Examination of Witnesses (Questions 20-39)|
GERSHON CBE, MR
WEDNESDAY 12 DECEMBER 2001
20. That would sound more impressive if it were
not for the other side of the page. If you look at page 10, second
column, again in banner headlines which you have signed up to
it says that further understanding is required of the returns
contractors earn. If you do not actually understand the returns
they earn how do you know whether they are giving you good value
for money or not? It just reinforces what I have said about the
value for money inadequacies.
(Mr Gershon) I am sorry, I do not agree. Firstly,
this does not say that there is no understanding today of what
contractors earn. It says there needs to be further understanding,
but the critical test of value for money if you run a competition
21. You are misunderstanding me. We have £100
billion already committed and you do not even have any meaningful
information to give this Committee on rates of returns for contractors.
Let us give you an example we had a little while ago when we were
dealing with the prisons in the last Parliament. The contractwas
it for Fazakerley, or was it Parc, Sir John?
(Sir John Bourn) Fazakerley.
22. The contractor said that they required a
50 per cent premium on their normal rate of return for a prison
PFI contract, 50 per cent on top of what they would normally expect
with a conventional building contract. That seems somewhat obscene.
(Mr Gershon) That was a very early prison in a very
novel market where for the private sector there would have been
very significant risk. As the market matures that risk declines
and you would expect therefore the rate of return that a contractor
expects to decline. This was against a background that in the
history of public sector procurement in areas like prisons there
were significant cost and time overruns on which the contractor
was being asked to take the risk as it moved across from the public
to the private sector.
23. They were making so much profit on their
existing PFI contracts that they were using the profit to invest
in new PFI contracts because they were such a good deal. Let us
take it a stage further. We at that time also, and this is dealt
with here, discovered that they had made significant bonus profit
as a result of re-financing. I tabled a question and Sir John
and his colleagues very kindly prepared a memorandum based on
the questions I tabled to every department. Out of a relatively
small proportion of these 400 contracts they found that in only
15 per cent<fu1> was there any understanding to share in
re-financing profits. We well understand how they arise. The risk
is early onborrow short and high interest rates at the
beginning. When the income flow comes in as you get to the building
phase you have got the income flow and you now go to a lower rate
of interest and longer term borrowing. That is predictable. It
was in some of the early contracts in relation to railways but
it was not in the later ones. Where was the monitoring of that?
Where was the value for money there? Why did Treasury in its guidance
tell departments and authorities that they were not to seek any
share in re-financing windfall profits? It is in the report and
it was in their guidance. They, you were told, are now re-writing
that guidance. Is it re-written yet and what is the outcome?
<fo1> C&AG's Report, figure 8, p 13.
An earlier memorandum, summarising the answers to Parliamentary
Questions in July 2000, showed that 24 per cent of 105 PFI contracts
listed by departments included arrangements entitling departments
to share in refinancing gains: The Refinancing of the Fazakerley
PFI Prison Contract, 13th Report from the Committee of Public
Accounts (HC 372, Session 2000-01), Appendix 3, para 5.
(Mr Gershon) If I can clarify the position
on that, in 1999 we alerted departments to the issue of re-financing
and said it was an issue that they needed to take into account.
Last year we issued further guidance to departments on the subject
of re-financing. The revision of the Standardisation of PFI Contracts
that is currently out for consultation, and which we expect to
publish by next March, explicitly steers clients towards a 50-50
share of re-financing gains and approval of all re-financing.
24. You have got there after all this time.
Oh, no, you have not got there because you still have some consultation.
We do not know, as it is only out to consultation, that that is
what the guidance will state at the end, do we? It is conceivable
if you do not get the results you want in the consultation that
it may not happen. You have not exactly been expeditious.
(Mr Gershon) It is also the case that if the OGC is
now consulted by departments on the subject of re-financing and
for a new contract they get a very clear steer in advance of the
revision of standardisation which is 50-50.
25. There you are. It shows that some of the
shouting that government departments get in this Committee does
at least achieve something. Let us move to the contractual side.
I am in favour of PFI but I want it to work properly. I want it
to be a good deal for everyone. I want contractors to get a reasonable
rate of profit but I want the taxpayer to get a reasonable deal.
I have no objection in principle, unlike some people, to the PFI
notion. I want it to work effectively. On risk transfer how much
further ahead have we gone since we ran into the nonsenses we
had with the Passport Office and so on when they incurred costs
of £12.5 million as a result of the failure of Siemens, and
that two weeks before a hearing here, they were only able to get
Siemens to pay £2.5 million towards the losses? That did
not seem much of a risk transfer. The fault was mainly that of
the company and its computer system and yet the costs were borne
by the department. Are we advanced on that now?
(Mr Gershon) I think there is a much better understanding
amongst public sector clients that there are certain aspects of
the risk that cannot be transferred, particularly the ultimate
responsibility for delivering a public service. As risk management
techniques develop within the public sectorand the understanding
that there is a retained riskthat is sharpening up focus
as to what sort of risks you can sensibly seek to transfer to
the public sector, and those that you have to be mindful to retain
in the public sector and that should influence how you select
and manage your private sector contractor. I am very mindful of
the report that came out recently from this Committee about its
hearing on the NAO report on risk management where what you advocated
was that in the selection of partners (not just private sector
partners but also other partners) clients need to understand and
satisfy themselves about the risk management systems in their
partners. That is certainly one of the things that we take on
board. We do not necessarily use the same language but if you
look at the guidelines around the Gateway review process that
is one of the things that is tested by these independent reviews.
