Finance Committee

8th Report, 2008 (Session 3)

Inquiry into methods of funding capital investment projects

SP Paper 182 £15.30 Session 3 (2008)

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Finance Committee

8th Report, 2008 (Session 3)

Inquiry into methods of funding capital investment projects

Published by the Scottish Parliament on 16 December 2008

Finance Committee

8th Report, 2008 (Session 3)

Inquiry into methods of funding capital investment projects

CONTENTS

Remit and membership Executive summary 1 Report 9 Introduction 9 Evidence taken by the committee 9 Purpose of the report 10 Structure of the report 10 Current funding methods 11 Key issues in comparing PPP/PFI and conventional borrowing 17

Overview 17 Comparative Studies 18 Conventional Borrowing 19 Accounting treatment 19 Cost of finance 22 Risk 26 PPP/PFI refinancing 30 Competition and complexity in procurement 34 Options appraisal 37 Service delivery, quality and flexibility 39 Governance and accountability 47

Non-profit distributing organisation 49 Other approaches 56 Key issues in the current context 60 The Scottish Futures Trust 71 Abbreviations used in the report 81 Glossary of key terms 82

ANNEXE A: EXTRACTS FROM THE MINUTES 85

ORAL EVIDENCE AND ASSOCIATED WRITTEN EVIDENCE

Please note that all oral evidence and associated written evidence is published electronically only, and can be accessed via the Finance Committee’s webpages, at: http://www.scottish.parliament.uk/s3/committees/finance/inquiries/capitalInvestment.htm 9th Meeting, 2008 (Session 3), Tuesday 15 April 2008 WRITTEN EVIDENCE

Glasgow City CouncilHealth Facilities ScotlandTransport ScotlandScottish Funding CouncilCity of Edinburgh CouncilScottish Water

ORAL EVIDENCE

Lynn Brown, Executive Director of Financial Services, Glasgow City Council Douglas Griffin, Director of Finance, NHS Greater Glasgow Peter Haggarty, Assistant Director, Health Facilities Scotland Guy Houston, Director of Finance and Corporate Services, Transport Scotland Riona Bell, Director of Funding, Scottish Funding Council Donald McGougan, Director of Finance, City of Edinburgh Council Douglas Millican, Finance and Regulation Director, Scottish Water

SUPPLEMENTARY WRITTEN EVIDENCE

Scottish Funding Council 10th Meeting, 2008 (Session 3), Tuesday 22 April 2008 WRITTEN EVIDENCE

Scottish Council for Development and IndustryBritish TelecomAudit ScotlandCIPFA in Scotland

ORAL EVIDENCE

Iain Duff, Chief Economist and Policy Manager, Scottish Council for Development and Industry Martin Southern, Senior Consultant, BT Public Services Scotland Russell Frith, Director of Audit Strategy, Audit Scotland Angela Scott, Head of CIPFA in Scotland

SUPPLEMENTARY WRITTEN EVIDENCE

British Telecom

Audit ScotlandCIPFA in Scotland (on asset management)CIPFA in Scotland (on government deficit and debt)

11th Meeting, 2008 (Session 3), 29 April 2008 WRITTEN EVIDENCE

PricewaterhouseCoopersDundas and Wilson C.S. LLPKPMGMcGrigors LLPDr Jim Cuthbert and Margaret Cuthbert, Public Interest Research Network, University of StrathclydeMargaret Cuthbert and Dr Jim CuthbertMark Hellowell, Research Fellow, Centre for International Public Health Policy, University of EdinburghPPP Forum

ORAL EVIDENCE

Paul Brewer, Partner, Public Private Advisory, PricewaterhouseCoopers Amanda Methven, Partner, Planning and Projects Group, Dundas and Wilson C.S. LLP Jenny Stewart, Head of Infrastructure and Government, KPMG Michael Watson, Partner, Banking, Energy and Infrastructure and Procurement, McGrigors LLP Nigel Middleton, Managing Director, Barclays Private Equity Darryl Murphy, Managing Director, Infrastructure Finance, HSBC Iain Wales, Head of Structured Finance for the UK and Ireland, Dexia Public Finance Bank Dr Jim Cuthbert and Margaret Cuthbert Dr Iain Docherty, School of Business and Management, University of Glasgow Mark Hellowell Jan Love, PPP Forum

SUPPLEMENTARY WRITTEN EVIDENCE

McGrigors LLPBarclays Private EquityMark HellowellDr Jim Cuthbert Dr Jim Cuthbert and Margaret Cuthbert (on the capital charge) Margaret Cuthbert and Dr Jim Cuthbert (on refinancing) Dr Jim Cuthbert and Margaret Cuthbert (on NPDO schemes)

12th Meeting, 2008 (Session 3), Tuesday 6 May 2008 WRITTEN EVIDENCE

Architecture + Design ScotlandMott MacDonald

Keppie DesignRobertson Capital ProjectsBalfour Beatty CapitalOgilvie Group DevelopmentsQuayle MunroForth Electrical Services LtdCanmore Partnership Ltd

ORAL EVIDENCE

Gareth Hoskins, Board Member and Scotland's Healthcare Design Champion, Architecture + Design Scotland Alan Ledger, Project Director, Mott MacDonald David Stark, Managing Director, Keppie Design Alan Fordyce, Managing Director, Robertson Capital Projects Ian Rylatt, Managing Director, Balfour Beatty Capital Steven Tolson, Director, Ogilvie Group Developments Jo Elliot, Deputy Chief Executive, Quayle Munro Dylan Fletcher, Group Board Director, Forth Electrical Services Ltd Andrew Gordon, Chief Executive, Canmore Partnership Ltd

SUPPLEMENTARY WRITTEN EVIDENCE Architecture + Design ScotlandMott MacDonaldOgilvie Group DevelopmentsCanmore Partnership Ltd

13th Meeting, 2008 (Session 3), Tuesday 13 May 2008 WRITTEN EVIDENCE

British Medical AssociationUNISON UNISON (further submission)

ORAL EVIDENCE

Jon Ford, Head of Health Policy and Economic Research Unit, British Medical Association Dave Watson, Scottish Organiser, Policy, UNISON Ken Wimbor, Assistant Secretary, the Educational Institute of Scotland

14th Meeting, 2008 (Session 3), Tuesday 20 May 2008 WRITTEN EVIDENCE

Falkirk CouncilArgyll and Bute CouncilCordale Housing Association (submission to Scottish Government’s consultation) Network RailNorthern Ireland Strategic Investment BoardProCure21, Department of Health

The EDI Group Ltd ORAL EVIDENCE

Dougald Middleton, Head of Transport and Distribution, Ernst and Young Bryan Smail, Head of Treasury and Investment and Project Director, Falkirk Council Bruce West, Head of Strategic Finance, Argyll and Bute Council Michael Gerrard, Deputy Chief Executive, Partnerships UK; Stephen Gibson, Director, Cordale Housing Association; Robert MacDowall, Director, DTZ; Ron McAulay, Director for Scotland, and Fred Maroudas, Director of Finance, Network Rail Martin Spollen, Strategic Adviser, Northern Ireland Strategic Investment Board Ray Stephenson, Programme Manager, ProCure21, Department of Health Ian Wall, former Chief Executive, The EDI Group Ltd

SUPPLEMENTARY WRITTEN EVIDENCE Argyll and Bute Council

15th Meeting, 2008 (Session 3), 27 May 2008 WRITTEN EVIDENCE

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth

ORAL EVIDENCE

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth

SUPPLEMENTARY WRITTEN EVIDENCE John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth

19th Meeting, 2008 (Session 3), 9 September 2008 WRITTEN EVIDENCE

Canmore Partnership LtdGlasgow City Council (submission to the Scottish Government’s consultation) McGrigors LLPUNISON

ORAL EVIDENCEPaul Brewer, Partner, Public Private Advisory, PricewaterhouseCoopers Lynn Brown, Executive Director of Financial Services, Glasgow City Council

Andrew Gordon, Chief Executive, Canmore Partnership Ltd Donald McGougan, Director of Finance, Edinburgh City Council Dougald Middleton, Head of Transport and Distribution, Ernst and Young Nigel Middleton, Managing Director, Barclays Private Equity Angela Scott, Head of CIPFA in Scotland Dave Watson, Scottish Organiser, Policy, UNISON Michael Watson, Partner, Banking, Energy and Infrastructure and Procurement, McGrigors LLP

OTHER WRITTEN EVIDENCE

Submissions were also received from the following organisations in response to the original call for evidence.

Aberdeen City CouncilAssociation of Scotland’s CollegesBank of ScotlandCarillion Private FinanceCBI Scotland CIPFA Directors of FinanceComhairle nan Eilean SiarFife CouncilGrant ThorntonHBJ Gateley-WareingInstitute of Chartered Accountants in England and Wales, Institute Members Group in ScotlandInstitute of Value ManagementNHS LothianScottish Enterprise Edinburgh and LothianScottish Environmental Services AssociationSTUC

In addition, submissions were also received from the following organisations in response to the Committee’s request for views on the Scottish Futures Trust proposals.

Architecture + Design ScotlandCordale Housing AssociationIan WallNHS Greater Glasgow and ClydeScottish Funding Council

Finance Committee

Remit and membership

Remit: 1. The remit of the Finance Committee is to consider and report on-

(a) any report or other document laid before the Parliament by members of the Scottish Executive containing proposals for, or budgets of, public expenditure or proposals for the making of a tax-varying resolution, taking into account any report or recommendations concerning such documents made to them by any other committee with power to consider such documents or any part of them; (b) any report made by a committee setting out proposals concerning public expenditure; (c) Budget Bills; and (d) any other matter relating to or affecting the expenditure of the Scottish Administration or other expenditure payable out of the Scottish Consolidated Fund.

2. The Committee may also consider and, where it sees fit, report to the Parliament on the timetable for the Stages of Budget Bills and on the handling of financial business. 3. In these Rules, "public expenditure" means expenditure of the Scottish Administration, other expenditure payable out of the Scottish Consolidated Fund and any other expenditure met out of taxes, charges and other public revenue. (Standing Orders of the Scottish Parliament, Rule 6.6) Membership: Jackie Baillie (Deputy Convener) Derek Brownlee Joe FitzPatrick

James Kelly Alex Neil Jeremy Purvis Andrew Welsh (Convener) David Whitton Committee Clerking Team: Clerk to the Committee Susan Duffy Senior Assistant Clerk Mark Brough Assistant Clerk Allan Campbell Committee Assistant Stuart McLean

FI/S3/08/R8

Finance Committee

8th Report, 2008 (Session 3)

Inquiry into methods of funding capital investment projects

EXECUTIVE SUMMARY

This executive summary outlines the key themes and recommendations arising from the report.

Purpose of this report

The context in which this report has been produced is one of on-going development of the Scottish Government’s proposed Scottish Futures Trust. The report seeks to identify major issues that should be considered in any approach to public capital investment, along with key points that should be addressed in the development of the Scottish Futures Trust to ensure that it operates in an appropriate way and delivers value for money (paragraph 12).

Current funding methods (paragraphs 15-37)

The report describes the range of ways in which investment in capital projects can be undertaken, such as prudential borrowing including borrowing from the Public Works Loan Board, bond finance and various models of PPPs/PFIs.

The Committee also received written evidence about a range of other models, variants and combinations of different approaches, some of which would require legislative change. The Committee did not examine those proposals which would require legislative change, but recommends that the Scottish Government should investigate them further (paragraph 37).

Key issues in comparing PPP/PFI and conventional borrowing (paragraphs 38-173)

Many of the key points raised in evidence can apply to all approaches to capital investment. However the evidence tended to focus on comparing PPP/PFI and conventional borrowing.

Accounting treatment (paragraphs 47-61) Although in itself not part of the analysis of PPP/PFI and conventional borrowing, accounting treatment forms an important part of the background context. The UK

SP Paper 182 1 Session 3 (2008)

Finance Committee, 8th Report, 2008 (Session 3)

Government has announced that from 2009-10 onwards Government would prepare its accounts using the International Financial Reporting Standards (IFRS). However, at the time of the publication of this report, the UK Government had yet to explain what effect IFRS could have on the options available to public bodies to fund capital investment.

It is clear that the application of IFRS may have implications for the funding of capital investment and the Committee is disappointed that the situation remains uncertain. The Committee believes that decisions need to be taken as soon as possible, recommends that the Scottish Government continues to pursue this issue with the UK Government and hopes that the UK Government will provide more clarity on the issue (paragraph 61).

Comparing the cost of finance (paragraphs 62-78) It is difficult to make direct comparisons between the actual costs of borrowing from the private sector and borrowing through government sources such as the Public Works Loan Board (PWLB). There are a number of factors to be considered, such as the risk of default and the expected returns.

The Committee notes that there have been difficulties in providing comparable information on life-cycle costs for different methods of funding and procurement. The Committee believes that such information should be available for projects on a consistent and comparable basis and calls on the Scottish Government to develop and publish a robust investment option appraisal framework capable of producing comparable information on whole-life costs for future projects regardless of which method of procurement or operation is used. (paragraph 78).

Assessment of risk (paragraphs 79-95) A key element in the funding of capital projects is the assessment of risk. Risk can present itself in a number of ways, such as the possibility of cost and time over-runs, maintenance requirements and usage which differ from expectations, changes in service delivery, interest rate movement and other financing changes.

From the evidence, it would appear there is a lack of clarity on how risk is and should be measured. This results in risk being measured in a variety of ways which makes it difficult to make an accurate comparison between different projects. Therefore, the Committee recommends that the Scottish Government explore how improvements can be made to ensure that risk is measured and accounted for in a systematic manner to ensure consistency across all methods of investment and to ensure accurate comparisons can be made (paragraph 95).

PPP/PFI refinancing (paragraphs 96-109) Refinancing refers to the process by which the private sector can rearrange its bank loans at a lower interest rate once the project is signed and make a financial gain from this. The scope for refinancing of PPP/PFI deals has been one of the areas that has attracted substantial comment. Whether the public sector’s interests are protected should the private sector benefit from refinancing opportunities has a significant influence on the perception of the extent to which PPP/PFI deals represent value for money. The Committee heard considerable evidence on this, and the extent to which this aspect of contracts has now become standardised to help protect the public sector’s interests.

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Finance Committee, 8th Report, 2008 (Session 3)

The Committee notes that varying practices have been adopted in the past on the distribution of refinancing gains between the private and public sectors, and acknowledges some concern that the benefits may not always have been secured by the public sector. The Committee welcomes further recent guidance from the UK Government on the subject and recommends that the method for triggering refinancing provisions, and the sharing of any benefit accruing via them, should be transparent and equitable (paragraph 109).

Competition and complexity in procurement (paragraphs 110-121) A number of issues were raised in evidence with regard to procurement, such as competition, lead times, the cost of tendering and competitive dialogue.

The Committee recommends that the Scottish Government should:

• re-examine when and how competitive dialogue procedure needs to be applied, and the extent to which experience in other countries might lead to more efficient systems;

• consider how to retain and recycle knowledge so that repeated development costs are minimised;

• consider other ways to ensure participation of smaller Scottish companies; and

• investigate instances of limited competition for recent projects and seek to address this issue in any future capital investment arrangements (paragraph 121).

Options appraisal (paragraphs 122-129) The Committee believes that a broad range of options for funding and procurement of capital projects should be in place. The Committee notes the Scottish Government’s decision to make NPDO models the default form of private finance, and the statement in the Value for Money Guidance that, where NPDO is not suitable, other private finance models will be assessed.1 The Committee recommends that public bodies should select the method of financing which delivers best value to the taxpayer. The Committee, therefore, agrees by division that all methods of finance should be considered equally on their merits. A minority of the Committee endorses the Scottish Government’s position that the NPDO model should be the default option (paragraph 129).2

1 Scottish Government, November 2008. Value for Money Assessment Guidance: Capital Programmes and Projects. Para 1.17 states: “For sectors where it is viewed that NPD is not suitable, consultation with the Scottish Futures Trust is required in order to determine the appropriate Private Finance model to test.” Available at: http://www.scotland.gov.uk/Resource/Doc/919/0068647.doc [Accessed: 27 November 2008] 2 At its meeting on 25 November 2008, the Committee divided on the proposition that all methods of finance should be considered equally on their merits. For: 5 (Jackie Baillie, Derek Brownlee, James Kelly, Jeremy Purvis and David Whitton); Against: 3 (Joe FitzPatrick, Alex Neil and Andrew Welsh); Abstentions: 0.

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Finance Committee, 8th Report, 2008 (Session 3)

Delivery of facilities on time and on budget (paragraphs 131-135) The ability to deliver a facility on time and on budget, and operate it to achieve the desired service output, are key components of considering the merits, and value for money, of different approaches to capital investment. As with other facets of value for money, it is a difficult comparison to attempt.

The Committee recognises that there are potential difficulties in comparing PPP/PFI and conventionally procured projects and differing views over whether PPP/PFI delivers to time and budget. However, it also assumes that there is no reason why incentives and disciplines, which it is asserted are inherent in PPP/PFI projects, cannot be more widely used in projects funded wholly by the public sector. The Committee recognises that incentives appropriate to the public sector will need to be devised but it recommends that the Scottish Government ensures that comparable project management approaches are applied in any future arrangements (paragraph 135).

Service operation (paragraphs 136-139) Aside from simple cost factors, an essential element of value for money is whether the asset delivers what was promised and it is also important for all long-term projects to feature benchmarking and market testing throughout their lives. A report from the House of Commons Public Accounts Committee highlighted some concerns in this area.

The Committee believes that periodic benchmarking and market testing are essential to ensure contracts are delivering best value for the taxpayer, and recommends that the Scottish Government includes such procedures in future projects and ensures that these procedures themselves work in the best interests of the taxpayer. The Committee notes the concerns raised by the Public Accounts Committee, and recommends that they are addressed in contracts for all future projects (paragraph 139).

