Allen, 12-62).

Crititics of the PFI system argue that this type of procurement commands a lot of commercial confidentiality and this further limits accountability hence complicating the ability to create comparison between the privately financed and publicly financed schemes. The changes of demand, supply, and other unforecasted factors in future in the long-term contracts may create unfavorable restrictions in the future if many projects are attached to the PFI projects. For instance if the project is prematurely terminated the public sector will be required to settle all the outstanding debt, interest and foregone profits even though this will entirely depend on the terms and conditions of the contract (Addis & Talbot, 84-145).

There are three types of risks namely:

  • construction,
  • Operating and,

The PFI facilitates the construction performance by passing the design and construction risks to the private sector. According to the National Audit Office (NAO) report of 2003, a larger percentage of the PFI projects are completed in time and well budgeted in comparison to those that are controlled and managed by the public sector procurement. This is because the private sector capitalizes on the consequences and the penalties involved in case the project is late in addition to the fact that they avoid over-budgeting in the process. The PFI provides a better means to deal with risks that are related to the two key cost components namely: the operating cost and the upfront investment cost. During the year 2001, approximately 76% of the projects allocated to PFI were completed in time while 79% were within the budget. For the convectional procurement, only 30% of the projects were on time and 27% were within the budget thus we can see that the performance of the PFI was better. For a better analysis the above information can be summarized in the table below:

 

 

 

Type of Procurement % of Projects Completed on Time % of Projects Completed Within the Budget.
PFI 76 79
Convectional 30 27

 

 

For the PFI, the demand risks are basically under the responsibility of the public sector but the major income source entirely depends on the future demand trends and thus the public sector is bound to encounter huge losses if it fails to forecast the future market conditions accurately. A good example is the first PFI project for the Royal Armories in Leeds. The gap that was between the projected demand and the actual demand led to severe consequences as the museum could not raise enough funds to cover the operating costs and the payment of debts. In 1999 alone the museum had an average of 400 000 against the projected 750 000 and thus due to this overestimate of demand, the museum collapsed due to financial crisis (Johnson, 142-173).

The process of bidding is takes some time and this is a major limitation of the PFI between the consortium and the client as it wastes a lot of time and resources, also at the early stages of the procurement procedure, the sector client resourcing is inadequate. Another problem is the standards of testing the PFI projects are substandard and eventually the projects that are introduced in the market are untested or poorly tested in addition to the fact that some of the public sector clients have little or no expertise and it is their first time to commission a building. There is also lack of direct contact of the client and the design group especially during the early stages of bidding; this would have enabled both parties to brief each other on the best design so as to influence the best stakeholder. The concept design of the client is enough to develop a tender where the consortia are challenged to implement their own innovation and competition so as they are capable of producing the required design in reference to the construction financing, facilities management, among others (Hill, 88-126).

There are several challenges that are faced while refinancing a PFI especially with reference to the adjustments that are made to the risk profile of the PFI project and the huge amount of profit which are taken by the private stakeholders. Refinancing creates additional risks in form of increased liabilities to the public sector especially towards the completion of the PFI project more so if the contract period has been extended. For instance, a PFI may have a life span of 30 years but with a senior debt profile of 25 years; this difference of 5 years gives time for the senior debts to be cleared. In case the PFI consortium decides that refinancing of the project should be at the termination of the construction period when the project is operational, then will be able to minimize the debt-free tail to approximately one year. The extra cost of borrowing additional money for the PFI project is likely to be cut down as the risks which accompany the construction period are over. However, this is a great benefit to the private sector for it is now capable of borrowing extra funds which are refundable to the shareholders (Allen, 12-62).

The deals that arise from refinancing the PFI do not yield the projected returns to the public sector. In 2007, The House of Commons Public Accounts Committee reported that up to December 2006, the government had the right to secure £93 million only instead of the expected £175-£200 million even though early refinancing had earned high rates of return to the shareholders of the private sector. The development of PFI in secondary markets has assisted the investors to invest in shares using the money originally invested in the PFI projects which are currently in progress thus creating portfolios of PFI investments (Grimsey & Graham, 118-166).

The role of a project manager changes considerably from one project to another. For example, a project manager may be present at the start of the project i.e. During the Initial stage of Invitation to Tender (ITT), bidding and the preferred bidder up to the operational stage or in other case the clients project manager may be simply brought to the construction stage. For the Local Authorities, the internal project managers are considered to be the best as long as they prove beyond any reasonable doubt that they are competent. The major advantages of using a project manager include:

  • They are readily available at a lower cost;
  • The skills of project management are inbuilt and honed in-house;
  • Decision making is controlled by the awarding authority.

