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Risk and Value for Money

Management in the UK PPP/PFI


Projects

Professor Akintola Akintoye


School for Natural and Built Environment
Public Private Partnership

The whole concept of Public Private


Partnership is a government policy to tackle
financial problems in facility provision, and an
integrated private management skill to
increase efficiency, effectiveness and quality
(HM, 2000).
The level of private sector involvement might
range from a purely service provision, without
recourse to public facilities, through service
provision based on public facilities usage, up
to “public facilities” ownership.
PPP Models in UK
• Asset Sales (Sales of surplus public sector assets)

• Wider Market (Introducing the skills and finance of private sector to help better uses
of the assets in the public sector)

• Sales of Business (The sales of shares in state owned business by flotation or


trade sale)

• Partnership Companies (Introducing private sector ownership into state owned


business, while still preserving public interest trough legislation, regulations, etc.
• Private Finance Initiative
• Joint Ventures (public and private sector partners pool their assets together under
joint management)

• Partnership Investments (public sector contributes to the funding of


investment by private sector parties, to ensure that the public sector shares in the return
generated)

• Policy Partnerships (private sector individuals or parties are involved in the


development or implementation of policy)
Private Finance Initiative

8 Private Finance Initiative (PFI) is a type of PPP where,


project financing rests mainly with the private sector.
8 PFI schemes involve creating partnerships between the
public and private sectors
8 This initiative represents the strategy through which
Government contracts to purchase quality public sector
services, on a long term basis from the private sector, and
includes maintaining and possibly constructing the
necessary infrastructure.
8 This is fundamentally about the delivery of a service rather
than the procurement of construction assets. However,
assets may be required to facilitate the delivery of the
required service.
There are various types of PFI/PPP but the most
common in Britain requires the private sector to
Design, Build, Finance and Operate (DBFO)
facilities, usually for 25 - 35 years (7-15 years for
equipment).

The private sector finances construction and is


repaid by the state, in regular payments, for the
use of the buildings and services provided under a
facilities management contract.

Payments are classified as revenue, not capital


and thus do not count against public borrowing
and do not commence until the building is
completed.
Fundamental Requirements of PFI
Schemes

Public sector must secure value for money; and


There must be significant transfer of risk to the
private sector
Other: there must be effective private sector
control: the public sector must not have the
dominant influence in joint ventures
PPP: Private Finance Initiative

• Design, Build, Finance and Operate


• Hard and soft facilities management
• Risk transfer
• Value for money
• Buying a service, not an asset
• Whole life asset performance
• Performance-related reward
• Private finance, off balance sheet
• Bankability
• Output specification
• 'special purpose vehicle' company run the
project
• Advisers and consultants
• Long term contracts
Four inter-related principles at the
heart of the PFI

Genuine risk transfer


Output specification
Whole life asset performance
Performance-related reward
PPP/PFI Risk and Value
Research Outputs at GCU

o Standardised Framework for Risk Assessment and


Management of Private Finance Initiatives (Funded
Research by the EPSRC)
o Local Authority risk management and the Private
Sector (Funded Research by the RICS)
o Public Private Partnership: Managing Risk and
Opportunities (Published by Blackwell Publishing,
Edited by A Akintoye, M Beck and C Hardcastle.
o Risk Management of Construction Public Private
Partnership Projects, PhD Thesis by Bing Li
(Supervised by A Akintoye, C Hardcastle and M
Beck)
Value and Number of Signed PPP/PFI Projects

8000 120
Capital Value (£'millions)

7000 104 105


6000 Value 88 83 90
85

No. of Projects
5000 Number 75
4000 62 60
56
3000 45
2000 34 30
22
1000 15
7 9
0 1 2 2 2 2 0
87
90
91
92
93
94
95
96
97
98
99
00
01
02
03
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
Years
£' million

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PFI projects: Total value per sector

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O
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Signed UK PPP/PFI Projects (1990-2003)

16,000 200

14,000 175
Capital Value (£'millions)

12,000 Value 150

No. of Projects
10,000 Number 125

8,000 100

6,000 75

4,000 50

2,000 25

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Signed UK PPP/PFI Projects: Average size of projects

Sector
Capital Value (£'millions)

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Signed UK PPP/PFI project average size

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Sectors
Analysis of Signed PPP/PFI Projects

Health School Transp. Defense Home Water Housin Others Total


Value Office Waste g/office
(£‘ m) Mgt

Less
than 10 69% 26% 7% 22% 41% 5% 29% 50% 42% (234)