Flexibility (paragraphs 149-167) The ability of services to respond flexibly to changing service needs is an element of quality – but, when considering capital investment projects over a 30-year timeframe, it is also fundamental to a comparison of the long-term costs of different funding approaches. The Committee heard a wide range of evidence on the perceived inflexibility of PPP/PFI contracts but also the potential benefits of having whole life maintenance costs being built into a contract, as tends to be the case under PPP/PFI.

The Committee believes that it is important that, however they are provided or funded, public services are capable of evolving over time to meet changing demands and the expectations of users. The Committee believes that the public sector should only enter into long-term arrangements or contracts if sufficient flexibility can be built in without excessive cost, or if there can be certainty around the future demands on services (paragraph 167).

Governance and accountability (paragraphs 168-173) Throughout the inquiry, a number of witnesses emphasised the importance of identifying and monitoring the costs of PPP/PFI projects to assess value for money. The Scottish Information Commissioner has recently decided that contract

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Finance Committee, 8th Report, 2008 (Session 3)

information relating to a number of operational PPP/PFI schemes should be disclosed. Nonetheless, it appears that disclosure of material relating to schemes at earlier stages is likely not to be forthcoming. There has been an ongoing review of the operation of the Freedom of Information (Scotland) Act 2002, and one of the issues raised by the Scottish Information Commissioner and the Scottish Government is the extent to which it should apply to private companies delivering public functions.

The Committee takes account of the recent decisions of the Scottish Information Commissioner and recommends that a review is concluded on what information can be made public with regard to all types of contracts for public works, with a view to being as open and transparent as possible (paragraph 173).

The Non-Profit Distributing Organisation approach (paragraphs 174-207)

The basic structure of a contract under the NPDO model is the same as for traditional PPP/PFI. However there is a cap on the return for the private sector and in some projects any refinancing gains have been shared with a charity established for community benefit.

Governance (paragraphs 184-186) The involvement of stakeholder and independent directors in NPDOs was said by a number of witnesses to offer greater transparency on the operation of the special purpose vehicle (SPV), although there appears to be no empirical evidence of this effect or of any greater community involvement to date.

The Committee recommends that the Scottish Government ensures that consistent guidance is in place to ensure that the operation of charitable bodies established as part of NPDO schemes is conducted in a transparent manner, and that the governance arrangements and financial controls are at least as strong as those applying to the public sector generally. The Committee further recommends that the Scottish Government considers whether and how NPDO models might develop in the future without the automatic need for the use of a separate charitable body (paragraph 186).

Costs (paragraphs 187-192) Despite the change of structure, the actual process for securing the best value funding package remains largely the same for the NPDO model as for PPP/PFI, and under NPDO the public sector still pays a fixed unitary charge over the life of a project in the same way as for conventional PPP/PFI. A range of evidence was received on whether NPDO is cheaper overall than PPP/PFI.

The Committee notes that comparative costs between all funding models have been difficult to determine throughout this inquiry. The Committee calls on the Scottish Government to develop a robust framework capable of producing comparable information on whole-life costs for future projects regardless of which method of procurement or operation is used (paragraph 192).

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Finance Committee, 8th Report, 2008 (Session 3)

Market acceptance (paragraphs 193-203) There was much debate during the evidence sessions around the acceptability of the NPDO model to the market, particularly around the balance of refinancing provisions.

The Committee notes concerns raised by some witnesses on the potential for refinancing provisions in NPDO schemes to discourage some investors, and calls on the Scottish Government to review how refinancing provisions in NPDO models might be amended to ensure that they achieve intended aims without discouraging investment (paragraph 203).

Transferability (paragraphs 204-207) Witnesses generally agreed that, while the NPDO schools models used so far cannot simply be transferred to areas with different risk profiles and delivery capabilities, the key concepts of the NPDO approach can be applied in different sectors and to projects with different risk profiles.

However, the Committee cannot offer any recommendations or conclusions about the operation of the NPDO model as there is not yet enough evidence about its effectiveness as an alternative to PPP/PFI (paragraph 207).

Key issues in the current context (paragraphs 222-279)

Asset management (paragraphs 225-249) In a supplementary submission to the Committee, Angela Scott from CIPFA Scotland made a number of suggestions to improve asset management in the public sector. The Committee notes that these suggestions had not been put through CIPFA’s own internal governance procedures and therefore are not to be interpreted as the position of CIPFA.

The Committee concurs with CIPFA’s suggestions and recommends that the appropriate bodies examine ways in which these suggestions can be taken forward (paragraph 249).

Conventional public borrowing (paragraphs 250-258) Under Section 66 of the Scotland Act 1998, Scottish Ministers may only borrow money from the UK Government and may only borrow for the purpose of meeting a temporary shortfall in the Scottish Consolidated Fund or providing a working balance in the Fund. Local authorities can fund capital projects under the prudential borrowing regime, either on the open market (which has rarely been used) or through the Public Works Loans Board. However, a similar prudential borrowing framework is not in place for other parts of the public sector in Scotland.

The Committee notes that borrowing powers are already available to local government in Scotland, and could in theory be extended to other public bodies. The Committee notes the restriction set out in the Scotland Act on borrowing by Scottish Ministers and the apparent uncertainty on the consequences of extending such powers for the amount of funding provided to the Scottish Government under the current Statement of Funding Policy. The Committee further notes the uncertainty on the extent to which there is scope to extend the existing prudential borrowing regime without a restriction being imposed by HM Treasury.

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Finance Committee, 8th Report, 2008 (Session 3)

The Committee urges the Scottish Government to seek clarification from the UK Government on the scope to extend the existing prudential borrowing regime, both in terms of the amount borrowed and the bodies capable of undertaking such borrowing (paragraph 258).

Variations and joint working within the public sector (paragraphs 259-263) Several witnesses indicated that variations between public bodies in several respects, including governance structures, powers, funding practices, and accounting and tax treatment mean that they have different levels of flexibility in their capital investment options.

The Committee considers that the current framework makes it difficult for joint working and joint funding to take place and, therefore, recommends that the Scottish Government liaises with the UK Government to determine why various bodies must operate under different regimes and whether it is possible to simplify the current system (paragraph 263).

Managing market capacity (paragraphs 264-270) Several issues emerged related to the theme of how the public sector can manage the way in which projects are offered to the market in order to ensure optimum delivery and value for money. In this context, any potential hiatus in the pipeline of deals coming to the market is a concern, especially given the long lead time that projects have in procurement.

The Committee recommends that every effort is made to ensure that public bodies maintain a steady flow of capital projects to provide a regular supply of project opportunities for the construction industry and that there is sufficient transparency to ensure that the construction industry is aware that such opportunities exist (paragraph 270).

Skills (paragraphs 271-279) Throughout the inquiry, there has been wide consensus that the skills of the public sector are vital to ensuring value for money is achieved in capital investment, regardless of the procurement and funding model.

To ensure a steady flow of capital projects from public bodies, it is important that there are sufficient skills within the public sector and the Committee recommends that every effort is made to ensure that there is and will continue to be sufficient skills capacity in the public sector (paragraph 279).

The Scottish Futures Trust (paragraphs 280-316)

On 20 May 2008, the Scottish Government published a strategic business case, entitled Taking Forward the Scottish Futures Trust. In evidence the Cabinet Secretary for Finance and Sustainable Growth explained that the proposed SFT is about securing less expensive funding, but also “a new approach to the organisation and packaging of infrastructure investment opportunities in Scotland”. He said that it had three key components: reliance on the use of the NPDO model for financing projects; providing central expertise in project development; and

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aggregating projects to guarantee efficiencies in risk, finance and delivery arrangements.3

The Committee believes that while it is the Scottish Government’s view that the SFT will become a more attractive source of funding for national and local projects, that has yet to be proven. The Committee believes that the current economic climate may make it more difficult to introduce a new funding model for capital projects. The Committee, therefore, recommends that no infrastructure projects, national or local, should be delayed or postponed pending the introduction of the SFT funding (paragraph 316).4

3 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Cols 560-1. 4 The Committee divided on a proposal to insert the following paragraph before paragraph 316: “The Committee found no clear evidence that a separate limited company, the Scottish Futures Trust, is required to deliver better co-ordinated, managed and delivered infrastructure investment. Neither did the Committee receive clear evidence that any other funding option is to be available offering better value for money separate to all existing NPDO, PPP, prudential borrowing and traditional capital financing methods and believes any function to deliver better value for money and efficiency should be carried out by central government as part of its existing drive for better value for the public purse.” The proposal was disagreed to on a casting vote. For: 4 (Jackie Baillie, James Kelly, Jeremy Purvis and David Whitton), Against: 4 (Derek Brownlee, Joe FitzPatrick, Alex Neil and Andrew Welsh), Abstentions: 0.

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INTRODUCTION

1. On 25 September 2007, the Finance Committee agreed its approach to conducting an inquiry into the methods of funding capital investment projects.

2. The Committee agreed that the remit of the inquiry would be to consider and report on the advantages and disadvantages of different actual and proposed models of funding capital investment projects. This was designed to encompass the implications of the different models for public bodies’ costs and revenue streams and for the management and public benefit of the projects.

3. The inquiry was conducted against the background of the Scottish Government consulting on a proposed Scottish Futures Trust, which it described as a model “whose main aim is to provide an alternative means to PFI for channelling public and private capital into infrastructure investment programmes.” Its aim is to provide a more attractive approach by addressing some perceived criticisms of the PPP/PFI model that have been widely applied in the last 10-15 years, redirecting “excess profits made from traditional PFI funding” and improving partnership and management.1

4. In order to consider future policy development, the Committee examined evidence from the recent history of capital investment in Scotland in some detail. The Committee considered the key public sector perspective of what is required in order to ensure a good service outcome for the public, in terms of both value-for-money and quality of service delivery. However, it also sought to understand the conditions, approaches and mechanisms to ensure deliverability through sufficiency in both content and quality of private sector engagement and involvement with public projects.

5. At the time of conducting this inquiry, the long-term effects of the current financial situation on capital investment were not yet known.

EVIDENCE TAKEN BY THE COMMITTEE

6. An open call for written evidence was issued in September 2007. Over 30 submissions were received by the closing date in December. A substantial volume of evidence was received on a range of issues – including finance, procurement, project management, service design and delivery.

7. The Committee took oral evidence over the course of seven meetings in April and May 2008, hearing from a very wide range of witnesses who have substantial experience of all aspects of the recent history of capital investment in Scotland, and who are involved in the market currently. Witnesses included:

• a range of public sector bodies • legal and financial advisers • lenders and investors • academic and financial commentators

1 Scottish Government. (2007) Consultation on the role of a Scottish Futures Trust in infrastructure investment in Scotland. Scottish Government. Available at: http://www.scotland.gov.uk/Publications/2007/12/19093017/0 [Accessed 15 September 2008]

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• architects and designers • constructors • project managers and operators • trades unions

The Committee concluded this phase of its inquiry by taking evidence from the Cabinet Secretary for Finance and Sustainable Growth. 8. Towards the end of this phase, the Scottish Government published a strategic business case on its proposed Scottish Futures Trust. The Committee, therefore, took further evidence on this on 9 September from a range of stakeholders.

9. Some of the witnesses appearing before the Committee had previously responded to the open call for written evidence, and many then provided additional written evidence when called to give oral evidence. A number of witnesses were also asked to provide supplementary material on particular points raised during oral evidence, and very helpfully did so. The Committee would like to record its thanks to all those who provided written or oral evidence to the inquiry.

10. The Committee would also like to record its appreciation of the assistance it has received throughout this inquiry from its independent adviser, Grant Thornton – represented by Nathan Goode and Marianne Burgoyne of its Government and Infrastructure Advisory team. Both the advisers and SPICe produced a number of briefing papers which were of considerable assistance to the Committee.

11. The Committee's remit is restricted to considering matters related to the policy and administration of the Scottish Government. However, as the issues around the options for funding capital investment projects relate fundamentally to the policy frameworks and principles for public finance management set at a UK level, the experience of projects elsewhere in the UK formed an important part of the evidence. For this reason, the Committee was dismayed that its invitations to Treasury officials and to the Chief Secretary to the Treasury, The Rt Hon Yvette Cooper MP, to give evidence were declined. The Committee did receive a written submission from the Treasury later in the inquiry.

PURPOSE OF THE REPORT

12. The context in which this report has been produced is one of on-going development of the Scottish Government’s proposed Scottish Futures Trust. The report seeks to identify major issues that should be considered in any approach to public capital investment, along with key points that should be addressed in the development of the Scottish Futures Trust to ensure that it operates in an appropriate way and delivers value for money.

STRUCTURE OF THE REPORT

13. The report is structured as follows:

• A brief summary of some of the main funding options that the public sector may use (paragraphs 15–37)

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Finance Committee, 8th Report, 2008 (Session 3)

• A detailed examination of how PPP/PFI and ‘conventional borrowing’ compare in key respects, including:

• Accounting treatment (paragraphs 47–61)

• Cost of finance (paragraphs 62–78)

• Risk (paragraphs 79-95)

• PPP/PFI refinancing (paragraphs 96-109)

• Competition and complexity in procurement (paragraphs 110-121)

• Options appraisal (paragraphs 122-129)

• Service delivery, quality and flexibility (paragraphs 130–167)

• Governance and accountability (paragraphs 168-173)

• An examination of the non-profit distributing organisation model which has been developed to address some past concerns (paragraphs 174–207)

• A summary of key points from other approaches to improving capital investment (paragraphs 208–221)

• Some key issues in the current context (paragraphs 222–279)

• An examination of the Scottish Government’s proposed Scottish Futures Trust (paragraphs 280–316).

14. This structure includes specific conclusions or recommendations on particular issues, and highlights a number of broad areas around which the Committee makes recommendations for any future approaches to public sector capital investment.

CURRENT FUNDING METHODS

Overview

15. The total Scottish Budget is known as Total Managed Expenditure (TME) and comprises Departmental Expenditure Limit (DEL) and Annually Managed Expenditure (AME). AME covers expenditure which is difficult to predict precisely but where there is a commitment to spend or pay a charge. Examples include teachers’ and NHS staff pensions and motorway and trunk road interest charges. The DEL is the discretionary element of the budget and is made up of DEL Resource and DEL Capital. DEL Resource is equivalent to the in-year costs of providing services but also includes PPP/PFI unitary charge payments. Table 1 below presents the elements comprising the 2009-10 budget.

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Table 1: Allocation of TME to DEL and AME: Cash Terms2

£m 2009-10 Budget Total Departmental Expenditure Limit (DEL) of which: 29,297.9

DEL Resource 25,775.0 DEL Capital 3,522.9

Annually Managed Expenditure 5,462.6 Total Managed Expenditure 34,760.5 PPP payments are made from the DEL resource budget and in 2009-10 are projected to be £680 million. Figure 1 below depicts the proportions of the 2009-10 DEL budget which the government plans to spend on DEL resource (minus PPP/PFI Unitary Payments), PPP Unitary Payments and DEL capital. Figure 1: 2009-10 DEL by Resource, PPP/PFI Unitary Payment and Capital

DEL Capital12%

PPP Unitary payments2%

DEL Resource (minus PPP/PFI Unitary

Payments)86%

16. The Scottish Government’s Infrastructure Investment Plan 2008, which was published in March 2008, states that “infrastructure investment in Scotland already utilises a variety of funding methods and that is set to continue…The majority of investment continues to be made by the public sector at its own hand.”3

17. In the Draft Budget 2009-20104, total capital spending by the Scottish Government in 2009-2010 is shown as £3.5 billion. Table 5 of the Draft Budget gives an estimate of £369 million of capital spending by the private sector on signed deals and Table 6 shows estimated payments under PPP contracts of £680 million in 2009-10. 2 The figures in this table do not take account of the re-profiling of £227 million of capital expenditure from the 2010-11 budget to 2009-10, announced by the Cabinet Secretary for Finance and Sustainable Growth in a letter to the Finance Committee dated 1 December 2008. 3 Scottish Government. (2008) Infrastructure Investment Plan 2008. Available online at: http://www.scotland.gov.uk/Publications/2008/03/28122237 [Accessed: 10 December 2008] 4 Scottish Government. (2008) Draft Budget 2009-10. Available online at: http://www.scotland.gov.uk/Publications/2008/09/12140641 [Accessed: 10 December 2008]

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18. There are a range of ways in which investment in projects can be undertaken such as prudential borrowing including borrowing from the Public Works Loan Board, bond finance and various models of PPPs/PFIs. The following sections describe each of these current funding methods in detail. Proposed funding methods are considered later in the report.

Prudential borrowing

19. The Scottish Government funds the debt servicing costs (i.e. principal and interest) of some borrowing, known as ‘supported borrowing’, through the financial settlement. This is a capital allocation for each local authority to direct towards its own priorities. Unsupported borrowing, arranged under what is known as the ‘prudential regime’, is financed through local authorities’ own general resources.

20. The Local Government in Scotland Act 2003 repealed previous controls on local authority borrowing and introduced the “prudential borrowing framework”. This allows local authorities the freedom to determine for themselves how much they can afford to borrow – based on the primary criterion of affordability - and proceed with investment without central government approval. This flexibility is underpinned by the requirement to follow a professional framework developed by the Chartered Institute of Public Finance and Accountancy (CIPFA), known as the “prudential code”5 and it has given local authorities increased flexibility. The City of Edinburgh Council described it as “a great enhancement to local authorities’ ability to invest sustainably and properly”.6

21. Under the prudential code, local authorities must assess the impact of borrowing in the context of their financial sustainability throughout the whole term of the loan, allowing a wide assessment of affordability and also opening opportunities for borrowing against savings and future income streams.