We are also in the process of developing enhanced guidance for
accounting officers about seeking value for money in complex procurements,
not just PFI but PFI is a good example of a complex procurement,
and we have factored in that aspect about looking at risk management
systems in that advice. You would say, "Bloody slow; they
ought to be doing it faster", but
26. In slightly more delicate language that
is exactly what I would have said.
(Mr Gershon) In our pedestrian way we are slowly but
surely trying to get to where you would have liked us to be a
long time ago.
Mr Williams: I think you have successfully talked
me through my 15 minutes so I give in at this stage.
27. I am very sorryI should also have
welcomed Mr Peter Ryan; I am sorry, the Head of the Private Finance
Policy Unit. As you have not had a chance of saying yet I would
like to give you the opportunity now. Do you have any comments?
(Mr Ryan) Amplifying Mr Gershon's response, there
is clear evidence that in certain contracts we are seeing effective
risk transfer and there are contracts where a private sector partner,
having failed to perform adequately, is suffering significant
financial penalty. We are learning. We are not perfect but we
are doing better.
28. I want to start on figure 1, page 2, and
also figure 36, page 35, which are obviously connected. Mr Gershon,
you said earlier that figure 36 on page 35 shows that there is
no cause for complacency. Clearly there are a number of areas
in a lot of contracts where the evaluation of how good the contract
is in terms of value for money has suffered quite a lot even within
the first year. That worries me. My first question therefore is,
in those cases where the evaluation has fallen were the authorities
concerned simply fooled by the contractor into thinking that they
had got a better deal than they had?
(Mr Gershon) No, I do not think they were fooled.
I think in some areas common understanding about what was really
required by the contract and what each party had to deliver only
became apparent after the award of the contract. That could have
been a contributing factor.
29. So the authorities got it wrong, did not
set up the contracts properly and as a result suffered?
(Mr Gershon) Partnering is a bit like marriage. You
enter into it with the view of having a long term relationship
and sometimes, regretfully, you discover after the marriage ceremony
that the person you thought you had married does not quite turn
out to be as you had expected. They have bad habits that only
come to light after the wedding ceremony.
Chairman: Or vice versa.
30. Where is Mrs Gershon?
(Mr Gershon) Do not draw any conclusions whatsoever
about the state of my own marriage. It was excellent on the day
of contract award and remains excellent.
31. You say they were not fooled but something
went wrong clearly. You think that what happened was that the
authorities made a mistake, they misunderstood what they were
letting themselves in for?
(Mr Gershon) Or there was lack of mutual understanding
about what was really required.
32. It does not seem to me that it matters much
whether the contractors understood or not. The point is that the
authorities thought they were getting a good deal; now they do
not. It may still be satisfactory but it is certainly a worse
deal than they thought they were getting.
(Mr Gershon) Yes.
33. Either they were being deliberately fooled
or they made a mistake and misunderstood what they were doing.
(Mr Gershon) Or potentially they selected the wrong
34. In that case they made a mistake. Selecting
the wrong partner seems to me to be a clear case of making a mistake.
(Mr Gershon) Yes. What do you do then to try to make
the relationship work? In one instance in which I had some personal
involvement helping the parties come to a revised arrangement
to put the relationship on a stronger footing was the PFI contract
for the Armed Forces Personnel Administration Agency where, after
the contract was awarded, the relationship went through a bad
period and it was necessary to reconstruct it to get to a point
where the client now believes that it has the potential to start
to deliver value for money. If you look at the NAO report it also
illustrates RAF Mail which went from excellent to marginal but
also records somewhere else in the report that the relationship
has been redefined and the early signs following that reconstruction
35. Let me pass on from that if I may and say
that if we again compare figure 1 to figure 36 the apparently
successful outcome of PFI in the NAO view seems to depend very
heavily on figure 1. In other words, as Mr Williams was saying
earlier, you seem content with what is happening because most
people seem to think it has gone well but this is after all a
fairly subjective view of what was happening.
(Mr Gershon) I was careful not to express contentment
in the answer I gave to the Chairman's questions, Mr Rendel.
36. You indeed said there was no cause for complacency.
Nevertheless it seems that your general view is that on the whole
most people feel that these arrangements have been at least satisfactory
and yet within one year of their start in 23 per cent of cases
the perception of how good the value for money is has deteriorated
within the first year.
(Mr Gershon) I am slightly confused by this reference
to the one year. I recognise the 23 per cent but I do not recognise
the one year.
37. I think somewhere in here we were told that
most of the ones that are being looked at had been in operation
for about a year.
(Mr Finlay) The contracts had been let for at least
a year, so some contracts had been operating for a year, some
two years, some three years.
(Mr Gershon) For example, one of the projects here,
which happens to be in my direct area of responsibility, was let
in 1996. It was four years.
38. The point I am making is not whether it
was one year, two years or three years but they are still on the
whole, because PFI is a fairly new business, at the early end
of their existence. Some of them may be halfway through by now.
They have been three years of a six-year contract but a lot of
them will be a lot longer than that. Some of them, as we know,
go right up to 30 years and are right at the beginning of their
term. That being the case, and given that apparently the estimation
of value for money is falling away, are you confident that at
the end of these contracts we will still have more than 50 per
cent in the satisfactory or better area?
(Mr Gershon) As I said, we are taking a number of
measures to strengthen client capability. If you take these 100
projects what could be done to improve value for money would be
in the areas of looking at the skills involved with people in
managing the contract, the partnering, the strength
39. Excuse me, Mr Gershon, I do not think you
are answering my question. What I want to know is, if you look
at figure 1 and you take figure 1, not just at the contract letting
which is the light blue and concurrent which is the dark blue,
but if you were to take all these at the end of the contract time,
would you get a graph which still showed more than 50 per cent
in the first three blocks?
(Mr Gershon) My belief is yes.