Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 60 - 79)



  60. Could you talk about the question of risk? What are the risks associated with the project?
  (Sir Andrew Turnbull) One of the risks that we have is if it exceeds it costs. That makes no difference to us. We still pay 14 million. If they are late, they do not start getting the 14 million until we move in. Next are latent defects. EP and its architects surveyed this building extensively. If it turned out once they started knocking it apart that it was a lot more difficult to deal with or there was a lot more asbestos, for example, and they had to spend more money correcting that and it took them longer to correct that, that was their risk. There was a risk of listing and planning consents. There was broad agreement on the nature of the refurbishment with the planning authority, Westminister, but if it turned out that English Heritage were more fussy about this piece of stucco and that bit of panelling, that was EP's risk. There is the tenancy risk at the other end of the building. If there is a delay in finding a tenant, that is a risk that is transferred. They have to provide a set of facilities and management services to a particular standard. They have made an estimate as to how much it is going to cost them. If it turns out that it cost them a lot more than they estimate, that is again their risk. A risk that we have transferred is a pre-committed level of maintenance. As the tenant, we know that we will get this building maintained. We are not at risk of another part of the Treasury denying us the money in some future spending round to maintain it. That is a very comfortable position to be in. In the process, we have protected the residual value of this building. Summing that up, basically we only pay for what we get. There is quite an extensive risk transfer going on.

  61. It says on the Office of Government Commerce website that the net present cost should include an estimate of the risk that would be retained by the public sector compared to the PFI option. Is there a number for that and if so what is it?
  (Sir Andrew Turnbull) I do not have a number in my head for that.

  62. You do not know how much risk would have been retained by the public sector? How can you begin to make a decision about whether to do this or not if you do not have a figure in your head?
  (Sir Andrew Turnbull) In doing the public sector comparator, we made allowances for some of these risks, latent defects, cost over-runs and so on, and they were factored into that alternative calculation.

  63. How much risk overall is retained by the public sector compared to the PFI option? That is one of the key things we need to know in order to decide to go the PFI route or not, is it not?

  Am I wrong?
  (Sir Andrew Turnbull) The risks we retain are probably common to both.

  64. This is the definition of net present cost: "This is the net cost (taking into account any project revenues) estimated by the public sector of undertaking a project itself and producing the same or similar outputs under conventional procurement. The NPC should include an estimate of the risk that would be retained by the public sector compared to the PFI option . . ."

  (Sir Andrew Turnbull) This is telling you what you should put into the public sector comparator. We did put an element of risk into the public sector comparator. We assumed, for example, that the cost over-run could be one of three figures, 10 per cent, 15 per cent or 20 per cent.

  65. Forgetting the refurbishment costs for the moment, is the building going to cost less to run and maintain in the future than it does now?
  (Sir Andrew Turnbull) It will cost more. That is because it is a hell of a sight better building. The relevant comparison is will it cost more or less than what we would otherwise have been forced to do with it.

  66. £9 million a year sounds quite a lot of money for one building. Over 35 years, that is £315 million. If you add on 125 million, the cost of the refurbishment, that comes to 440.
  (Sir Andrew Turnbull) What is not in that nine million is the 50 or 60 million that we would have to spend in the next three or four years to rectify the serious defects in this building.

  67. Are you saying that the 50 or 60 and the 125 are separate numbers?
  (Sir Andrew Turnbull) The £125 million was my ball park figure for the value of the bond. Actually, it was £127.8 million. There is then the mezzanine debt and the equity making the capital cost £141 million.

  68. It is still only 16 million more than 125?
  (Sir Andrew Turnbull) Yes.

  69. The 60 million that you have talked about that you would have had to spend in the next three or four years and the 141 are completely separate figures?
  (Sir Andrew Turnbull) One is the cost of patching up: the other the cost of a major refurbishment.