22. The NHS – and other Scottish central government bodies – are not generally able to borrow on their own account. However, CIPFA stated that a freedom (subject to monitoring and regulation) similar to prudential borrowing powers has been extended to foundation hospital trusts and, more recently, NHS trusts in England.7

23. Other approaches to providing flexibility similar to that offered by prudential borrowing have been developed elsewhere in the public sector. The Scottish Funding Council (SFC) described the flexibility of individual colleges and universities to borrow up to delegated amounts, with a system for the SFC to assess affordability before consenting to any higher amounts.8 It also explained that while it is not allowed to borrow and cannot issue bonds, it is developing a central borrowing facility on which individual institutions can draw. The mode of finance for this facility has not yet been decided.9

5 CIPFA. (2003) The Prudential Code for Capital Finance in Local Authorities. London: CIPFA. 6 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 342. 7 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 382. 8 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 342. 9 Scottish Parliament Finance Committee, Official Report, 15 April 2008, Cols 340-341.

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Public Works Loan Board

24. Prudential schemes also allow for local authorities to borrow from the Public Works Loan Board (PWLB) – a statutory body in the UK Debt Management Office, which can offer fixed and variable rate loans to prescribed bodies at more favourable rates than can be achieved in the market. Smaller projects are capable of being funded under the prudential approach, whereas they have not tended to be suitable for PPP/PFI funding. With local authorities’ freedom to judge affordability, there is also a responsibility to report to central government to allow monitoring of overall borrowing.

Bond Finance

25. Schedule 3 of the Local Government (Scotland) Act 1975 permits local authorities to raise money through issuing bonds – tradeable debt instruments. This remains a possible option, and is discussed further in regard to the Scottish Futures Trust at paragraph 290 below. However, in terms of current approaches to capital investment, the City of Edinburgh Council stated that bonds are not generally the most attractive option as access to the PWLB now provides sufficient borrowing at a lower rate than would be available in the bond markets.10 The Scottish Funding Council (SFC) also said that it was examining a group borrowing facility because “issuing a bond to a much smaller organisation would not be attractive to lenders”.11 Several witnesses referred to bond issues from Network Rail and Transport for London – which have been backed by central government guarantees and offered at extremely competitive rates.

PPP/PFI

26. The private sector has always been involved in public capital projects in a range of roles, even if only as a construction contractor. The Private Finance Initiative (PFI) was introduced by the Conservative government in 1992 to open up opportunities for more private sector involvement in the provision and modernisation of public services. PFI combines the public procurement of capital assets from the private sector with an approach to contracting for private provision of certain services. In the PFI model, the private sector contractor also raises the capital finance for the project. In 1997, the Labour government adopted the term Public Private Partnerships (PPP) which, according to the then Chancellor, the Rt Hon Gordon Brown MP “reinvigorated”12 PFI. PPPs are arrangements typified by joint working between the public and private sector. PPP is not a single model, rather it is an umbrella description and PFI is a form of PPP. Since 1997, the two terms have tended to be used interchangeably. There are many forms of PPP around the world, and the Committee’s advisers produced a briefing on international PPP structures.13

27. There is a huge range of variation in projects under the PPP/PFI concept. The most common involves private sector contractors designing, building, 10 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 341. 11 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 340. 12 House of Commons Hansard, 2 July 1997, Col 315. 13 Available on the Committee’s webpage at: http://www.scottish.parliament.uk/s3/committees/finance/inquiries/capInvest/adviserIntl.pdf

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financing and operating facilities to fulfil an output specification set by the public sector commissioning body, such as a local authority or health board. Despite the variation, the general principles and the methods of securing funding are generally similar.

28. A contract to deliver a project is established between the public sector body and a special purpose vehicle (SPV) that is set up by a private sector consortium to deliver the project. The capital finance raised by the private sector is secured primarily on the revenues that will be generated by the project over the life of a contract – typically 25 to 30 years. The PPP/PFI contractor will receive a guaranteed spread of revenue payments over the contract period. The public sector does not own the capital asset during the contract period. Contracts will either provide for ownership of the asset reverting to the public sector at the end of the period or remaining with the contractor. Some evidence indicated that contracts may also specify that the public sector owes valuable residual obligations to the contractor for a further period.14

29. Different models are possible for the revenue payments to the SPV. In some cases there may be an agreement that the contractor receives payment through user charges. In others the payment is a fee (the ‘unitary charge’15) from the public body for the use of the facility. Central government support for these costs (known as ‘level playing field support’ and then ‘revenue support’ in Scotland, and as ‘PFI credits’ in England) has been available to public bodies to support the costs of PPP/PFI projects. In Scotland, this has met 80% of the costs.

30. According to Mark Hellowell from the Centre for International Public Health Policy as of October 2007, the total capital value of PPP/PFI contracts across the UK was £56.9 billion. Of this, £5.2 billion was spent in Scotland (equivalent to £1,028 per head); £50 billion in England (£1,017 per head); £1.1 billion in Northern Ireland (£631.4 per head) and £618 million in Wales (£213 per head).16

31. HM Treasury’s published forecasts show the aggregate future revenue commitments under PFI deals for the years 2006-2032 to be £155 billion. The flow of projects is also expected to continue in future, with the 2007 UK budget providing for a further £10.9 billion PFI credits for an expected £22.2 billion worth of projects to reach financial close by April 2011.17 The Scottish Government stated that unitary charges on existing capital investment deals already create a stream of commitments to 2041-42 for all variants of the model. The commitment totals £500 million of revenue in 2007-08, rising by 13.9%, 15.6% and 17.1% in the

14 Margaret Cuthbert and Dr Jim Cuthbert: The Royal Infirmary of Edinburgh – A case study on the workings of the Private Finance Initiative. Written submission to the Finance Committee. 15 The ‘unitary charge’ is calculated by reference to the costs incurred by the project company, including costs of: construction, service, financing, insurance and other project costs. 16 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 17 HM Treasury. (October 2007) 2007 Pre-Budget Report and Comprehensive Spending Review. HM Treasury. Available at: http://www.hm-treasury.gov.uk/pbr_csr07_index.htm [Accessed: 10 December 2008]

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next three years respectively, to reach £787 million in 2010-11, and only beginning to decline significantly after 2032-33.18

32. The following table shows the unitary payments made by Scottish and UK governments on PPP/PFI deals in recent years, including non-profit distributing organisation deals19:

Year Scotland

£mUK £m

1997-98 2 169 1998-99 14 621 1999-00 51 882 2000-01 73 1,242 2001-02 144 1,909 2002-03 287 2,239 2003-04 360 2,955 2004-05 374 3,623 2005-06 405 3,999 2006-07 443 4,755 2007-08 509 5,350 2008-09 608 6,043 2009-10 705 6,566 2010-11 794 6,695 Use of surplus assets

33. Receipts generated from disposing of assets are one source of funds available for use for capital investments. Receipts from the sale of assets in the local government sector can be retained to be used for a capital purpose or to make principal repayments on a loan. However, receipts in the health, central government, further and higher education and registered social landlord sectors generally have to be remitted back to Scottish Ministers. Bodies often obtain permission in advance from Ministers to sell assets and retain receipts where this retention is an essential part of a business case for funding larger capital projects. As these projects will almost always be sanctioned or funded by Ministers, permission is rarely withheld.

34. As an example of the potential scale of this option, the City of Edinburgh Council stated that it has generated almost £300 million through asset sales since 1996 and plans for a further £115 million over the next four years.20 Several witnesses mentioned other approaches to using surplus assets, such as the potential for joint public-private ventures – for example, where a local authority can contribute land to a project in order to help lever in potential private sector 18 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 562. 19 Sources: Scottish Government. (2008) personal communication, and UK Treasury, PFI Signed Projects List. Available at: http://www.hm-treasury.gov.uk/d/pfi_signed_projects_list.xls [Accessed: 3 December 2008]. UK figures exclude Scotland. 20 City of Edinburgh Council. Written submission to the Finance Committee.

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investment in infrastructure and facilities. However, careful consideration needs to be given to potentially significant issues of business transparency and accountability where public contributions are made to such projects.

35. Witnesses generally agreed that the opportunities from, and approaches to, asset sales are very variable across the public sector and across the country, and opportunities may be expected to diminish in the future. Edinburgh city council said that asset holdings are, in any event, insufficient to generate receipts to meet overall investment needs.21

Other methods

36. The Committee also received written evidence about a wide range of other models, variants and combinations of different approaches. Oral evidence received on different approaches such as the Local Improvement Finance Trusts (LIFTS) is discussed in the section entitled “Other Approaches”. CIPFA stated that leasing of some assets is an option where it can provide better value than borrowing – for example, where it can allow flexibility in harnessing changing technology.22 In some cases authorities may have the option of using revenue budgets to fund capital expenditure directly, if other budgetary pressures allow. Direct central government capital grants have also been provided to support particular initiatives or to focus expenditure on a particular service area – for example, the fire capital grant.

37. Some other suggestions advocated approaches that may require legislative change. For example, Edinburgh city council discussed the possibilities of local tax increment financing or supplementary business rates schemes to underpin and stimulate targeted infrastructure development in a particular area. It expressed concern that – in contrast to experience in other countries - there is currently no incentive for local authorities to increase the revenue received from non-domestic rates. It suggested that allowing local authorities to retain a proportion of increases would allow them to finance, under the prudential framework, investment in infrastructure.23 The Committee did not examine these proposals from the Council in detail, but recommends that the Scottish Government should investigate them further.

KEY ISSUES IN COMPARING PPP/PFI AND CONVENTIONAL BORROWING

Overview

38. During evidence to the inquiry, the following were raised as key issues that need to be addressed in relation to capital investment. Many of the key points raised in evidence may apply to all approaches to capital investment and may offer lessons for any future capital investment approach. However, the evidence to the Committee tended to focus largely on comparing PPP/PFI with conventional public borrowing.

21 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Cols 335-6. 22 CIPFA Directors of Finance Section. Written submission to the Finance Committee. 23 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 361.

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39. The choice of method should be based on the objectives and benefits that the public sector seeks to achieve through a particular project, the risks that are inherent in trying to achieve those objectives, and an assessment of which parties have the skills, capability and knowledge best to take on those risks. BT Scotland and others suggested that only when these factors are determined should the best financial mechanism for sharing the risk and, equally, allocating reward for achievement of the benefit, be devised in order to meet the public sector’s objectives.24

40. As stated in the introduction, the long-term effects of the current state of the financial markets on capital investment are not yet known. However, an issue which should be borne in mind in the current climate is the reluctance of financial institutions to lend money and even where institutions are still prepared to lend, they are tending to lend less than they did previously. Additionally, it is not clear at this stage to what extent the changes in public finances could impact on the borrowing rates offered by the Public Works Loan Board.

Comparative Studies

41. A proper comparison depends on the extent to which the different factors can be identified and assessed for similar projects procured under different routes – and the evidence indicated that there has not been such a study. The interaction of many factors over a long period of time means that it is difficult to produce a straightforward list of projects and assess what their costs would have been under different procurement and financing routes. To achieve an accurate comparison, a number of PPP/PFI and conventional procurements would need to be examined in detail (both in terms of the infrastructure and the associated operations) over a substantial length of time. However, evidence suggested that obtaining appropriate comparative data is extremely challenging.

42. Examinations of public capital expenditure have tended to focus on one approach and to emphasise the need for caution in making comparisons. Audit Scotland published a study of PPP/PFI schools projects in 2002.25 This reported benefits for the projects in terms of project management, risk transfer and financial control. However, it stated that the benefits were not necessarily unique to PPP/PFI and suggested that comparisons are inherently uncertain and subjective. This relative lack of comparison makes it difficult to establish in isolation whether the perceived benefits of a facility derive from the PPP/PFI method or simply from the fact that the facility is new. Audit Scotland stated that there is, “a risk that procurement decisions were driven by stereotypes of poorly performing alternatives to PFI rather than good evidence of demonstrable benefit”.26

43. Commentators also generally emphasise that operational experience of PPP/PFI contracts is still relatively limited and, consequently, that comparative whole-life costs cannot yet be fully assessed. There has also been some concern 24 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 368. 25 Audit Scotland for the Accounts Commission. (2002) Taking the initiative - Using PFI contracts to renew council schools, June 2002. Available online at: http://www.audit-scotland.gov.uk/docs/local/2002/nr_020612_PFI_schools.pdf [Accessed: 10 December 2008] 26 Audit Scotland. Written submission to the Finance Committee.

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that the selection of projects to study can create very significantly biased results – and different commentators sometimes appear to have used the same projects to support contradictory conclusions.

Conventional Borrowing

44. A number of witnesses emphasised the perceived strengths and weaknesses of the traditional public borrowing approach. Conventional borrowing has been described as a comparatively cheap and flexible approach, retaining all control of the project within the public sector. It is also a method in which the public sector retains complete ownership of the asset. However, there have also been criticisms of it, as typified by separation of construction from maintenance, under-investment in life-cycle costs, a lack of focus on whole-life costs and poor management disciplines.

45. Many witnesses outlined the perceived strengths and weaknesses of the PPP/PFI model, often presenting them as contrasts to the perceived weaknesses of conventional borrowing. For example, Dundas and Wilson, a legal firm which has acted as an adviser for PPP projects, summarised the key benefits as: cost certainty while allowing the cost to be spread; risk transfer that equates to value for money; disciplines that lead to improved deliverability of projects to time, budget and performance criteria; and a focus on whole-life considerations being integral to the contract.27 Others emphasised the improved relationships that may be gained from the public sector dealing with a single contractor which is incentivised to deliver.

46. Dundas and Wilson also highlighted several areas that may be perceived as weaknesses: high costs of procurement; higher cost of finance; inflexibility of contractual arrangements; and a perception of high private sector profits being made from public services. A significant portion of the evidence heard by the Committee focused on examining all of these perceptions.

Accounting treatment

47. Although in itself not part of the analysis of PPP/PFI and conventional borrowing, accounting treatment forms an important part of the background context. One of the reasons advanced by many witnesses for the growth in the use of PPP/PFI was its ability to secure investment additional to that which could be secured through conventional public capital spending. However, several witnesses expressed uncertainty about the effect that accounting treatment changes may have on achieving this.

48. At present, if a project is financed under PPP/PFI, the unitary charge paid for the use of the building and services provided is accounted for as current spending. Treasury guidance allowed most PPP/PFI transactions to be classed as ‘operating leases’ rather than ‘finance leases’. The capital expenditure associated with projects does not normally score as public expenditure and the public sector’s future liability for the debt is not recognised on the balance sheet. This is known as

27 Dundas and Wilson. Written submission to the Finance Committee.

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‘off-balance sheet’ financing. Normally, with appropriate transfer of risk to the private sector, a PPP/PFI project would be expected to fall ‘off balance sheet’.

49. Audit Scotland said that, in previous years, “Government was prepared to support a number of capital projects, but only if they were off balance sheet. Of course, that led to all sorts of incentives for public bodies to organise contracts to meet the accounting criteria that got them off balance sheet.”28 However, Audit Scotland stated that the accounting methods currently used for PPP/PFI projects are, in practice, “leading to inconsistent accounting and balance sheet treatments” and “resulting in a number of large capital assets being on nobody’s balance sheet”.29

50. In the 2007 UK Budget, the then Chancellor of the Exchequer announced that from 2008-09 onwards Government would prepare its accounts using the International Financial Reporting Standards (IFRS). This results from a global desire for standardisation in reporting requirements. Financial statements play a particular role in transparency and existing public sector accounting frameworks are, therefore, in the process of moving to these new common rules. One likely area of change is the public sector accounting treatment of PPP/PFI assets.

51. Under IFRS, there is not one single standard that directly addresses accounting for PPP/PFI projects. However, there is an assumption that the fixed asset, where it is used for public service delivery, will be recognised on the public sector user’s balance sheet. The extent to which PPP/PFI projects will be recognised in public sector accounts in this way will depend on the precise nature of the concession, potentially including issues such as who retains ownership of the infrastructure at the end of the contract and where the control, risk and reward lies. Similarly, some leases may require to be reclassified as ‘finance leases’ and recognised on the balance sheet as the consequence of capital expenditure.

52. The Treasury currently produces information on the proportion of PPP/PFI commitments accounted for on the public balance sheet as part of its regular update on PPP/PFI data.30 However, there is as yet no clear picture of exactly how much liability from PPP/PFI is likely to move onto the public sector balance sheet, although it is expected that the vast majority will have to do so at a value reflecting the point reached in the contract. The terms of all individual contracts need to be examined, and the application has now been delayed until 2009-10 for central government and health bodies, because neither the Ministry of Defence nor the Department of Health – the two biggest PPP/PFI users – is sufficiently advanced in identifying the movements required. Local government will apply IFRS from 2010-11. It is considered possible that a very significant portion of the total value of existing PPP/PFI schemes could be added and, of course, the same consideration applies to any future schemes.

28 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 392. 29 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 388 – gives the example of Kilmarnock Prison, which is not on the balance sheet of either the provider or the Scottish Prison Service. 30 The Treasury’s PFI Signed Projects List – March 2008 lists 103 projects in Scotland, of which the capital value for only two is listed as scored on the public balance sheet. Available online at: http://www.hm-treasury.gov.uk/d/pfi_signed_projects_list.xls [Accessed: 10 December 2008]

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53. Although the Chief Secretary to the Treasury declined to give oral evidence to the Committee, her office responded to a request for further information on 14 August 2008. Among other issues, the Chief Secretary was asked what effect IFRS could have on the options available to public bodies to fund capital investment.

54. In that letter, the Treasury stated that, “No decisions have yet been made on the budgeting implications of IFRS. However, it is the intention that decisions on whether or not to use private finance should continue to be made on value for money grounds. In devolved spending areas these value for money judgements are a matter for the Scottish Executive to make within their block budget.”31

55. Decisions on this have implications for central government policy, and may affect the appetite for different approaches to capital investment. One of the UK Government’s self-imposed fiscal rules has been that public sector net debt (PSND) should remain below 40% of GDP over the economic cycle. It has been suggested that part of the attraction of PPP/PFI schemes has been that the off-balance sheet accounting adopted to date has allowed significant levels of capital investment to be made in recent years without increasing PSND. A number of witnesses to the Committee’s inquiry commented on this ‘additionality’.