11 - 25 14% 39% 7% 24% 20% 11% 29% 31% 22%(121)

26 – 50 6% 19% 12% 20% 22% 37% 22% 15% 15%(81)

51 - 100 8% 14% 20% 20% 14% 32% 8% 2% 12%(65)

Over 100 4% 2% 54% 15% 4% 16% 12% 2% 9%(50)


PFI Expenditure compared with
total public capital spending

Capital Exp PFI %PFI


92/93 21.6 0.0 0%
93/94 19.9 0.1 1%
94/95 20.6 0.2 1%
95/96 20.0 0.4 2%
96/97 17.3 1.1 6%
97/98 17.0 1.5 8%
98/99 18.5 2.2 11%
99/00 19.6 2.8 13%
00/01 22.7 4.3 16%
PFI Market for School Building:
Scotland Example
Scotland Asset value Total Cost %
School (£m) (£m)
Projects
Glasgow 225 1,200 18.8
Falkirk 65 340 19.1
Edinburgh 80 300 26.7
West Lothian 27.8 156 17.8
Total 397.8 1996 19.9

• 75% of total PFI in Scotland has been in Schools


• Aggregate cost of £1,996 million over next 30 years to
procure assets with aggregate value of £397.8 million
(i.e. overall cost is 5 times higher that value of assets)
Debate over PPP/PFI

11.03.2004 / FT
Tim Stone (International Chairman of PPPs at KPMG)
warned that the Government's PPP investment
programme may place unreasonable demands on the
capacity of the private sector to deliver:

• there is currently a shortage of risk capital and


procurement skills in the public sector, combined with a
shortage of skilled PPP teams in the private sector.

• The Government must guide the PPP market and


manage the phasing and introduction of new projects,
otherwise it risks the loss of UK skills to developing PPP
markets in continental Europe
Importance of PFI

• There can be an increase in cost-


effectiveness e.g. maximising the benefits of
supply chain management
• Lessons learned from one scheme can be
applied to others through the process of
continuous learning
• Forward spending commitments can be more
transparent and certain
• There are better incentives to perform as
payments are directly linked to the
contractor’s performance
Attractiveness of PPP/PFI

• Project Economy (improved maintainability,


accelerated development, improved buildability, etc),
• Technology Improvement and Transfer (to
local enterprise)
• Public Sector/End-Users Benefits (budgetary
control, local economy development, reduced public sector
administrative cost)
• Private Sector Innovation and Creativity
(integrated solutions)
• Overall Savings (risk transfer, capped final service
costs)
Negative Elements of PPP/PFI

• Public and Private Sector Inexperience


• Excessive Commercialisation
• High Participation Cost and Time
Critical Success Factors for
PPP/PFI Projects

• Effective Procurement
• Project Implementability
• Government Guarantee
• Favourable Economic Conditions
• Available Financial Market
Value for Money in PPP/PFI
Factors: Factor Analysis

• COST SAVINGS (those which contribute towards


project cost-effectiveness)
• SUSTAINABILITY (factors associated with the long-
term effectiveness of the relationships between the
public and private sector stakeholders)
• RISK TRANSFER (the adequacy of risk transfer
mechanisms incorporated into project agreements)
• EFFECTIVE PROCUREMENT MEASURES
(efficiencies derived from the procurement system
itself).
Measures that enhance VFM in
PPP/PFI projects
Public Private Total
Mean Rank Mean Rank Mean Rank
Efficient risk allocation 3.88 1 4.07 4 4.02 1
Output based specification* 3.50 4 4.07 2 3.91 2
Long-term nature of contracts* 3.00 6 4.07 3 3.78 3
Early project service delivery 2.69 7 4.12 1 3.72 4
Risk transfer 3.50 3 3.60 7 3.57 5
Competitive tender 3.56 2 3.48 11 3.50 6
Private sector management skill* 2.38 12 3.81 5 3.41 7
Optimal use of asset/facility - efficiency* 2.63 9 3.57 9 3.31 8
Private sector technical innovation* 2.38 13 3.62 6 3.28 9
Nature of financial innovation* 2.50 11 3.54 10 3.25 10
Lower project life cycle cost* 2.38 14 3.57 8 3.24 11
Off balance sheet public sector financial treatment* 3.07 5 3.29 13 3.23 12
Improved/additional facilities to the public sector* 2.63 8 3.36 12 3.16 13
Profitability to the private sector 2.31 15 3.05 15 2.84 14
Level of tangible and intangible benefits to the users 2.50 10 2.95 16 2.83 15
Reduction in disputes, claims and litigation 2.19 16 3.05 14 2.81 16
Low shadow tariffs/tolls* 1.88 18 2.76 17 2.49 17
Environmental consideration 2.00 17 2.52 18 2.38 18
Best PFI projects

Similarities: The making of profit, achievement of value for money and successful risk
management of projects appear to be the some of the common reasons advanced by
the participants.

