Opinion

Will Carillion collapse and NAO report end PFI?

30 January 2018 | By John Tibbitts

Double blow could change attitudes to PFI projects. John Tibbitts explains.

John Tibbitts

Despite what you may have heard, January’s National Audit Office (NAO) report on PFI and PF2 doesn’t actually form a view on the value for money of PFI, or make suggestions on how it might be improved. 

However, the demise of Carillion, a major PFI investor, constructor and operator, has been a gift to those who oppose privately-financed public infrastructure.

The government has rightly initiated investigations into the Carillion collapse, but so far has remained largely silent on PFI – and PF2, its “reformed” version. The reason for this is that it is a useful procurement process for the government.

The Infrastructure and Projects Authority has identified the need for more than £300bn of investment in the five years to 2020-21. Some of this will come from tax receipts and state borrowing but a significant proportion will be privately financed.

Opponents of PFI argue that no risk is transferred to the private sector. Well, the £375m Carillion had to write down on recent PFI projects looks like a fairly major risk transfer to the company’s shareholders. The failure of another PFI specialist Jarvis was also partly due to it underestimating the risk involved.

So despite its flaws, PFI does work from a government perspective. The bigger question now is whether the industry still has the enthusiasm for it. Without guarantees from the construction and FM companies that underpin the whole project finance structure, and provide the upfront investment, PFI schemes won’t get off the ground.

Nobody starts off with the intention of replicating Carillion’s mistakes, but can those signing off PFI bids really be sure that all the risks are well understood and properly priced? Anyway, how do you price in risk to cover a potential loss of £375m?

In the past, there has always been at least one company prepared to take a short-term view on risk. But with the lessons from Carillion fresh in the mind, many contractors may adopt a more cautious approach.

John Tibbitts was managing director of Kier Project Finance and is now an independent consultant

Comments

You might conclude that the NAO finds nothing fundamentally wrong with PFI as a model; it balancing advantage, risk and reward into an acceptable value-for-money proposition between the parties. PFIs are above all not a one-size-fits-all proposition. Bidding and finance costs do make PFI inherently suited to larger projects where only those with deep pockets, the capacity for the securities and an appetite for the broader risks can play. In PFI models, the deal is opened to considerable external scrutiny before commitment; as technical, legal and commercial risks and obligations are all examined against the operating model before lenders are convinced enough to approve and sign up, so these ought to be more 'secure' projects. However, if your portfolio of PFI projects doesn't contain either enough inherent risk contingency and/or you trade at such low margins; then one failure can indeed be an enterprise risk. Couple this with poor acquisition decisions, consequential debt and poor operational control and financial prudence and the house can be blown down - as we now see.

Steve Frizell, 2 February 2018

There has been a trend over the last 30 years for non construction trained persons to take over the senior management of construction companies and who have very limited understanding of the risks and need for proper risk assessment. Likewise the City have also become involved by their demands for taking all the cash out of businesses and leaving insufficient reserves for those rainy days

Roger Ward FCIOB PQS(F), 8 February 2018

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