56. The forecasts in the UK Budget 2008 show PSND rising to 39.8% of GDP in 2010-11, meaning that the addition of only a small portion of PPP/PFI liability would breach the 40% rule.32 On 20 October 2008, the regular joint statement on public sector finances by the Office of National Statistics and the Treasury showed that net debt in September 2008 was equivalent to 43.4% of GDP, or 37.9% of GDP if Northern Rock is excluded. In his Mais lecture, the Chancellor of the Exchequer indicated that the self-imposed fiscal rule would not be applied in the current economic climate. He stated “to apply the fiscal rules in a rigid manner today would be perverse. We would have to take money out of the economy, exacerbating an already difficult situation”.33 In the 2008 Pre-Budget Report, the Chancellor of the Exchequer stated that, in the current exceptional economic circumstances, allowing borrowing to rise is the right choice and set what he described as a “temporary operating rule” to govern borrowing in the current economic context. He projected that UK net debt as a share of GDP would increase to 48% in 2009-10, 53% in 2010-11 and would peak at 57% in 2013-14, and then subsequently falling as a share of the economy by 2015-16.34

57. At the time of conducting this inquiry, the exact method of accounting for PPP/PFI projects had not yet been resolved by the Treasury and its position on whether application of IFRS will, in fact, lead to any significant reclassification of PPP/PFI debt remained unclear. No further detail was provided in the 2008 Pre-Budget Report. However, the Committee understands that the Financial Reporting 31 Letter from the Assistant Private Secretary to the Chief Secretary to the Treasury to the Clerk to the Finance Committee dated 14 August 2008. 32 This forecast was made before the extra borrowing announced by the Chancellor on 13 May 2008 to fund increases in income tax personal allowances, and does not include the impact of further spending on supporting the banking industry. 33 The Mais Lecture on Maintaining Stability in a Global Economy given by the Chancellor of the Exchequer at the Cass Business School, London, 29 October 2008 34 House of Commons Hansard, 24 November 2008, Cols 493-4

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Advisory Board has recently approved the final version of the IFRS-based Financial Reporting Manual to be issued by the Treasury for the opening balance sheet, shadow accounts and first full IFRS accounts. That manual includes specific rules for accounting for PPP/PFI projects, and it is expected that the impact of these rules will be that the draft opening balance sheets will show the vast majority of existing PPP/PFI schemes in health and central government to be on balance sheet.

58. A number of witnesses emphasised that it is unclear what effect the implementation of these proposed accounting changes would have on the market for infrastructure investment – both in terms of the Government’s appetite for encouraging PPP/PFI-style investment, and of any impact on the private sector’s willingness to invest in such schemes.

59. Audit Scotland confirmed that accounting treatment is a technical issue, with no difference in cash flows whichever approach is used.35 NHS Greater Glasgow and Clyde stated that the public sector hopes “that someone will work out a way of ensuring that the change, which is a non-cash item, has no impact on our ability to provide services”.36

60. The key point made by many witnesses with regard to IFRS application is that on-balance sheet accounting will at least force public authorities to think more clearly about the merits of different approaches. Several witnesses emphasised that accounting determination should never in any event be influencing capital investment decisions and the choice of procurement and funding methodology. Quayle Munro stated that, “There is a great liberation in that, as it allows us to think up many different structures that may have the effect of improving value for money.”37 Audit Scotland stated that assessment of projects should now “more genuinely reflect their overall value for money as there are no incentives for bodies to construct contracts in ways to simply achieve an off balance sheet accounting treatment.”38

61. It is clear that the application of IFRS may have implications for the funding of capital investment and the Committee is disappointed that the situation remains uncertain. The Committee believes that decisions need to be taken as soon as possible, recommends that the Scottish Government continues to pursue this issue with the UK Government and hopes that the UK Government will provide more clarity on the issue.

Cost of finance

Project finance 62. Finance for each PPP/PFI project will have different characteristics, depending on the nature of the project, its size and risk profile, and market conditions at the time. The terms offered by the funding providers will also be dependent on a number of factors, including current market conditions and the risk

35 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 383. 36 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 352. 37 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 489. 38 Audit Scotland. Written submission to the Finance Committee.

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associated with the project. However, the basic structure of the finance will be similar.

63. The finance to meet the capital costs of a PPP/PFI project has tended to consist predominantly of debt (known as senior debt), with a smaller proportion of equity, or risk capital – typically in a 90:10 debt:equity ratio. The special purpose vehicle (SPV) is responsible for securing the debt funding required to construct the asset. The ability to secure a predominance of debt (i.e. loans to be repaid on set terms) reflects the secure and predictable cash flows expected from the contract.

64. Shareholders supply the remainder by providing equity finance (risk capital) in recognition that there are risks which debt providers would be unwilling to bear. Finance from equity holders normally includes a large element of sub-ordinated or junior debt. The providers of equity finance (usually construction contractors, major service providers and financial investors) will expect to receive a higher return than debt providers as, in the event of default, junior debt ranks lower and is only repaid once all senior debt claims have been satisfied. However, using junior debt results in a more tax efficient structure than pure equity alone.

65. The unitary charge paid by the public sector commissioning body is calculated by reference to the costs incurred by the SPV. The charge is usually split into availability and service elements. The availability element (often approximately 60% of the total unitary charge according to Mark Hellowell of the Edinburgh University Centre for International Public Health Policy39) is a fixed cost, providing the SPV with the income required to meet its capital financing costs, taxation and equity dividends and to build up reserves to meet life-cycle costs. The service element includes payment for service costs, routine maintenance and management.

66. Normally the debt-service element remains roughly constant. However, because some or all of the unitary charge is index-linked, the gap between revenues and fixed costs widens over time, potentially increasing profits if variable costs can be controlled. In different models of PPP, that profit would be directed to different entities (e.g. the SPV of a PPP/PFI scheme, or a charity of an NPDO scheme). Financial models tend to provide for debt to be repaid some years before the end of the contract, potentially further enhancing profit in the later years of projects. However, this ‘tail’ has reduced in later projects as the risks of PPP/PFI projects have become better understood and more acceptable to funders. The financial model also aims to deliver a target rate of return over the life of the contract, with different returns at different stages. Very substantial shareholder dividends could be expected to be concentrated in the final years of a project.

67. The characteristics of the funding package secured will have a significant impact on the level of the unitary charge. The SPV is responsible for securing the best value funding package, running a funding competition to seek to ensure both value for money and deliverability. The funding package chosen in the particular circumstances - bank, bond or a mixture of both - will be dependent on the package that offers best value to the public sector. As experience of the risks has

39 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee.

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developed, bidders have been able to develop instruments to hedge some of them and offer lower unitary charges.

Comparing the cost of finance 68. It is difficult to make direct comparisons of the actual costs of borrowing from the private sector and through government sources such as the PWLB. There are a number of factors to be considered, such as the risk of default and the expected returns. McGrigors stated that it could not identify any figures to allow direct comparison of PPP/PFI and PWLB projects.40

69. Government borrowing is the cheapest way of raising funds as it is backed by tax revenues and so is regarded as virtually risk-free, and with no margins or fees levied. Scottish Enterprise stated that the PWLB rates in October 2007 were 4.85% for 30-35 year loans.41 The City of Edinburgh Council said that, currently, “Every £10 million of borrowing would cost us about £800,000 per annum over a 20-year period”.42

70. Overall, there was a consensus among witnesses that the cost of private capital is higher. Various examples were given of the cost of senior debt raised privately for PPP/PFI projects. CIPFA, citing the 2002 Audit Scotland report, stated that private financing costs were 2.5%–4% above those of direct public borrowing, adding costs of between £0.2-£0.3 million a year for each £10 million invested.43

71. Evidence generally indicated that the gap between the costs of public and private borrowing has narrowed as the PPP/PFI market has matured. The Treasury stated in December 2006 that the cost of debt finance on recent PFI hospital deals was 0.7% above government gilt rates.44 In April 2008, KPMG stated to the Committee that rates have reduced considerably and, in the last six months, would typically be 0.6% above PWLB rates.45 At the time of writing this report, there were indications that debt margins were rising.

72. As noted above, higher risk attaches to the capital raised through equity and sub-ordinated or junior debt, resulting in higher expected returns. Canmore suggested that a fair return on risk capital is 14%. Balfour Beatty Capital also suggested this figure, and explained how elements of that return cover other costs, such as those for unsuccessful bids.46

73. A number of witnesses mentioned the impact that the current tightness in the credit markets may have on privately-financed projects, but there was no clear consensus. Some indicated that the availability and pricing of debt would be more conservative for an unpredictable period, leading to less competition to fund 40 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 413. 41 Scottish Enterprise. Written submission to the Finance Committee. 42 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 330. 43 CIPFA Scotland and CIPFA directors of finance section, joint response to Scottish Futures Trust consultation 44 Treasury evidence quoted in House of Commons Committee of Public Accounts. 25th Report, Update on PFI debt refinancing and the PFI equity market, (April 2007) HC158 (2006-07). Available online at: http://www.publications.parliament.uk/pa/cm200607/cmselect/cmpubacc/158/158.pdf [Accessed: 10 December 2008] 45 KPMG. Written submission to the Finance Committee. 46 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 476.

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projects. However, others emphasised that the public sector ‘covenant’ of guaranteed income streams and a consequently very low risk of default puts the public sector in a powerful position to benefit from a “flight to quality” where, comparatively, “the tightest possible deals can be cut”.47 However, in the current climate, pricing is still rising due to the limited availability of credit even for what could be termed ‘secure’ clients such as the public sector.

74. PWC emphasised that there are ways of reducing the cost of debt, although “these will need to be carefully calibrated so as not to weaken its disciplinary influence”.48 The PPP Forum also highlighted potential policy initiatives to reduce the cost of private capital while still maintaining the disciplines it brings. It suggested increased use of public sector contributions or government-backed guarantees for a proportion of the debt.49 Several witnesses highlighted that Transport for London and Network Rail are able to raise funds at very low margins (around 0.3%) above government gilt rates as a result of being backed by government guarantees. Carillion highlighted credit guarantee finance, where HM Treasury essentially raises funds from the market and lends on to PFI contractors. Others highlighted different approaches to bundling projects (both at the level of an individual procuring authority, and at a programme level), to secure the benefits of aggregation.

75. Although not directly a point about the cost to the public sector of securing private capital, a number of witnesses emphasised particular examples of high returns that have subsequently been secured by the private sector as evidence of the costs being too high. BT Scotland acknowledged that, with PPP/PFI, “over the years, some projects have been far too expensive or the system has not given the benefits that were wanted”.50

76. Margaret Cuthbert, an economist whose research in recent years has concentrated on public finance in Scotland cited the example of the Hairmyres Hospital project, where she stated that a total gross (non-discounted) return of £89.1 million over the life of the project was expected to accumulate to junior debt providers whose equity stake was only £100.51 Dr Jim Cuthbert argued that a major element of what is perceived as excess profit is a result of “inappropriate indexation of the non-service element of the unitary charge”, and that the extent to which this has been corrected needs to be examined.52 Analysing this, they argued that, for the same stream of availability charges due for the new Edinburgh Royal Infirmary, “the public sector could have borrowed 2.04 times the amount of capital which was actually raised”.53 Others suggested that, without indexation, the unitary charge would simply need to be higher so that the same amount of money goes through the financial model over the life of the contract to achieve the target rate of return.

47 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 539. 48 PricewaterhouseCoopers. Written submission to the Finance Committee. 49 PPP Forum. Written submission to the Finance Committee. 50 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 372. 51 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 449. 52 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 436. 53 Jim Cuthbert and Margaret Cuthbert, 2008. Written submission to the Finance Committee.

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77. Mark Hellowell also stated that the source of ‘excess returns’ has not been sufficiently well studied.54 Neither is it sufficiently clear from the evidence heard the extent to which some of the examples cited by witnesses can be regarded as examples of bad practice and poor deals negotiated in the early years of PPP/PFI when risks were uncertain, and unlikely to be repeated now or representative of the sector as a whole. Significant standardisation in contract terms and approaches is said to have followed Treasury guidance produced in 1999. Notwithstanding the issues noted above, the Treasury suggests throughout its guidance that the additional cost of private finance is not so significant that it inherently undermines the potential for PPP/PFI to demonstrate value-for-money. PWC emphasised that, while a local authority pays a higher cost of capital, “it is buying something completely different from what it would be buying if it raised money against its own balance sheet to fund a project.”55 The question is whether the increased financing costs are adequately off-set by any benefits that other factors such as whole-life costing and appropriate risk-sharing in PPP/PFI are said to bring to projects. These points are examined further below.

78. The Committee notes that there have been difficulties in providing comparable information on life-cycle costs for different methods of funding and procurement. The Committee believes that such information should be available for projects on a consistent and comparable basis and calls on the Scottish Government to develop and publish a robust investment option appraisal framework capable of producing comparable information on whole-life costs for future projects regardless of which method of procurement or operation is used.

Risk

Overview 79. A key element in the funding of capital projects is the assessment of risk. Risk can present itself in a number of ways, such as the possibility of cost and time over-runs, maintenance requirements and usage which differ from expectations, changes in service delivery, interest rate movement and other financing changes. A number of issues associated with risk were raised in evidence.

Methods of risk transfer 80. In traditional procurement methods, the public sector does not pay for risks through a premium being added to borrowing costs. The taxpayer effectively underwrites the risks, and provides capital at a lower cost. However, the risks still exist and the public sector then bears the costs when risks materialise and must be addressed. It is just that the costs of the risks are not built into the up-front cost of borrowing.

81. Evidence to the Committee suggested that the risks in capital projects are not generally insurable, but operate in “an entirely bespoke situation”.56 Quayle Munro

54 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 55 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 413. 56 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 415.

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stated that, “If an easy way of insuring such risks existed, I would like to think that we would have found it by now.”57 However, the question appears to be not so much whether some form of insurance model is a better approach to funding capital expenditure than the financial returns implied by PPP/PFI. Rather, it is whether, in approaches where they are not costed in at the beginning, the public funds will be available - and appropriately prioritised - for the necessary extra expenditure should the risks materialise. The public sector generally requires a suite of insurances to cover all aspects of the physical project itself.

82. PPP/PFI projects are said to provide value for money through the private sector taking on, pricing, and managing these project risks more effectively than the public sector could. As the PPP/PFI contractor will only start to receive payments when the delivery of public services starts – and will suffer deductions if specified performance criteria are not met - the effective transfer of risk is said to provide robust discipline and incentives to supply services on time and consistently to the stated quality.

83. Witnesses indicated that the risk model is an essential element of lenders’ decision-making. Due diligence by senior debt funders will rigorously test the capability of the PPP/PFI contractor to manage the risks that affect performance, in order to ensure repayment of the debt. Banks also impose discipline throughout the period of the loan through close monitoring of project performance. However, according to Mott MacDonald, a global management, engineering and development consultancy, “when the public sector funding route is taken it is up to the client to impose that discipline on himself.”58 Similarly, the equity holders have an incentive to manage the project actively. Balfour Beatty Capital explained that, beyond a contractor’s liquidated damages liabilities, “equity provides another layer of what is, in effect, a cash-collateralised performance bond that has to be burned through before the company fails”.59 Robertson Group also emphasised that, after other bonds and guarantees, “A 100 per cent liability sits on companies such as ours.”60

Risk premium 84. Essential to any assessment of whether value for money is achieved through PPP/PFI is the question of whether optimal financial risk is effectively transferred to the private sector without the guarantee by the taxpayer against loss, and how the private sector seeks to cost the return it demands in order to accept this. It will generally be necessary to identify and cost risks individually to assess whether the expected benefits of PPP/PFI are sufficient to outweigh its perceived extra costs and disadvantages. Public bodies need to consider individually, and on a case-by-case basis, whether it is better to accept residual liability or to pay the premium required by the private sector. As Ian Wall said, “We cannot get rid of risk; rather, we must decide whether to accept it or pay someone else to accept it.”61

57 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 484. 58 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 455. 59 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 477. 60 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 477. 61 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 544.

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85. The higher the risk being accepted by the contractor, the greater the risk premium that is likely to be included in the bid costs to compensate them for their exposure. Determining whether the premium is acceptable to the public sector can be inherently problematic as some risks are difficult to quantify and it is always a matter of judgement – although experience of actual outcomes is increasing all the time. Several witnesses emphasised that the fact that many PPP/PFI projects are highly profitable does not mean that there is no risk and is not in itself an indication that the projects, as signed, did not represent good value for the public - but simply that the SPV has successfully managed risks.62

Level of risk for the private sector 86. It is difficult to identify robust data on the profitability of projects and to identify whether any projects have in fact made a loss. A survey undertaken by KPMG in 2007 found that 83% of managers indicated that the contract was delivering a positive annual profit, with 70% having done so in each year of operation. In 25% of these cases, profits have been better than expected, and significantly better in 3% of cases. 17% of contracts were not delivering profits, 38% were delivering less profit than expected and 11% were delivering significantly less than expected.63 This does not answer the question as to whether any projects have made a loss. When asked whether, apart from the East Lothian schools project, any projects had made a loss, Jan Love from the PPP Forum described situations where there had been a lower than expected profit. When pressed on whether that could equate to making a loss she responded that “there are schemes where people have made losses….I can’t give examples because they are individual companies.”64

87. The early PPP/PFI deals were said by some witnesses to have been priced on terms that reflected the uncertain risks of a new market, thus giving potential for significant gains if the risks were successfully managed out. Several witnesses emphasised that this is balanced by the fact that real risks were accepted and investors lost money on some projects. Many witnesses acknowledged that the need to get up to speed and make a new model work had contributed to some poor decisions and poor-value projects in the early years of PPP/PFI. Equally, many witnesses emphasised that the PPP/PFI market has matured. Over time it has also been acknowledged that PPP/PFI may be more suited (and more likely to be judged better value for money) to some types of public service projects than others.