  70. Which will mean that you do not have to spend the 50 or 60 million. So I am right. Forget the 50 or 60 million. If you add the 141 and add the existing cost, nine million a year, you come to 315 million, which is the current maintenance cost over 35 years, plus 141. That comes to 456 but you are paying out 490 over the 35 years, are you not?
  (Sir Andrew Turnbull) We have done the calculation differently.[2] The net present value of the public sector comparator, allowing for the additional risk that would involve, would have been £189 million. The project we are going ahead with has a net present cost of £169 million. In discounted terms, we think this project is £20 million cheaper than going ahead with a similar modernisation project carried out as a public sector project.

Mr Rendel

  71. If the project had gone ahead in 1997 rather than being put on hold because there was an election and a change of government, would there then have been financing competition?
  (Sir Andrew Turnbull) Probably not. This was an idea that was developed by the Treasury Task Force which came into existence in 1997. We have been lucky in that technical progress in the financial world had moved on in that year and a half and when we revived the project a technique was available to us that we had not developed in 1996.

  72. Somebody—presumably Exchequer Partnership if they have been sensible enough to go ahead with finding the best funding route—would have been left with an extra 13 million?
  (Sir Andrew Turnbull) Yes. It could have cost us more. You could say this vindicates the decision to have another look at it.

  73. I am trying to find out whether somebody lost 13 million.
  (Sir Andrew Turnbull) I do not think anyone has lost 13 million.

  74. Or lost the opportunity to make an extra 13 million profit.
  (Sir Andrew Turnbull) We have an indexed flow of payments that we are making and we have come up with the idea of funding that by indexed bond. We have managed to get a match between the nature of the flow of payments and the nature of the finance raised. When you do that, you knock some risk out of the system. There has been a genuine saving to everyone. As it happens, we think we have captured most of that for the Treasury.

  75. As a result of going through this process with the better methods that you have discovered and this brainwave that you would go in for financing competition, you are happy that in the second part of this report there are now criteria laid out as to when you might want to do the same sort of thing in the future?
  (Sir Andrew Turnbull) Peter Gershon is consulting on this at present and has set out the criteria, building on the findings of this report. Some of it we may want to modify in the light of the discussion and conclusions you eventually reach, but we are trying to get agreement on the criteria throughout Whitehall and the public sector on when is a good idea to go down this route and when it is no and at least when you should ask the question.

  76. Are you happy that you have now got sufficient controls in place to make sure that those criteria, when you have decided what they are, will be used in the future and therefore we will not in future have you or your successors before this Committee to say, "Why on earth did you not use financing competition because clearly you ought to have done?"
  (Sir Andrew Turnbull) I cannot say we would never get a project where we regretted not having it. The main sanction is that if we go ahead and it turns out badly then we will have to answer to you. We have quite a lot of influence through PUK on the formative stage of projects, particularly large projects. It is certainly a question we will be putting to any team putting together a proposal.

  77. Mr Lewis, from what we have just heard, it looks as if your original proposals would have cost the Treasury £13 million more than the final position. Why did you get it £13 million wrong to start with?
  (Mr Lewis) I would not say that we got it wrong. At the time, we were making certain assumptions about the project. Things had moved on from when we first priced the project and we were going to make certain assumptions in terms of the funding competition. It is possible we would have gone down the index linked bond route. We were looking at different options at the time and when the project was relaunched we had to look at it in a commercial manner.

  78. Are you saying that if it had gone ahead in 1997 it would have cost the Treasury £13 million more than it finally did and there is no way you could have avoided that?
  (Mr Lewis) I cannot say that because we had not gone into the depth of the funding competition that happened in the end.

  79. Why not, given that presumably you could have offered the Treasury a lower price and been more likely to win the contract had you bothered to find out that there were other ways of financing the project which might have cost as much as £13 million less?
  (Mr Lewis) In terms of the way the project was funded eventually, at the time there were relatively few index link bonds. From my point of view, things had moved on .The long concession term was one of the issues which we would have had to look at at the time.

2   Note by witness: The calculation by Mr Bacon ignores the interest cost on the £141 million of capital raised. Ref answer to Q188. Back

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