Differences: Each type of organisations proffered diverse reasons for describing certain
schemes as best.
PFI Risks

Design and Construction Risks


Commissioning and Operating Risks (incl.
Maintenance)
Residual Value Risk
Demand (or Volume / Usage) Risk
Technology and Obsolescence Risks
Regulation (incl. taxation, planning permission,
environmental)
Project Financing Risk
System Approach to RM
Identify the Risks and
Probability of Occurence

Are the Risks


Accepable?
Yes No

Acceptable Risks Can the Risks


Be Mitigated?
Yes No

Risks Are Mitigated and Can the Risks


Are Now Acceptable Be Spread?
Can the No Yes
AcceptableRisks
Be Spread?
No Provide the
Yes Appropriate
Spread
Can the Risks
Provide the
Be Retained?
Appropriate
Spread Yes No

Is the Event Abandon


Controllable onceAccident the Idea of
Occurs? the Activity
Yes No

Provide Retain
Contingency Risks and
Plan and Re-examine at
Retain Risk Intervals
Re-Classification of PFI Risks

• MACRO RISKS
– political, policy, economic, legal, social, industrial and
natural

• MESO RISKS
– selection, finance, design, construction,
technical, operation

• MICRO RISKS
– public service vs. private profit
PFI Risk Factor Criticality

Risk Factors Risk Group Mean Rank

Construction time delay Meso 3.56 1


Construction cost overrun Meso 3.51 2
Operation cost overrun Meso 3.5 3
Higher maintenance cost Meso 3.45 4
Design deficiency Meso 3.27 5
Frequency of maintenance Meso 3.23 6
Low operating productivity Meso 3.23 7
Legislation change Macro 3.18 8
Operational revenue below par Meso 3.18 9
Quality of workmanship Meso 3.17 10
Interest rate Macro 3.02 11
Relative weight

0%
4%
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12%
16%
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Type of risk
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Po
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So
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Ti
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investigated during a PFI project
Risk categories most frequently
Major types of risk examined

Similarities: All participants consider the common risks in PFI, like performance related
risks, financial risks, cost risks, construction risks, legislative changes, etc.
Main risk identification techniques

Similarities: All PFI participants rely on experience and consultation when they identify
risks.
Differences: Different other approaches are also used by different participants, like: risk
matrices are used by consultants, workshops by clients, databases by construction
companies, etc.
Similarities: Broadly similar methodologies are used in the risk evaluation process with
emphasis on Semi-quantitative and Qualitative approaches.

Differences: While all parties utilise external consultants, there are different degrees of
reliance. Notably most Client organisations tend to be significantly influenced in their
decision making.
Risk Assessment strategies

• Assess every risk as it is


• Assess every risk but model the price via
probabilities
• Assess on the main risks
• Benchmarking
• Adjudication in risk evaluation
• Reactive risk assessment
• Proactive risk assessment
• Sensitivity analysis in risk assessment
Problems encountered in risk evaluation

Similarities: All participants in one or another form refer to lack of common


understanding (experience, structure, clarity, etc.) during the risk evaluation. They admit
that this is not a precise science, but the variability of the approaches is sometimes seen
as a problem.
Differences: The public wants to see the whole process more transparent, while the
private sector requires more commercial approach.
Framework for risk assessment
and management for PFI projects
Grid 1 Grid 2 Grid 3 Grid 4

Public Risk Risk Risk


Iteration Negotiation Risk
Sector: Allocation
Risk Estimation
Assessment Allocation Price Procedures
Introduction Closed

Continuous
Risk Negotiation

Business OJEC Best three Preferred Financial


need notice bids bidder close
Some Conclusions

➲ In PFIs project risks are the fundamental area of discussion. It


determines bids’ competitiveness.
➲ Response to PFI risks is dependent on each organisation’s policy
or strategy.
➲ The expertise available for risk management of PFI projects is
shallow - predominantly experience based.
➲ The procurement method is growing and most expect to gain
experience as this matures.
➲ Although standardisation of the process will be of benefit to the
industry, this is still a tall order in view of lack of any coherent
practice at the moment.
➲ PFI uptake will be limited to those already have experience. This
is undesirable as it can stifle innovation