88. The number of examples of project failure, where risk has been taken on but not managed successfully, appears to be low. Barclays Private Equity stated that, “PFI/PPP would not exist as a procurement mechanism if such difficulties were commonplace, but we have suffered financial loss and have had to put more money into a project merely to enable it to be delivered for the public sector.”65

62 See Balfour Beatty Capital, Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 476. 63 KPMG. (2007) Effectiveness of operational contracts in PFI. Available online at: http://www.kpmg.co.uk/pubs/305432_PFI.pdf [Accessed: 10 December 2008] 64 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 444. 65 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 428.

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89. A number of witnesses cited the example of the East Lothian schools project – where problems arose due to insolvency of a contractor/investor at an early stage of construction – as illustration of how the risk transfer in PPP/PFI is effective in dealing with project failure at no additional cost to the public sector, albeit with, in that case, considerable delay in services being delivered.66 Under traditional public borrowing, the local authority would have had no insulation against meeting these extra costs itself or abandoning the project.

90. The Committee was made aware of three other projects where the public sector had bought out the contract for very considerable assets – the Skye Bridge, West Lothian College and Inverness Airport terminal. However, these are not examples of contractor failure. A paper from the Committee’s adviser indicated that these are examples where changes in service delivery or policy priorities had a significant impact on the attractiveness and continued suitability of the original PPP/PFI contract to the public sector body. 67

91. Dr Iain Docherty from the University of Glasgow also suggested that, on very large or complex projects, such as the Metronet concession for the London Underground, “the public sector always retains the bottom-line risk”.68 There was no clear evidence presented on whether this is as a result of poorly-constructed contracts, or whether it is inevitable once projects become over a certain critical size or importance. Mott MacDonald cited the Channel Tunnel Rail Link where, in a package underpinned by Eurostar revenues, the successful bidder agreed to take on the risk but got its forecast of demand substantially wrong – obliging the UK Government to intervene and provide guarantees to ensure project delivery.69 Clearly, transfer of risk is essentially related to a correct assessment of controllability of risk, and the governance structure of the project reflecting this.

92. The Committee heard a range of views on whether the transfer of risk is effective and the allocation of risks between the public sector and the contractor is optimal. Balfour Beatty Capital stated that, “The value attaching to these risk transfers almost always outweighs the higher cost of finance.”70 However, Mark Hellowell cited a study to argue that the actual cost of capital in PPP/PFI projects significantly outweighed what should have been expected for an investment with the particular project’s risk. He also cited research to suggest that the assessment of the value of risks transferred is “highly subjective”.71

Assessment of risk 93. Economist Margaret Cuthbert and Dr Jim Cuthbert who was previously the chief statistician at the then Scottish Office stated that, on the new Edinburgh Royal Infirmary project (when value for money assessment could be said to have

66 See written submission to the Finance Committee by Dundas and Wilson 67 The Committee’s adviser provided background details on the costs of these buy-outs to the public sector. 68 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 446. 69 Mott McDonald. Supplementary written submission to the Finance Committee. 70 Balfour Beatty Capital. Written submission to the Finance Committee. 71 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee.

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been in its early stages), certain risks were invalidly included in the assessment.72 With regard to risk, they also stated that, “if you hand out to five different PFI schemes the expected value of something going wrong – if there is a 20 per cent chance of the project going wrong, you will hand out 20 per cent of the expected cost – in four out of five cases, the project will not go wrong and that cost will be banked as a windfall profit. In the remaining case, the project will go wrong and the 20 per cent that you have handed out will not cover the cost, so the scheme will go bust.”73 The Cabinet Secretary argued that profit from refinancing (see below) inevitably means that, “the natural conclusion must be that we have come to the wrong conclusions on the actual risk transfer involved”.74 However, Dundas and Wilson stated that there appears to be no empirical evidence on whether it is better value for the public sector to retain the risks of asset management and deal with them in-house or through short contracts.75

94. Some witnesses emphasised that the public sector has tended not to appreciate risk adequately and has, as a result, been demonstrated to be prone to ‘optimism bias’ – a systematic tendency in risk assessment mechanisms to assume the best possible timetable and cost outcomes. However, there was no clear evidence on whether there is any inherent reason why the private sector should manage risk better than the public sector. This is a particularly complex issue, with risk profiles varying at different stages of projects, and perceptions of risk varying as experience of different projects has developed. However, as outlined in the Scottish Public Finance Manual, all capital projects with a total budget exceeding £5 million must be assessed for their level of risk.76 High risk projects must undergo a ‘gateway review’ (for PPP projects this is termed a ‘key stage review’) which is undertaken at each key decision stage by a small independent team. Some witnesses argued that the private sector’s expertise is focused on managing certain kinds of risks. However, there was little direct evidence presented of effective risk management on an individual project basis.

95. From the evidence, it would appear there is a lack of clarity on how risk is and should be measured. This results in risk being measured in a variety of ways which makes it difficult to make an accurate comparison between different projects. Therefore, the Committee recommends that the Scottish Government explore how improvements can be made to ensure that risk is measured and accounted for in a systematic manner to ensure consistency across all methods of investment and to ensure accurate comparisons can be made.

PPP/PFI refinancing

96. Refinancing refers to the process by which the private sector can rearrange its bank loans at a lower interest rate once the project is signed and make a financial gain from this. 72 The Royal Edinburgh Infirmary: A Case Study on the Workings of the Private Finance Initiative, Margaret Cuthbert and Jim Cuthbert, 2008. Written submission to the Finance Committee. 73 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Cols 446-447. 74 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 577. 75 Dundas and Wilson. Written submission to the Finance Committee. 76 Scottish Government. (2007) Scottish Public Finance Manual. Available online at: http://www.scotland.gov.uk/Topics/Government/Finance/spfm [Accessed: 10 December 2008]

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97. The scope for refinancing of PPP/PFI deals has been one of the areas that has attracted substantial comment. Whether the public sector’s interests are protected should the private sector benefit from refinancing opportunities has a significant influence on the perception of the extent to which PPP/PFI deals represent value for money. The Committee heard considerable evidence on this, and the extent to which this aspect of contracts has now become standardised to help protect the public sector’s interests.

98. Following completion of the construction phase and experience of the early operational period (typically one year for standard projects) of a project, many of the most significant risks are deemed to have been overcome. This enables contractors to reduce their financing costs as funders may be prepared to offer them improved terms to reflect the reduced risk. Some commentators suggested that the opportunity for substantial refinancing gains has arisen mainly from very conservative and unfavourable funding terms offered in early PPP/PFI deals before the market and associated risks were fully understood.

Refinancing of debt 99. The majority of the benefit of refinancing will be derived through being able to change the gearing - increasing the proportion of senior debt in the project to replace some of the equity (or sub-ordinated or junior debt). Balfour Beatty Capital stated that, typically, the cost of equity or sub-ordinated debt investment is a 14% real cash return77 - while some witnesses suggested around 6% as a typical cost of senior debt. A change in the ratio of the two can, therefore, produce a potentially significant gain.

100. Interest rate movements since the agreement of financial terms for the project would generally only have an impact in relation to any additional senior debt, due to penalty conditions connected with making changes to the original tranche of debt. Refinancing can also extend the term of senior debt – which, at the outset of a 30-year project, may typically have been on a 25-year term. Extending repayment later into the project allows extra borrowing against the security of several extra years’ revenues, creating cash which can be returned to shareholders but adding debt to the project.

101. Margaret Cuthbert and Dr Jim Cuthbert raised a number of high profile early PPP/PFI projects, highlighted by the National Audit Office (NAO), where very significant refinancing gains were made – for example, the Norfolk and Norwich University Hospitals NHS Trust, where the contractor (Octagon) increased its investors’ internal rate of return to 60%, from the 19% predicted when it bid for the contract.78 These rates appear to have been used as a proxy for whether the projects represent value for money.

102. However, there has also been some concern that refinancing leads to the public sector’s potential exposure to additional risks coming at a time when the PFI contractor has received most of the benefits of refinancing and might then become less rigorous about managing performance. Margaret Cuthbert and Dr Jim

77 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 476. 78 Margaret Cuthbert and Jim Cuthbert, PFI: Refinancing, supplementary written submission to the Finance Committee, May 2008

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Cuthbert stated that restructuring allows investors to take out the net present value of future profits, dissipating the reserves and the discipline of the private sector to deal with any future potential difficulties – such as increased maintenance costs. They stated that, in accepting a share of the refinancing gains, the Norfolk and Norwich Trust agreed substantial increases in termination liabilities and a five-year extension to the contract.79 The NAO has suggested that this kind of deal reflected a lack of negotiation skills by the public sector at a local level.80

103. Regardless of actual profit levels, the perception appears to be established that significant refinancing gains for the private sector, combined with additional risks for the public sector, indicate that public benefit is not being maximised. In early PPP/PFI projects, the public sector contracting authority did not receive any direct benefit from refinancing. Following examples of very substantial gains being made on early projects, the UK Government acknowledged that considerable sums had potentially been lost to the public sector by not having a contractual entitlement to share refinancing gains. This led to provision being made for the public sector to share in refinancing gains – thus improving the potential value for money of deals.

104. It was clear from evidence from contractors and financiers that they believe the private sector should be rewarded for the risk that it takes – which is not shared with the public sector - and the way in which it has managed a project. However, it was also clear that it had been accepted that refinancing gains should be shared with the public sector. Canmore Partnerships summed this up by saying: “What is a fair return? I would say 14 per cent, which is why I would accept a capped return of 14 per cent. Is refinancing good value? Yes, if it happens. Should it be shared with the public sector? Of course it should.”81

105. The position on refinancing gains when the Committee took its evidence was that the UK Government had initiated a new approach to PPP/PFI contracts, requiring refinancing gains to be shared equally between the public and private sector for all deals signed after July 2002. In deals signed prior to this date, a voluntary code of conduct issued by the Office of Government Commerce in 2002 set the expectation that the private sector would voluntarily share 30% of any refinancing gain.82 In October 2008, this approach was further modified. Refinancing gains will be shared equally where there is a refinancing gain of up to £1 million. The private sector will receive 40% and the public sector 60% of refinancing gains up to £3 million and where refinancing gains are over £3 million, private sector investors will receive 30% of the gain while the public sector will receive 70%. This approach is mandatory for all projects that were still in

79 Margaret Cuthbert and Jim Cuthbert, PFI: Refinancing, supplementary written submission to the Finance Committee, May 2008 80 Referred to in House of Commons Committee of Public Accounts. 25th Report, Update on PFI debt refinancing and the PFI equity market, (April 2007) HC158 (2006-07). Available at: http://www.publications.parliament.uk/pa/cm200607/cmselect/cmpubacc/158/158.pdf [Accessed 17 October 2008] 81 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 486. 82 Office of Government Commerce, Refinancing for early PFI transactions Code of Conduct, October 2002. Available online at: http://www.hm-treasury.gov.uk/d/PPP_Refinancing_Code_of_Conduct.pdf [Accessed: 10 December 2008]

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competitive procurement at 1 November 2008 (ie, where final bids have not been receive or the competitive dialogue procedures have not been closed). It is therefore, not mandatory for projects at preferred bidder stage or where final bids are received before 1 November 2008. However, this approach is “encouraged” where it is not mandatory.83 In addition, the Scottish Government states in its recently published NPD explanatory note that it has adopted the same position for NPDO projects.84

Refinancing of equity 106. Some initial equity investors have sought to sell their investments in PPP/PFI projects, resulting in the development of a secondary market for equity. Unlike refinancing of debt, there is no guidance from the Treasury requiring provisions for any gains made from the refinancing of equity to be shared with the public sector. Equity investors have put at risk their own capital that would have been lost in the event of project failure. Refinancing of equity is, therefore, seen by the Treasury as a legitimate source of return for the private sector.

107. A number of witnesses also suggested that, as the market has matured and there appears less development risk in PPP/PFI projects, pension funds are buying stakes in projects on the secondary market because of their attractive profile of sustained and stable guaranteed return over a long period. There is a possibility that increased investor interest in infrastructure funds and the introduction of new sources of capital may assist in increasing competition for new projects. However, there is also the risk of reduced competition as a result of shares becoming too concentrated in a few funds – particularly as one of the reasons for refinancing can be to create added efficiencies through portfolio effects.85 Batching of PPP/PFI assets in investment portfolios may risk distancing investors from the operation of projects, potentially dissipating the disciplines to resolve problems that are said to be a key benefit of the PPP/PFI approach.

108. A change in equity ownership of the private sector PPP/PFI contractor is seen by some as a transaction that is outside the public sector’s interest. However, an understanding of how value for money can be appraised (and ensured for future deals) depends in part on access to information about what is in the contract. The Treasury publishes information on the equity holders in current PPP/PFI projects,86 although the House of Commons Committee of Public Accounts has recommended that this needs further work to be comprehensive. The NAO suggested that it is not clear that all early refinancings will necessarily have been reported to public sector commissioning bodies.87

83 HM Treasury. (2008) Standardisation of PFI Contracts: Amending Refinancing Provisions. Available at: http://www.hm-treasury.gov.uk/d/sopc4_addendum171008.pdf[Accessed 7 November 2008] 84 Scottish Government. (2008) NPD explanatory note. Available online at: http://www.scotland.gov.uk/Topics/Government/Finance/18232/NPDExpNote [Accessed: 10 December 2008] 85 Dundas and Wilson, quoted in Margaret Cuthbert and Jim Cuthbert, PFI: Refinancing, supplementary written submission to the Finance Committee, May 2008 86 HM Treasury, PFI Equity Holders – November 2007. 87 National Audit Office, PFI Refinancing Update, November 2002. Available online at: http://www.nao.org.uk/publications/nao_reports/01-02/01021288.pdf [Accessed: 10 December 2008]

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109. The Committee notes that varying practices have been adopted in the past on the distribution of refinancing gains between the private and public sectors, and acknowledges some concern that the benefits may not always have been secured by the public sector. The Committee welcomes further recent guidance from the UK Government on the subject and recommends that the method for triggering refinancing provisions, and the sharing of any benefit accruing via them, should be transparent and equitable.

Competition and complexity in procurement

110. A number of issues were raised in evidence with regard to procurement, such as competition, lead times, the cost of tendering and competitive dialogue.

Competition 111. Sufficient competitive pressure is essential to ensure good value for money in any contractual situation. For PPP/PFI contracts, strong competition is said to play a central role in ensuring that risk transfer is effective and properly priced. Any factors which may lead to a reduction in competition therefore need to be examined carefully.

112. No evidence was presented on the level of competition among contractors bidding for contracts to build facilities procured using conventional borrowing. A number of witnesses suggested that there may be anecdotal evidence that the level of competition for PPP/PFI contracts has reduced in recent years. Jenny Stewart of KPMG cited factors such as the global market that now exists and skills shortages and stated “the point is not as much about the funding model per se as it is about the general issue of being in a global marketplace. Trying to attract people to Scotland is very important.”88 The NAO has reported that PPP/PFI projects generally attract a relatively low level of competition and cited the two main issues as the general complexity of tendering for PPP/PFI contracts and the particular pressures created by the ‘competitive dialogue’ procurement procedure.89

Lead times 113. There was some contradictory evidence on whether conventional or PPP/PFI contracts are more prone to long lead times – complicated by the need to disentangle contractual complexity from the effects of the procuring authority changing plans. CIPFA suggested that using a borrowing model it was possible to design, procure and build two schools in 18 months, while it took two years simply to set up the contracts for a PPP/PFI project undertaken around the same time.90 However, Keppie Design cited the example of 15 and 16 years taken to design and build Ninewells Hospital and Aberdeen Royal Infirmary using public funding and separating design and construction.91 Avoiding changes in specification by the commissioning authority through improved management would clearly bring benefits in both PPP/PFI and conventional procurement. 88 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 442. 89 National Audit Office. (2007) Improving the PFI tendering process. Available online at: http://www.nao.org.uk/publications/nao_reports/06-07/0607149.pdf [Accessed: 10 December 2008] 90 CIPFA Directors of Finance Section. Written submission to the Finance Committee. 91 Keppie Design. Written submission to the Finance Committee.

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Cost of tendering 114. The cost of the tendering process for PPP/PFI projects is generally accepted to be high compared to traditional procurement, regardless of the size of the project – although it should be noted that a PPP/PFI contract also has to deal with issues such as service and maintenance levels and costs.. Various witnesses cited different figures for bidding costs, ranging from 1% to 3% of capital costs. Ogilvie Group stated that costs for abortive bids may regularly be over £1 million, which cannot be sustained by medium-sized Scottish businesses.92 Audit Scotland estimated that the total of all set-up and adviser costs in the schools projects it examined were between 5% and 15% of capital cost.93 Barclays Private Equity also indicated that, because an SPV generally exists to run one particular project, knowledge recycling by both private and public sectors is poor, leading to repeating of development costs each time.94

115. The alleged high transaction and development costs to both public and private sectors were said to have several effects. They have established a presumption that PPP/PFI projects with a low capital price are likely to represent poor value for money, and a number of adverse comments on PPP/PFI appear to relate to smaller projects which some witnesses acknowledge with hindsight were not appropriate for this funding approach. Bid cost also appears to be at least part of the reason for some infrastructure projects being bundled together for offer to the market – with, for example, a single contract being offered for provision of several schools. Several witnesses emphasised that, while there may be a strategic rationale for it, bundling and focus on high value contracts can have the effect of putting projects out of the reach of all but the biggest companies, potentially excluding many Scottish businesses. The high costs are also one of the reasons for a variety of centralised and standardised approaches to contracts and the tendering process, in an attempt to limit the new advisory and developmental work that is required on each new project.