 

The client’s project manager has the responsibility of ensuring that all the deadlines are met within the contract period of the project since when the deadlines are not punctually met, the cost of implementing the project rises, so an internal project manager is viewed to be the best since he will be capable of protecting the interests of the client. A project manager conducts many issues on behalf of the client and he is practically involved in the inception, bidding and management of the project. The manager provides the basic inputs in the project and this entirely depends on his operational skills and the fundamental roles of a project manager. Different stakeholders have varying interests in the project and the significance of proper management. Some investors will consider the appreciation risk to be the basic skill while others will approach the issue from a political point of view. Many of the clients lack the understanding of the process of implementation of the project and so it is the responsibility of the project manager to make sure that they are informed of the market trends and the projected inflation so as to be aware of the right decisions to make (Johnson, 142-173).

Recently the role of a project manager has been changing, and this has led to integrated functions of the project manager. A project manager is required to provide technical advice to his client in addition to assisting in the co-ordination of programmes within the entire PFI project further he has the responsibility of acquiring information and preparing a summary of the findings, this is to say that he should provide all the required kinds of advice excluding financial and legal matters as these will fall under different separate categories. All the members and sections involved in a PFI need almost all the factors of project management of management; a role that project managers execute. For instance, supposing a client employs a project manager to aid in designing an outline that will create public awareness of the PFI project through advertising and also assisting through the bidding process on the basis that the project manager will be employed post-contract, then it means that the project manager will have the entire responsibility to check on the design and comment on the variation costs or just simply certify that the building is up to standard after completion of the contract (Hill, 88-126).

Otherwise the role of a project manager can vary from time to time, from project to project since he can also be delegated by the client to constantly inspect the quality assurance of the contractor and also provide ideas and opinions on whether the building will be satisfactory for occupation after it has been completed. Some of the major roles that are conducted by project managers include:

  • Being the clients agent;
  • Offering technical advice;
  • An independent certifier of the client, and
  • A Special Purpose Vehicle’s (SPV) Representative.

 

Recent research has proven that the fundamental reason to include SPV is to aid in the technical analysis and the measurement of the financial capacity and the consortium has little or no production in the construction company. Thus, a project manager can be delegated the responsibility of preparing a cost plan in addition to the schedule of the work to be done. The most productive project managers are those who clearly understand the PFI project being undertaken and perhaps those who have been in the project since its early stages of development for he understands the evolution of the project step by step. A client will be less successful if he uses various project managers at various stages of development of the PFI project since some project managers will undertake unfamiliar duties and tasks implemented in the project. To be a more successful client, an individual has to optimize the professionalism and skill of an individual project manager (Allen, 12-62).

The PFI project requires the client to identify potential risks. The truth is that within all the sectors of the PFI, it is the client who bears the expense of mitigating the risks since the private sector is ready to take the responsibility of the risks but on condition that the risks are put at an appropriate cost. However, the PFI does not lack a mechanism which will delegate the responsibility of the risk to the most appropriate; the traditional procurement methods pass both the risk and the cost to the client. PFI may not actually account for the time value of money in reference to the management of the risk it offers a level of certainty (Addis & Talbot, 84-145).

 

 

 

Works Cited

Allen, G. The Private Finance Initiative (PFI): Economic Policy and Statistic Section. House of Commons Library research paper. London. (2001).

 

Addis, B. & Talbot, R. Sustainable Construction Procurement. McGraw-Hill. (2001).

Abbot, C. Private, Finance and Public Partnerships. Prentice hall. (2002).

Hill, J & Collins, J. PFI: Meeting the Sustainability Challenge. London: Green Alliance. Publishers. (2004).

 

Crossley, R. Reputation, Risk and Reward. London Publishers. (2004)

Kibert, C. Proceeding of the First International Conference on Sustainable Construction. Tampa: University of Florida. 6-9 November, 1994.

Grimsey, D. & Graham, R. PFI in the engineering sector. Construction and Management. Routledge. (2000).

 

Hill, R. PFI and the Procurement Process. Prentice Hall. (2003).

Graham, R. Opportunities for Change in the Construction Industry. Allan & Bacon. (2001).

Johnson, D. Traditional and Public Finance Initiative Procurement Methods. London Publishers. (2005).

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