Select Committee on Public Accounts Appendices to the Minutes of Evidence



Letter to the Clerk of the Committee from HM Treasury

  At the Committee's meeting on 24 January the Chairman asked me about some of the implications of risk transfer in relation to PFI projects.

  The point that concerned the Chairman was that the assumptions being made about risk transfer might be open to question in that the nature of many projects was such that, should the private sector partner fail to deliver, the department had no option but to rescue the project. Possible implications of this that the Chairman mentioned were:

    (i)  if the contract dealt with this providing the department with the power to take over the assets, and perhaps the company operating them, it would produce a financing problem for the private sector PFI partner as he would have nothing of offer as security;

    (ii)  it could have implications for the balance sheet treatment of the PFI project and its classification for public expenditure purposes;

    (iii)  (a point made at the following week's hearing) the price that the department has paid for nominally transferring the risk to the private sector may not be justified as, if the project failed, the department would pay again to pick up the pieces.

  The Chairman's point underlines the importance of a thorough and realistic assessment of the allocation of risk when embarking on PFI projects, as with any other procurement. Current guidance (which did not exist at the time the Royal Armouries project took place) emphasises that risk should be allocated to whoever from the private or public sector is best able to manage it. The public sector body should therefore seek the optimum, not the maximum, transfer of risk (see, for example, para 3.18 of the Treasury's "Partnerships for Prosperity").

  The importance of business continuity may be such that the risk of ultimate failure is one that sometimes cannot be transferred to the private sector. In the case of an operational facility, such as a hospital, it would be normal in current contracts to have provisions enabling the public sector partner to take over the assets and their operation and/or to seek a new private sector partner. The contract may provide for the private sector partner to receive compensation for the transfer of assets to the public sector, thus addressing the problem of security for the project's financing that the Chairman identified.

  Moreover, in general, PFI deals are structured so that, if the contractor gets into difficulties, there is a strong incentive on the financier to step in and either get the contractor back on track or, if that is not possible, replace him with an alternative. It is only where both these options fail that the department would normally step in. In such circumstances the financier's interests in the underlying capital asset would be protected under the direct agreement with the department; however, the financier would lose his other costs. It is important to bear in mind that the power to step in and keep the service going does not necessarily mean that the contractor will be rescued or, if he is, that he will not pay a substantial financial price. There is no question of compensating the contractor for his losses.

  If a proper allocation of risks is identified at the beginning in accordance with current guidance, then the dangers that the Chairman identified should be avoided. The department should not end up paying for the transfer of risks that in reality have not been transferred and the balance sheet treatment of the project (for which there are accepted accounting standards) should not be compromised.

  The Chairman may also have had in mind the possibility of a department's views changing about the proper allocation of risk between the time the contract is signed and a subsequent failure of delivery. Views might perhaps change because of a change of policy. There may be a number of options available for rescuing a project in difficulty when this was not originally provided for in the contract and the effect on accounting treatment may differ depending on which option is selected. Some options may lead to the project moving onto the department's balance sheet and there may be public expenditure consequences. Other options may not have those consequences.

Brian Glicksman
Treasury Officer of Accounts

9 February 2001

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