Competitive Dialogue 116. The private sector has expressed some concern about the high costs incurred by preferred bidders. However, many witnesses emphasised that the difficulty of high bid costs has been multiplied by the ‘competitive dialogue’ procedure introduced in 2006 as a result of an EU procurement directive, which prevents early selection of a preferred bidder. Keppie Design stated that it “would almost go as far as saying that PFI is dead because of competitive dialogue, which makes a complicated process even more complicated”.95

117. Ogilvie also argued that competitive dialgoue is making it difficult for small and medium-sized Scottish businesses to participate. Therefore, it could potentially be argued that this militates against economic growth. Robertson Group estimated that it has “tripled or quadrupled our bidding costs, which are now

92 Ogilvie Group. Written submission to the Finance Committee. 93 Audit Scotland for the Accounts Commission, Taking the initiative - Using PFI contracts to renew council schools, June 2002. Available online at: http://www.audit-scotland.gov.uk/docs/local/2002/nr_020612_PFI_schools.pdf [Accessed: 10 December 2008] 94 Barclays Private Equity. Supplementary written submission to the Finance Committee. 95 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 464.

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several million pounds”.96 It can only afford to bid on one project at that level in a year, and all companies must seek to recover these higher costs from future successful bids, pushing the overall cost to the public sector up and potentially reducing competition and the potential for value for money.

118. Balfour Beatty Capital, however, argued that competitive dialogue has “brought benefits in terms of certainty of cost and commercial terms”.97 While acknowledging the cost issues, NHS Lothian stated that the procedure enables bidders to bring forward a variety of solutions to meet descriptive requirements and, therefore, “presents great opportunities to secure innovation”.98 Mark Hellowell also argued that the early selection of preferred bidder in other procurement methods risks changes to project specification coming at a high price as they are made in the conditions of monopoly.99

119. Robertson Group, however, also suggested that the process puts a huge burden on public sector organisations as they continue detailed design dialogue with more than one bidder through to the stage of being fit to go through the planning process, with “more design team meetings under competitive dialogue than…days during the bidding process”.100

120. While acknowledging the legal requirement to apply the competitive dialogue procedure, several witnesses did question whether it is being applied overly rigorously, and queried whether the directive may allow room for more flexibility of application.101 Roberston Group argued that there would be no legal difficulty in applying the invitation to negotiate or restricted procedures more widely.102

121. The Committee recommends that the Scottish Government should:

• re-examine when and how competitive dialogue procedure needs to be applied, and the extent to which experience in other countries might lead to more efficient systems;

• consider how to retain and recycle knowledge so that repeated development costs are minimised

• consider other ways to ensure participation of smaller Scottish companies

• investigate instances of limited competition for recent projects and seek to address this issue in any future capital investment arrangements.

96 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 468. 97 Balfour Beatty Capital. Written submission to the Finance Committee. 98 NHS Lothian. Written submission to the Finance Committee. 99 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 100 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 468. 101 For example, see Ogilvie Group, Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 474. 102 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 469.

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Options appraisal

122. The stated policy of the UK Government has been that PPP/PFI should only be used where it offers cost-effectiveness. It, therefore, developed a framework to allow PPP/PFI routes to be compared with other procurement methods at a project planning stage to identify the best value-for-money option. A public sector comparator (PSC) of a project’s outline business case was developed. This is a method to assess the net present value of the costs associated with a hypothetical traditionally-procured public sector capital project, adjusted for a risk factor, and then compared against the costs associated with a PPP/PFI scheme.

123. A range of private sector businesses emphasised strongly that value for money has been at the forefront of project delivery in Scotland. KPMG stated that, on the projects it has advised, it is content that, “the analysis was sufficiently rigorous to justify a value-for-money equation in favour of PFI/PPP.”103 CBI Scotland stated that, in the vast majority of cases, PPP/PFI compared well with the PSC. It said that average savings compared to the PSC in the health sector were around £2.5 million per project between 1999 and 2002, and in education between 1999 and 2003 an average saving of 4.1%. It also said that a Treasury taskforce report found that an average saving of closer to 17% among a sample of 29 projects from all sectors.104 Several public sector witnesses also said that their deals do appear to them to have been good value.

124. In its 2002 report on PFI schools, Audit Scotland stated that the PSC/PFI comparison on its own did not provide decisive evidence on best value. It also concluded that, while the analysis provided by a PSC was a useful aid to decision-making, there was an inherent uncertainty and subjectivity associated with the process105. Some witnesses went further and criticised the concept of the PSC as an inherently flawed process that is structurally biased towards the PPP/PFI route. Mark Hellowell stated that the validity of this approach to value-for-money assessment is manipulated in favour of PPP/PFI and has been questioned by academics and public auditors.106 This critique centred on a number of points. A fundamental point is that it is difficult to construct a valid hypothetical public sector model for the comparison on a genuinely like-for-like basis as there have been relatively few large non-PFI projects recently. The basic premise of making project approval dependent on a satisfactory PSC outcome (not only at outline business case stage but also at contract signature) was considered by many to have influenced the approach of PSCs. Equally, the simple pass/fail nature of the tests may not give an accurate estimate of the potential benefits of a particular approach.

125. On the detail of the calculation, Dr Jim Cuthbert and Margaret Cuthbert argued that resource costs, as measured in current cost accounting terms, greatly overstate the actual financing costs of capital assets, significantly distorting the 103 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 412. 104 CBI Scotland. Written submission to the Finance Committee. 105 Audit Scotland. (2002): Taking the Initiative: Using PFI contracts to renew council schools. Available online at: http://www.audit-scotland.gov.uk/docs/local/2002/nr_020612_PFI_schools.pdf [Accessed: 10 December 2008] 106 Mark Hellowell. Centre for International Public Health Policy. Written submission and Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 449.

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value for money test in relation to many PPP/PFI schemes. They suggested that it has burdened the public sector side of the comparison with the costs of current cost depreciation and capital charge, through the effects of the discount factor used, and giving an “unreasonably optimistic view of the long term affordability of the PFI option”.107 They suggested that many PPP/PFI value-for-money appraisals were similarly distorted until the Treasury refined the PSC in 2003 by revising the discount rate used from 6% to 3.5%.

126. Audit Scotland stated that using this rate is equivalent to including a specific provision for the cost of finance. However, it stated that, while these revisions are an improvement, the actual costs of debt funding are not included in the comparison, making it difficult to use effectively.108 It stated that the PSC has been perceived as a simple pass/fail test, but without adequate analysis of the reasoning.109 By way of contrast, the CBI Scotland stated that the PSC does not measure some claimed benefits of PPP/PFI, such as “managerial dynamism and potential for future innovation”.110 Mark Hellowell also argued that PPP/PFI costs are not revised upwards to include ‘optimism bias’, while those of the public sector option are – and he challenged the empirical basis cited in support of taking this asymmetrical approach.111

127. The appraisal system has evolved as the Treasury has sought to improve the assessment process, and a broader understanding of value for money is now encouraged – recognising that it depends as much on operational performance as getting the best deal initially. Mark Hellowell stated that, “There is no longer a PSC process running through procurement in England. There still is in Scotland.”112 The Scottish Government Financial Partnerships Unit updated its value-for-money guidance in 2007, consistent with Treasury policy and guidance. It applies to assessing investment decisions at different levels: at an overall programme level it is used to assess those programmes that are suitable for PPP/PFI; if a PPP/PFI route is chosen the individual investments and projects are reviewed for value for money through business case analysis; and further assessments are made during the procurement process. The aim is to provide a high-level justification if a PPP/PFI route for investment is selected.

128. More fundamentally than the detail of the framework itself, several witnesses argued that it has been operated in the context of a false choice and thereby undermining value-for-money conclusions. Several other witnesses were critical of the uneven incentives created by central government subsidy for the revenue costs of PFI projects – known as level playing field support in Scotland and as PFI credits in England. Glasgow City Council stated that, “The attraction of PPP was that 80 per cent of the capital was funded by the Scottish Executive”.113 A number

107 Jim Cuthbert and Margaret Cuthbert, The capital charge: problems arising from the misapplication of current cost accounting, supplementary written submission to the Finance Committee, May 2008 108 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 384. 109 Audit Scotland. Written submission to the Finance Committee. 110 CBI Scotland. Written submission to the Finance Committee. 111 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 112 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 449. 113 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 343.

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of witnesses suggested that, for certain projects particularly in the health and education sectors, authorities knew that they would not get funding for new facilities unless they used the PPP/PFI route. Audit Scotland emphasised the pressure that may be felt by procuring authorities as government support policies meant that “no project at all could proceed if the PSC suggested the PFI was not economic”.114 Unison suggested that, “If there was a level playing field, most projects would not touch PFI with a barge pole.”115

129. The Committee believes that a broad range of options for funding and procurement of capital projects should be in place. The Committee notes the Scottish Government’s decision to make NPDO models the default form of private finance, and the statement in the Value for Money Guidance that, where NPDO is not suitable, other private finance models will be assessed.116 The Committee recommends that public bodies should select the method of financing which delivers best value to the taxpayer. The Committee, therefore, agrees by division that all methods of finance should be considered equally on their merits. A minority of the Committee endorses the Scottish Government’s position that the NPDO model should be the default option.117

Service delivery, quality and flexibility

130. As noted above, many witnesses emphasised that value for money is now recognised to be as much about operational performance as simple cost comparisons. Evidence explored a number of aspects of operation in some detail.

Delivery of facilities on time and on budget 131. The ability to deliver a facility on time and operate it to achieve the desired service output are key components of considering the merits, and value for money, of different approaches to capital investment. As with other facets of value for money, it is a difficult comparison to attempt. The Committee heard considerable debate on the extent to which time and cost over-runs on projects are less under PPP/PFI than under conventional public procurement. A number of studies have examined cost and time over-runs on the construction of both conventionally-procured and PPP/PFI projects, and many witnesses argued that PPP/PFI projects generally seem to offer greater price and time certainty during construction.

132. In a 2003 report, the NAO found that almost three-quarters of projects secured under traditional methods came in over budget or late, compared to less 114 Audit Scotland. Written submission to the Finance Committee. 115 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 511. 116 Scottish Government, November 2008. Value for Money Assessment Guidance: Capital Programmes and Projects. Para 1.17 states: “For sectors where it is viewed that NPD is not suitable, consultation with the Scottish Futures Trust is required in order to determine the appropriate Private Finance model to test.” Available at: http://www.scotland.gov.uk/Resource/Doc/919/0068647.doc [Accessed: 27 November 2008] 117 At its meeting on 25 November 2008, the Committee divided on the proposition that all methods of finance should be considered equally on their merits. For: 5 (Jackie Baillie, Derek Brownlee, James Kelly, Jeremy Purvis, David Whitton); Against: 3 (Joe FitzPatrick, Alex Neil, Andrew Welsh); Abstentions: 0.

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than a quarter of projects procured via PPP/PFI. KPMG stated that only 20% of PPP/PFI projects are not on time and budget, and those 20% miss only by a fraction.118 Where PPP/PFI projects are late or over budget, the private sector bears the financial cost (although the residual impact on service delivery rests with the public sector). The NAO also found that 88% of the PPP/PFI projects it surveyed were delivered on budget, and of those that were not this was caused by the public sector changing specification rather than by the contractor.119

133. Many witnesses argued that the incentives that are integral to a PPP/PFI contract mean that time and cost over-runs and potential project failures are minimised, because of the due diligence disciplines and the constant policing of progress by investors. However, evidence to the Committee suggested that there is a significant debate over whether there is any inherent reason why – given the appropriate skills - appropriate disciplines to reduce the potential incidence of over-runs should not be built into the contract terms and project management approach for traditional procurement. Mott MacDonald stated that, “there is no reason why it should not be applied, provided that clients can manage the multiplicity of stakeholders and political pressures”.120 However, optimism bias is said to partly explain the apparent tendency for over-runs to be more typical in conventional projects.

134. There is a potential difficulty in comparing like-with-like as (while the bulk of capital spending has always been made through approaches other than PPP/PFI) there have been relatively few large comparable conventionally-procured projects in Scotland in recent years. It is also difficult to capture data for the full life-cycle costs of comparable projects, meaning that it is less easy to test whether approaches have improved. Mark Hellowell stated that there is little valid evidence to support claims that PPP/PFI delivers to time and budget, and that these factors have never properly been compared to modern public procurement.121

135. The Committee recognises that there are potential difficulties in comparing PPP/PFI and conventionally procured projects and differing views over whether PPP/PFI delivers to time and budget. However, it also assumes that there is no reason why incentives and disciplines, which it is asserted are inherent in PPP/PFI projects, cannot be more widely used in projects funded wholly by the public sector. The Committee recognises that incentives appropriate to the public sector will need to be devised but it recommends that the Scottish Government ensures that comparable project management approaches are applied in any future arrangements.

Operation 136. Aside from simple cost factors, an essential element of value for money is whether the asset delivers what was promised. Tying together the design, construction and maintenance of assets is a key perceived benefit of PPP/PFI. 118 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 407. 119 National Audit Office. (2003) PFI: Construction Performance. Available online at: http://www.nao.org.uk/publications/nao_reports/02-03/0203371.pdf [Accessed: 10 December 2008] 120 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 452. 121 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee.

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Integrating the operation of a facility into the contract, together with provision for deductions from the unitary charge for non-performance, is said to create strong disciplines to ensure operational delivery and to fix things that go wrong.

137. Empirical evidence seems to support this effect (although it should be noted that much of this is not current). The general conclusion from the Audit Scotland 2002 schools report was that the required outputs were being delivered, to the required standard and on time. A KPMG survey in 2007 of private sector project managers reported that 94% of contracts were meeting service level agreements.122 However, the Educational Institute of Scotland (EIS) stated that a 2004 survey showed that only 30% of its members believed that new or refurbished schools under PPP/PFI delivered value for money, and identified problems in relation to facilities management, basic maintenance and basic janitation.123 Direct evidence from users of services is more difficult to gather.

138. It is also important for all long-term projects to feature benchmarking and market testing throughout their lives, with external examination and comparison to ensure continuing value for money in the cost of on-going service provision. PPP/PFI contracts typically include provision for testing the value of services such as cleaning or catering every five or seven years. KPMG’s survey found that 85% of projects include such requirements. While there are relatively few contracts that are far enough advanced to have experienced this comparison, BT stated that it, “interestingly, usually results in improvements on both sides”.124 However, a report by the House of Commons Committee on Public Accounts found that, “there is a lack of comparative data to check whether prices proposed by incumbent suppliers are competitive” and that early experience shows that, “PFI contractors are using these processes [benchmarking and market-testing] to secure price increases and that some authorities are cutting services to pay for them”.125

139. The Committee believes that periodic benchmarking and market testing are essential to ensure contracts are delivering best value for the taxpayer, and recommends that the Scottish Government includes such procedures in future projects and ensures that these procedures themselves work in the best interests of the taxpayer. The Committee notes the concerns raised by the Public Accounts Committee, and recommends that they are addressed in contracts for all future projects.

Quality of services and service user experience 140. One of the fundamental questions about comparison of approaches to capital investment is whether one project type produces better outcomes than others. Again, comparisons in key sectors such as health and education are limited by the

122 KPMG. (2007) Effectiveness of operational contracts in PFI. Available online at: http://www.kpmg.co.uk/pubs/305432_PFI.pdf [Accessed: 10 December 2008] 123 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Cols 505 and 508, EIS and Royal Incorporation of Architects in Scotland, EIS survey of new and refurbished schools, report of findings, May 2004 124 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 379. 125 House of Commons Committee of Public Accounts. (2007). 63rd Report, HM Treasury: Tendering and benchmarking in PFI (November 2007) HC754 (2007-08). Available online at: http://www.publications.parliament.uk/pa/cm200607/cmselect/cmpubacc/754/754.pdf [Accessed: 10 December 2008]

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relatively few recent non-PPP/PFI projects. Responses to surveys also have the potential to be clouded by the fact that a facility is likely to be regarded as good by reason of the simple fact that it is new.

141. However, a KPMG survey on schools reported that, “overall, schools procured through PFI deliver better educational outcomes faster than those procured conventionally.”126 It stated that the overall rate of improvement is 20% higher in PFI schools, rising to 92% higher when comparing only fully rebuilt schools. The survey suggested caution about the findings given the small sample, short time-frame of operation and complex and dynamic nature of educational attainment. However, it also stated that it is the fullest body of evidence yet available on this subject anywhere in the world. It suggested that further study should be undertaken on the reasons for the effects it reported.

142. Empirical evidence on any relationship between capital procurement method and service quality appears to be limited. Architecture + Design Scotland (A+DS), however, stated that the majority of PPP/PFI schools projects it reviewed failed to live up to service quality expectations.127 Canmore stated that “there is no evidence to suggest that PPP design generally compares unfavourably with the designs used in direct, traditional procurement”.128 Keppie Design, however, compared any modern approach favourably with the 1960s and 1970s when the emphasis was on providing ‘lowest capital cost’ schools and hospitals that turned out to be very poor quality.129

143. Some of the evidence to the inquiry explored the possible reasons for any quality concerns with PPP/PFI. A+DS commented on the potentially greater propensity to encounter disconnect between clients or service users and designers in PPP/PFI than in traditional procurement, meaning that the personal touch can be lost.130 All witnesses agreed that the initial project briefing period is key, and A+DS said that some procurement methods provide more support than others through that process to eventual service delivery.131

144. Unison argued that this ‘disconnect’ is one facet of PPP/PFI undermining the concept of “public service ethos and team delivery”.132 However, several witnesses emphasised that this is partly due to bundling of projects (which has sometimes been seen in schools projects and some local health facility projects) and partly a consequence of a dash to replace failing public infrastructure quickly. In a desire to upgrade quickly, there is a trade-off to be had with individualisation of design.

145. The bundling of projects to secure cost-effectiveness in PPP/PFI may constrain the flexibility for consultation. The question appears to be whether there

126 KPMG. (2008) Investment in school facilities and PFI – do they play a role in educational outcomes?. Available online at: http://www.kpmg.co.uk/pubs/310991.pdf [Accessed: 10 December 2008] 127 Architecture + Design Scotland. Written submission to the Finance Committee. 128 Canmore Partnership Ltd. Written submission to the Finance Committee. 129 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 454. 130 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 454. 131 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 453. 132 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 504.

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is a necessary and qualitative difference in clients’ participation and influence in PPP/PFI – whether, for example, issues such as confidentiality aspects arising out of the financing model constrain the ability to consult service users? Glasgow City Council suggested that this is not the case, but that the costs associated with detailed consultation may be the constraint.133 However, NHS Greater Glasgow and Clyde emphasised that, given that it has to ensure that the asset is fit for service delivery, the private sector contractors in a PPP/PFI project are very keen to ensure that they engage effectively with the needs of staff and service users.134

146. There are, however, good examples of design working with service users, and so disconnect is not inevitable. A+DS suggested that the public sector comparator should include greater recognition of design quality aspirations.135 Several witnesses emphasised that the heart of the issue is simply about a client knowing what it wants and driving that through clearly. Mott MacDonald said that it is possible to provide high quality services whichever procurement method is applied.136 Detailed written submissions from Keppie Design and A+DS suggested some key procurement cultural and procedural changes that are required to ensure that quality of design is maximised (and also indicated that they should be pursued across all procurement routes).

147. Some witnesses commented on the potential for standardised designs to contribute to improvement. However, A+DS expressed particular concern about using a greater degree of standardisation based on exemplar designs, although it recognised some benefits and economies of scale through appropriately repeating small components of a design.137

148. In connection with design quality and sustainability, some witnesses acknowledged that there is a perceived unwillingness in some PPP/PFI situations to invest in what may be regarded as relatively innovative (and therefore higher risk) features – for example, biomass heating systems. A+DS stated that any perceived extra risk can be problematic if design teams are brought in after inappropriate cost plans have been set.138 Ernst and Young said that there was no reason why such features could not be included, provided that the specification was clear from the outset and that the public sector did not disincentivise the contractor by requiring disproportionate penalties for non-performance on one aspect such as this.139

Flexibility 149. As noted at paragraph 46 above, the relative inflexibility of PPP/PFI contracts is regarded as one of their weaknesses. A number of commentators have questioned whether PPP/PFI projects – which typically have 25 or 30-year terms - are sufficiently flexible to allow models of service delivery to be adapted to changed needs or policy priorities in the future. Barclays Private Equity

133 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 347. 134 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 347. 135 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 454. 136 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 453. 137 Architecture + Design Scotland. Written submission to the Finance Committee. 138 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 459. 139 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 530.

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acknowledged that this is fundamental to the fact that projects are debt funded and the sole source of repayment relates to a single facility.140

150. The ability of services to respond flexibly to changing service needs is an element of quality – but, when considering capital investment projects over a 30-year timeframe, it is also fundamental to a comparison of the long-term costs of different funding approaches. The evidence on flexibility covered two aspects: at a project level, the ease with which the contractual structure allows adjustments to be made; and, at a general level, the implications of having substantial fixed forward commitments for the way in which a public body can apply its funds to its priorities.

151. Some witnesses emphasised that the inevitability of a facility dating and requiring substantial expenditure to change is a concern for infrastructure regardless of procurement and funding method, and is not intrinsically an issue for PPP/PFI. Scottish Water also emphasised that the ease with which changes can be made competitively depends greatly on the nature of the asset.141

152. The balance of evidence suggests that this is a particular problem of the PPP/PFI approach. Dr Iain Docherty stated that, “change of use or on-going mid-life refreshments – which are normal over a 30-year period…[tend] to be charged at a premium rate”142, although there are limited numbers of projects old enough to have experienced significant change.

153. While there may be contractual mechanisms to test value for money for changes, contracts may also lock the public body into dealing with the initial provider to make any changes rather than examining a range of ways to achieve them, reducing the options for securing good value. A recent NAO report - which examined this issue in some detail - confirmed these views.143 Pricing life-cycle maintenance in at the beginning of a 30-year project clearly presents significant challenges, with the alternative simply being that the public body bears the pricing risk at the time of the maintenance requirement.

154. Trades unions suggested that a traditional procurement approach is always likely to provide for greater flexibility. In terms of individual contracts, Unison emphasised that the unitary charge for a PPP/PFI contract is costed on the original assumptions about service requirements. Many witnesses acknowledged that these can quickly become outdated. The BMA gave an example of hospital contracts that were based on a presumption of patient throughput being about 85%. The policy focus on waiting lists then almost immediately required higher throughput, with the unintended consequence that higher throughput resulted in financial penalties for the public sector under the PPP/PFI contracts.144 However, questions were raised over whether the service itself could be an inhibitor of

140 Barclays Private Equity. Supplementary written submission to the Finance Committee. 141 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 350. 142 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 437. 143 National Audit Office. (2008) Making changes in operational PFI projects. Available online at: http://www.nao.org.uk/publications/nao_reports/07-08/0708205.pdf [Accessed: 10 December 2008] 144 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 513.

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change and that such potential inflexibility could arise under conventional procurement as well as PPP/PFI.145

155. In part, this problem could be viewed as related to the public sector’s skills in designing an appropriate specification at the outset, and some witnesses suggested ways for the public sector’s approach to be improved. It is important to exclude the potential for concern about flexibility to be used as a cover for allowing costly indiscipline and indecision in the procurement process to be sanctioned. Mott MacDonald stated that a, “process of iteration…and continual refinement and development of the requirements is not the most efficient way to deliver a capital project.”146

156. Transport Scotland emphasised that the problem with specification changes relates to the public sector’s skills as a client, and that the key should be effective project management that gets the specification and any necessary flexibilities right from the outset.147 On this issue – as on several others – some witnesses emphasised that the PPP/PFI market has changed significantly over recent years and many of the issues raised in comparisons using early projects may now be treated very differently as the public sector’s approach to procurement has developed.

157. However, no evidence was presented on whether improved specification could overcome flexibility concerns. It is not clear whether there is a way to overcome this problem in PPP/PFI with more sophisticated contract terms, without it being at disproportionate cost, and without undermining the certainty that comes from having whole-life costs built in. Equally, there was no evidence presented on whether more recent contracts have been more successful at building in flexibility in a cost-effective way.

158. Ian Wall said, “I would be surprised if anyone around this table really thought that a contract could be written that explains and covers every eventuality.”148 Any attempt at building in flexibility would appear likely to increase the costs significantly, and still be unlikely to be able to anticipate adequately the service trends that may develop over 25-30 years.

159. Other witnesses indicated that the issue of flexibility is a particular reason why PPP/PFI approaches have come to be seen as unsuitable for use in particular sectors, acknowledging that the certainty required to make PPP/PFI a viable business proposition for investors is unduly restrictive for their needs. PPP/PFI is said to be a good approach for a client with stable long-term goals and service delivery patterns. The Scottish Funding Council stated that, “We have found that the concession-type contracts in PFI and NPD [non-profit distributing] projects do not work in a sector in which there is dynamic in the specification.”149 Evidence identified other features, including that PPP/PFI is generally unsuitable for refurbishment projects where risk is difficult to transfer. In recent years the Treasury has also stated that PPP/PFI is unlikely to be suitable for small capital 145 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Cols 516-517. 146 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 456. 147 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 350. 148 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 545. 149 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 345.

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value projects and for IT projects. Dr Iain Docherty went further, arguing that it is precisely in the education and health sectors in which PPP/PFI has been most used that, “new technology and working practices are changing how services are delivered and in which the pace of change is the fastest.”150

160. Related to the perceived inflexibility of PPP/PFI, however, is the benefit of whole-life maintenance costs being built into a contract. Keppie Design emphasised the potential importance of this as the lifetime maintenance costs of a facility are likely be in a ratio of 5:1 to initial capital costs.151 The contractual inclusion of lifetime costs in PPP/PFI seems to be widely acknowledged as having forced discipline on this issue and brought it to the fore, and the attraction of this approach was emphasised by many witnesses who commented on the dilapidated state of some public infrastructure in the past. Keppie Design stated that, “One hospital in Scotland has a maintenance backlog of £120 million, but that could not happen under PPP”.152

161. The Committee heard mixed views on whether the improvements which PPP/PFI is said to bring to public capital investment can be harnessed for good value and retained without the perceived downsides of the PPP/PFI approach, such as undesirable operational constraints. PWC suggested that its experience is that a single contract for through-life services associated with an asset is very difficult to achieve with another model. It has tried, but is “finding it difficult to get the hard and objective focus on getting it right first time that a bank brings. Equity is the integrator. The banks bring the discipline.”153

162. Other witnesses suggested that it is possible to achieve discipline in other approaches. Mott MacDonald said that there are design, build, operate and maintain contracts that do not have the private finance element.154 CIPFA stated that “there is no reason why there should not be such a focus under traditional procurement”.155 However, the maintenance budget, if separate, is often an easy target when there is pressure for savings. Glasgow City Council acknowledged that, “Local authorities have not dealt with the life-cycle maintenance issue particularly well.”156 NHS Greater Glasgow and Clyde also stated that there has tended to be “too much focus on the availability of capital to get a project established and less clarity about the certainty of the on-going funding that pays for the maintenance, capital charges, [etc]…that are associated with improving and creating an asset over a number of years.”157

163. In considering the implications of future commitment of revenue funds, some witnesses argued that the unsuitability of locking up funds in PPP/PFI contracts is far more widespread and fundamental. Trades unions suggested that the operational benefits of PPP/PFI projects having whole-life costs built in may be regarded as likely to take some time to become apparent, by which time the issue 150 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 438. 151 Keppie Design. Written submission to the Finance Committee. 152 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 457. 153 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 406. 154 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 461. 155 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 387. 156 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 336. 157 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 360.

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of inflexibility may come to the fore. The BMA stated that “it does not seem sensible to pre-empt income so far down the line”.158

164. Mark Hellowell argued, on the basis of case studies in the NHS both in Scotland and England that “the high cost of PFI, relative to non-PFI, buildings is impacting severely on authorities responsible for paying unitary charges, despite cuts and closures made to bridge gaps.”159 The BMA stated that Treasury rules ensure that the payments to a PPP/PFI contractor are a ring-fenced commitment for the life of the contract. New patterns of service delivery may, therefore, be impossible to achieve or will require additional capital expenditure.

165. By way of contrast, Unison suggested that, while service change in relation to a traditionally-procured facility will also always be difficult and challenging, the options are not constrained to the same extent by the need to continue paying unitary charges for a service that may no longer be ideal.160 The BMA argued that predicating the commitment of funds on certain patterns of service for a long time is inherently problematic, stating, “The more money we wrap up in such projects, the more it is likely that services will feel the pinch.”161

166. The trades unions stated that service change means that, by definition, the whole-life costs that are a key benefit of PPP/PFI cannot be wholly known at project appraisal stage. Keppie Design suggested that the revenue cost of the service delivered in a facility over 30 years (for example, the cost of doctors, nurses, etc. located in a hospital) may be in a ratio of as much as 200:1 to the construction costs of the facility.162 This suggests that a long-term constraint on the location and deployment of that huge resource is a major issue. On that basis, the trades unions argued that the whole life-cycle costs (and, by implication, value for money) of following a PPP/PFI route cannot be demonstrated. They felt that this is particularly the case as the vast majority of contracts are still at a relatively early stage. There was no conclusion from witnesses on whether, in the face of flexibility concerns, they considered it worth trying to achieve the integration of whole-life costs.

167. The Committee believes that it is important that, however they are provided or funded, public services are capable of evolving over time to meet changing demands and the expectations of users. The Committee believes that the public sector should only enter into long-term arrangements or contracts if sufficient flexibility can be built in without excessive cost, or if there can be certainty around the future demands on services.

Governance and accountability

168. Throughout the inquiry, a number of witnesses emphasised the importance of identifying and monitoring the costs of PPP/PFI projects to assess value for 158 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 505. 159 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 160 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 515. 161 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 518. 162 Keppie Design. Written submission to the Finance Committee.

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money. Similarly, it was acknowledged that the structure of different public sector budgets and accounts means that it is sometimes problematic to identify the total costs of delivering and maintaining a traditionally-funded facility. The lack of available data is one reason why it is so difficult to get consensus on value-for-money comparisons.

169. A number of witnesses stated that, as the SPVs are private companies, the arrangements surrounding most PPP/PFI deals are beyond the scope of current freedom of information legislation – although final business cases are public in some projects as a result of Freedom of Information requests.163 Dr Jim Cuthbert described his analysis of net present values of the non-service element of the unitary charge and internal rates of return on equity, and stated that, “Unless indicators like that are produced and published for all PFI schemes, we cannot know what is happening.”164

170. When considering the extent to which to push for greater openness on contracts, a difficult balance needs to be maintained with avoiding action that may damage the public sector’s interest in promoting sufficient competition. The Committee heard different views on the likely extent to which PPP/PFI operators would be willing to be open about contract terms. The PPP Forum said that there would be a reluctance to disclose commercially sensitive information that competitors would use, but acknowledged a need to “work a wee bit harder on transparency”.165 Dr Jim Cuthbert, however, argued that making information on projected profits available would positively enhance competition.166 He and Margaret Cuthbert also argued that benchmark statistics for the service component of contracts should be published, and that publication of all data should be a condition of new contracts.167

171. BT Scotland stated that, in respect of projects that it is involved in, a limited number of public sector stakeholders would have access to data on its margins and returns.168 Other witnesses indicated that much of the information for many projects was, or could be put, in the public domain.169 Keppie Design argued that market levels of profits by the various private stakeholders are now generally known.170

172. However, on balance, there was a degree of consensus on the need for openness and monitoring. Unison highlighted that the House of Commons Liaison Committee has called for select committees to have increased powers to scrutinise PPP/PFI contracts.171 The Scottish Information Commissioner has recently decided that contract information relating to a number of operational 163 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 569 and correspondence from the Cabinet Secretary for Finance and Sustainable Growth to the Committee, 20 June 2008. 164 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 436. 165 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 437. 166 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 448. 167 Jim Cuthbert and Margaret Cuthbert. Response to Scottish Government’s Scottish Futures Trust consultation 168 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 380. 169 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 473. 170 Keppie Design. Written submission to the Finance Committee. 171 Unison Scotland. Written submission to the Finance Committee.

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PPP/PFI schemes should be disclosed – material on which the analysis of Dr Jim Cuthbert and Margaret Cuthbert, referred to throughout this paper, has been based. Nonetheless, it appears that disclosure of material relating to schemes at earlier stages is likely not to be forthcoming. There has been an ongoing review of the operation of the Freedom of Information (Scotland) Act 2002, and one of the issues raised by the Scottish Information Commissioner and the Scottish Government is the extent to which it should apply to private companies delivering public functions.172

173. The Committee takes account of the recent decisions of the Scottish Information Commissioner and recommends that a review is concluded on what information can be made public with regard to all types of contracts for public works, with a view to being as open and transparent as possible.

NON-PROFIT DISTRIBUTING ORGANISATION

Introduction

174. During its evidence programme the Committee heard evidence on some particular attempts to adapt and replicate certain incentives, disciplines and risk-sharing in departing from the traditional PPP/PFI model. Several organisations with key experience of procuring, investing in, constructing and operating projects under a non-profit distributing organisation (NPDO) model gave evidence. The NPDO is one of the key approaches to public-private partnerships that has developed in very recent years to address some of the concerns expressed about earlier PPP/PFI projects.

175. The Scottish Government has said that it wishes to see this model used more widely. The Scottish Futures Trust (SFT) consultation document states that, for all projects where using private finance would be beneficial, the NPDO model will be used, and the SFT strategic business case says that providing guidance, structuring and compliance for NPDO programmes will be a core objective. In terms of specific projects, the Scottish Government has announced that it will adopt a form of NPDO for the procurement of the Borders rail line.

176. Evidence to the Committee focussed on the examples that have developed in Argyll and Bute, Falkirk and Aberdeen to deliver schools projects, and a proposed mental health project in Tayside.173 There appear to be only relatively slight differences (in governance and finance terms) between the examples. The Committee also heard evidence on other corporate structures, such as that of Network Rail, that have some similarities with the NPDO projects in Scotland.

177. The basic structure of the contract under the NPDO model is the same as for traditional PPP/PFI. Argyll and Bute and Falkirk Councils explained that the purpose of the NPDO structure is to cap the return of the private sector in order to

172 See Scottish Government. News release: Freedom of Information dated 30 June 2008. Available at: http://www.scotland.gov.uk/News/Releases/2008/06/30080541. [Accessed 12 December 2008] 173 The answer to Parliamentary Questions S3W-13341 and S3W-13347 on 3 June 2008 indicates that three other NPDO schools projects in Moray, Comhairle nan Eilean Siar and Orkney are in various stages of procurement.

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secure improved cost-effectiveness while retaining the disciplines of PPP/PFI, and to secure increased community involvement in the project and ownership of the outputs. Evidence to the Committee examined each of these issues.

178. As with all innovations that have sought to address perceived problems in the traditional PPP/PFI model, the evidence focused on the extent to which structural changes can be made to drive out inefficiencies and improve value for money, while still achieving the benefits of the disciplines and incentivisation said to be inherent in the PPP/PFI approach and stimulating sufficient market interest to ensure strong competition and project delivery. This also relates to the extent to which the public sector has the skills and capacity to manage this balance.

Key features of the model

179. Argyll and Bute and Falkirk Councils explained their NPDO structure in some detail in their written submissions. Around 90% of the funds are senior debt as normal. They said that their objective of reducing the cost of PPP/PFI (and the perceived possibility of excess profits accruing to the private sector) is approached in a number of ways. The private sector partners putting up the junior debt have only a nominal shareholding, and agree to have no dividend rights from their equity but simply an investment return of the interest earned on the junior debt they provide to the SPV (i.e. equity returns are capped). They also agree to distribute any surpluses beyond a certain level to a charity established for community benefit. The amount of profit to be retained by the SPV is set at a level that should ensure appropriate incentives and operational stability. Finally, the structure requires any refinancing gains from both junior and senior debt to be shared with the charity.

180. As well as a majority of members being from the private partners, the SPV board includes a ‘stakeholder’ director representing the public sector and an independent director. The stakeholder director is responsible for ensuring that the charity’s interests are represented at board level. The independent director’s role includes the right to initiate opportunities for refinancing. The Cabinet Secretary confirmed that central government funding support will also be available for NPDO projects, stating, “Subject to the approval of projects in the normal fashion, the revenue support payments will be available.”174

Appraisal

181. In appraising the NPDO concept, there was a general impression from witnesses that, while the model has considerable potential, its further development and wider application will require continued flexibility and sophistication from the public sector, particularly in respect of refinancing provisions.

182. Several witnesses described it as a “logical progression”175 from PPP/PFI. Some described it as a limited twist on traditional PPP/PFI, with relatively minor refinements as each new iteration has developed. The schools projects so far have been able to use the standard schools PPP contract, thereby accepting the

174 Scottish Parliament. Official Report, 28 May 2008, Col 9017. 175 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 522.

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market standard risk allocation and giving comfort to the market. The relative similarity, however, also allowed the same criticisms to be made of NPDO as of traditional PPP/PFI. Unison and others argued that it is a very minor variation on the model and that it “still maintains most of the other flaws of PFI/PPP”176 with no real departure from the discredited elements of the core PPP/PFI model, maintaining features such as higher borrowing costs and elements of risk transfer costs, leading to the same profits and inflexibility as traditional PFI.177 The BMA stated that it is “little different from PFI arrangements, because profit will still be taken from income streams” and that it “is almost just a semantic change from the PFI model”.178

183. Despite the similarities, Falkirk Council stated that the few areas that are NPDO-specific are challenging to deliver in a way that ensures efficiency, strong competition and appropriate management disciplines and incentives for performance.179 Argyll and Bute Council said that relatively complex discussions had been required with junior debt providers over risk and security as there is no real equity stake to absorb this.

Governance 184. The involvement of stakeholder and independent directors in NPDOs was said by a number of witnesses to offer greater transparency on the SPV operation, although there appears to be no empirical evidence of this effect or of any greater community involvement to date.

185. Falkirk Council suggested that accounting changes will, in future, negate the need for using a charity device.180 However, the role of the charity was described as a necessary device to ensure a tax-efficient channel for the public share of the surpluses and refinancing gains. While tax is still paid by the SPV on surpluses, it can distribute a share to a charity gross of tax.181 Unison argued that this is simply recycling public money, and there may be the risk of difficulties in the future if there is divergence between the public body’s aims and those of the charity.182

186. The Committee recommends that the Scottish Government ensures that consistent guidance is in place to ensure that the operation of charitable bodies established as part of NPDO schemes is conducted in a transparent manner, and that the governance arrangements and financial controls are at least as strong as those applying to the public sector generally. The Committee further recommends that the Scottish Government considers whether and how NPDO models might develop in the future without the automatic need for the use of a separate charitable body.

Costs 187. Despite the change of structure, the actual process for securing the best value funding package remains largely the same for the NPDO model. Differing 176 Unison Scotland. Written submission to the Finance Committee. 177 Unison Scotland. Written submission to the Finance Committee. 178 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 506. 179 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 521. 180 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 525. 181 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 525. 182 Unison Scotland. Written submission to the Finance Committee.

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views were heard on comparing the cost of capital. The Cabinet Secretary for Finance and Sustainable Growth stated that, “a fundamental difference exists between the NPD model, which protects the public interest, and PFI, which generates the excessive profits about which I am concerned.”183 He added that, “The cost to the public purse will be much less than the exorbitant PFI unitary payment charges that the public purse is currently having to carry”.184

188. However, under NPDO the public sector still pays a fixed unitary charge over the life of a project in the same way as for conventional PPP/PFI. This was confirmed by the Cabinet Secretary when he stated that the table outlining PPP/PFI unitary payments in Taking forward the Scottish Futures Trust included both PFI/PPP and NPDO debt.185 This table only shows total figures and is not divided between PFI/PPP and NPDO debt. While the capped equity return may reduce the opportunity for increased private sector profit through windfalls during the life of the project, it is not at all clear whether the net cost to the public sector through unitary charge payments will be any different from PPP/PFI. There is not the same flexibility of timing of profits described for PPP/PFI in paragraph 66 above, meaning that returns need to be flattened out over the years of the project, potentially increasing the costs in the early years.

189. Argyll and Bute Council stated that its NPDO model was formally appraised at full business case as better value for money than the public sector comparator, and earlier in the project development was also appraised as better value than traditional PPP/PFI.186 It said that the overall net cost was similar – with the capped return on junior debt being similar in cost to standard PPP/PFI equity return, perhaps reflecting some market perception of increased risk in using a new model, but the NPDO’s increased community benefit proved decisive in the appraisal.187 Mark Hellowell emphasised that this cost similarity was in spite of the senior lender to Argyll and Bute being the European Investment Bank, which offers preferential rates.188 Ernst and Young argued that importance of the increased community benefit indicated the need for more sophisticated value-for-money appraisal, considering the range of risk issues and fine-tuning the finance to match.189

190. KPMG suggested that, for NPDO overall, “funding costs look slightly higher than PPP/PFI”.190 CIPFA suggested that seeking to change the balance of risks will simply drive up the margins expected by the private sector.191 Quayle Munro agreed, suggesting that capped returns meant that, “we must bid for higher returns in the first place”.192 It is not clear whether, on balance, the level of future liabilities

183 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 578. 184 Scottish Parliament. Official Report, 28 May 2008, Col 9016. 185 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 577. 186 Argyll and Bute Council. Supplementary written submission to the Finance Committee. 187 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 526. 188 Mark Hellowell, Centre for International Public Health Policy. Written submission to the Finance Committee. 189 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 527. 190 KPMG. Written submission to the Finance Committee. 191 CIPFA Scotland and CIPFA directors of finance section, joint response to Scottish Futures Trust consultation. 192 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 481.

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for privately-financed projects would, therefore, be different if all were NPDO schemes. Canmore stated that non-NPDO bids were being refused for the Tayside mental health project, and said that this demonstrated a lack of confidence from the Scottish Government in the true value for money comparison of the NPDO model.193

191. On other costs, Argyll and Bute Council said that procurement costs were not significantly higher than the costs of a traditional PPP194, and Falkirk Council stated that the procurement timeframe was similar.

192. The Committee notes that comparative costs between all funding models have been difficult to determine throughout this inquiry. The Committee calls on the Scottish Government to develop a robust framework capable of producing comparable information on whole-life costs for future projects regardless of which method of procurement or operation is used.

Market Acceptance 193. The Cabinet Secretary expressed the view that the Scottish Government cannot second-guess or direct how the market will choose to deploy its resources and interest.195 However, the whole discussion of the NPDO model centred on how far the public sector can adapt its approaches to gain a better deal out of the PPP/PFI model before it becomes counter-productive because the market loses interest, competition is reduced and value for money is, therefore, undermined.

194. Falkirk Council stated that its experience of competition was good, with three very strong bidders remaining in the process throughout, while Aberdeen City Council also had three and Argyll and Bute two.196 The Cabinet Secretary also emphasised that levels of competition have not necessarily been high in traditional PPP/PFI projects, and the NPDO does not compare unfavourably.197 The NAO has stated that, since 2004, the proportion of PPP/PFI deals attracting only two bidders has more than doubled.198

195. Canmore, however, expressed concern that the Scottish Government, in making the NPDO model a centrepiece of the Scottish Futures Trust proposal, could be overstating the degree of market acceptance of this approach.199 It gave the example of the Tayside mental health project where it said there were few bidders, and compared it unfavourably to higher levels of interest in more simple PPP/PFI structures in the south of England. The Committee heard considerable evidence relating to this point.

196. Barclays Private Equity indicated that the capping of returns is not entirely accepted, saying “As an investor, we are concerned about regulation of our 193 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 678. 194 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 529. 195 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 573. 196 Falkirk Council. Written submission to the Finance Committee. 197 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 570. 198 Cited in House of Commons Committee of Public Accounts. (2007). 63rd Report, HM Treasury: Tendering and benchmarking in PFI (November 2007) HC754 (2007-08). Available online at: http://www.publications.parliament.uk/pa/cm200607/cmselect/cmpubacc/754/754.pdf [Accessed: 10 December 2008] 199 Canmore Partnership Ltd. Written submission to the Finance Committee.

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return.”200 It went on to say that it is concerned that, “the NPD model is a one-way bet – and not a very good one – for the investor.”201 HSBC also said that the investment arms of some contractors have already been less interested in NPDO.202 Bank of Scotland suggested that, in the mature PPP/PFI market, bidders had already reduced target return levels and removed the possibility of excessive returns.

197. Canmore indicated that capped returns are likely to be acceptable to a sufficient number of bidders but that, in the refinancing provisions, the Government is pushing too far and upsetting the balance between getting the best deal it can and retaining sufficient competition.203 It asserted that, “The Government is about to draw defeat from the jaws of victory by insisting on ridiculous terms for the non-core elements of NPD.”204 Robertson Group agreed, saying, “Forced refinancing is one sour aspect, although most of the market is quite happy with the rest of the structure.”205 Ogilvie Group said that, “The extra burden, risks and uncertainty do not equal the rewards that we would take.”206 Quayle Munro stated that, for this reason, “I find it difficult to think of the NPD as the panacea.”207

198. Robertson Group stated that, even though it has a long-term involvement as a maintenance contractor, refinancing means that it could be pushed out of involvement in the board after a year of operation.208 Robertson Group stated that, “you can lose your seat at the SPV table and continue on a subcontractor route, which is not a particularly good partnering arrangement.”209 Ernst and Young stated that the market views it as being pushed out after taking the major risks but before taking any return.210 Investors said that they view involvement in PPP/PFI projects as long-term, but the NPDO model risks creating a structure which forces them to regard it, and approach the pricing of it, on a short-term basis.211 Falkirk Council said that junior debt providers were concerned about how the refinancing provisions would affect the liquidity of their stake, and the valuation of it in any potential sale.212

199. A concern that crosses over from the financial model to the quality of operational delivery, and that unites the interests of both lenders and the public sector, is whether the model dilutes the incentives for the various parties to fix things that go wrong and for them to maximise efficiency. Robertson Group argued that there is no incentive to operate a facility as efficiently as possible or to innovate if all gains go back to the charity, and operators who are investors can be bought out against their will.213 Bank of Scotland emphasised that, although the 200 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 426. 201 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 428. 202 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 428. 203 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Cols 481 and 482. 204 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 479. 205 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 482. 206 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 469. 207 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 481. 208 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 470. 209 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 483. 210 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 532. 211 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 471. 212 Falkirk Council. Written submission to the Finance Committee. 213 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 472.

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senior debt situation in NPDO is effectively the same as in traditional PPP/PFI, a lender takes a keen interest in the business of every borrower and will clearly be concerned if the borrower appears to be disincentivised in any way.214 Forth Electrical Services also emphasised the importance of this point to it, as it invests in equity only in projects on which it is the facilities management contractor.215

200. The role of the independent director controlling refinancing means that it is not necessarily timed to maximise shareholder profit. Falkirk Council explained a number of market concerns that had to be overcome in its particular project about the way in which refinancing might be organised against the interests of private sector investors. It had been able to overcome those concerns through various assurances and modifications - particularly on the role and rights of the independent director - that ensured the continued interest of bidders.216 It was not clear from evidence whether these kind of modifications were particular to the circumstances or could be standardised in a way that will encourage wide market confidence in the model. McGrigors indicated that a refinement may be likely whereby a specified guarantee period may be required before an independent director can trigger a refinancing, but still expressed doubt as to whether this would provide sufficient long-term stability to attract the market.217

201. It is important to emphasise that the operation of the refinancing provisions has not yet been tested in practice. However, the consensus of witnesses appeared to be that the refinancing approach needs to be refined and more closely monitored and negotiated, while still avoiding undermining any value for money. Dundas and Wilson said that, “a bit more work probably needs to be done to soften the model at the edges if we want to maintain interest”.218 It said that margins are much finer now, and the refinancing gain may not be there in any event, implying that pushing too hard on this point may not be productive for the public sector.219

202. From another point of view, Margaret Cuthbert and Dr Jim Cuthbert also suggested caution on the public sector benefits that may accrue from refinancing of NPDO projects. They argued that it may “bite more deeply into any margin of free cash which should be reserved for risk” and burden a project with a greater degree of risk than a conventional PPP/PFI refinancing.220

203. The Committee notes concerns raised by some witnesses on the potential for refinancing provisions in NPDO schemes to discourage some investors, and calls on the Scottish Government to review how refinancing provisions in NPDO models might be amended to ensure that they achieve intended aims without discouraging investment.

214 Bank of Scotland. Written submission to the Finance Committee. 215 Forth Electrical Services. Written submission to the Finance Committee. 216 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Cols 523-4. 217 McGrigors. Supplementary written submission to the Finance Committee on the SFT. 218 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 421. 219 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 410. 220 Margaret Cuthbert and Jim Cuthbert, PFI: Refinancing, supplementary written submission to the Finance Committee, May 2008

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Transferability 204. Witnesses generally agreed that, while the NPDO schools models used so far cannot simply be transferred to areas with different risk profiles and delivery capabilities, the key concepts of the NPDO approach can be applied in different sectors and to projects with different risk profiles. Apart from incremental evolution of the model, witnesses did not identify any specific areas that they felt required radical change in order for the NPDO approach to be applicable elsewhere. However, it has not yet been tested on riskier and larger-scale projects, and the different stakeholders in different sectors mean that the structure might require to be different.

205. Ernst and Young suggested that, “the NPDO model lends itself to lower-risk and relatively standardised projects” 221. On projects perceived to be riskier, the model may have to be modified, perhaps by a higher level of junior debt and a different approach to liquidated damages. In regard to whether the model is scalable, KPMG and PWC agreed that it is not yet clear whether the markets will accept capped returns for a large number of projects, given the risks that may be faced.222 HSBC sounded a note of concern, arguing that, where a model needs to be modified to suit circumstances, “that level of pragmatism has been absent from many debates with the public sector.”223

206. A number of witnesses commented on whether bundling of risks would help overcome any concerns about applying the model more widely. Bundling has been common in PPP/PFI to make projects large enough to justify the high bid and process costs. However, KPMG suggested that bundling different risks from different sectors appears problematic – not least in terms of the individual and separate governance structure and fiduciary duty of each public sector body.224 PWC stated that, “to procure projects with a portfolio of debt, it is necessary to have a number of pretty consistent projects with pretty consistent risk profiles.”225 Ernst and Young also said that, while the model would be scalable if applied to similar types of assets, increasing size would be expected to increase the distance from community objectives.226

207. The Committee cannot offer any recommendations or conclusions about the operation of the NPDO model as there is not yet enough evidence about its effectiveness as an alternative to PPP/PFI.

OTHER APPROACHES

208. There is substantial evidence that many elements of the public sector have been carefully appraising their future approach to capital investment. The Committee, therefore, also sought to examine various other recent innovative Scottish developments, alongside some other high profile or innovative projects from elsewhere within the UK, in order to discern any lessons that could be more widely applicable in future Scottish policy development. Experience of other 221 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 529. 222 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Cols 416-7. 223 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Cols 426-7. 224 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 418. 225 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 418. 226 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 531.

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projects outside Scotland operating within the same UK public finance frameworks is, therefore, very important. There is a huge range of models for specific projects, both in the UK and abroad. This section gives a brief summary of some of the main features of only a few approaches, focusing on elements which might be relevant to the current policy development in Scotland. Further details are available in written submissions from the various organisations.

Cordale Housing Association

209. Cordale Housing Association (CHA) is a small community-based housing association with charitable status, based in Renton, West Dunbartonshire. The Committee heard from its director. It has developed an innovative public community partnership which it described as an alternative delivery model building on the strengths of PPP/PFI and NPDO models. It described the option of a housing association establishing a subsidiary company to build a local school, leasing it to the local community and reinvesting surpluses in the community. It said this is efficient as it does not involve shareholder requirements or private sector overheads, and can also use surpluses to offset the need for other public sector grants to the local community. CHA stated that this model is 100% privately-financed, but has managed to attract preferential rates.

210. Robert MacDowall of DTZ, who had worked with CHA as a consultant, suggested that the community association approach can address some of the governance issues that arise in the NPDO model.227 It has developed a framework that it said can demonstrate the financial value of social outcomes generated by its work, and that it can be applied more widely in the provision of capital investment.

EDI Group

211. EDI Group is a development company owned by Edinburgh City Council - a relatively unique approach among local authorities. The Committee heard from Ian Wall, its recently retired Chief Executive. Its submission outlined how the council-company model could address some of the perceived weaknesses of PPP/PFI, being run on a not-for-profit basis or returning profit to the council. EDI Group is best known for its work on commercial property, but said that its approach is equally applicable to large or small projects and to social infrastructure. It has built three schools to date and is currently working on a health centre. It proposed a model where a local authority sets up a company and grants it a lease for a facility. This is a well-known and simple legal structure, providing security for raising private capital from any source at the lowest rates and, according to EDI Group, allowing greater flexibility and competition than PPP/PFI.

Local Improvement Finance Trusts (LIFTS)

212. Several witnesses mentioned the English Local Improvement Finance Trusts (LIFTS) model in evidence, although the Committee was not able to hear directly from a representative. They are the longest-standing example of a long-term strategic partnership variant on the PPP/PFI model, involving the private sector working with one or more primary care trusts to develop and upgrade the primary

227 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 541.

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care facilities in an area. Robertson Group stated that LIFT is a long-term partnering project, where the public sector has equity in the private company and voting rights on the board.228 It explained that this shows many of the same capped or shared return features as the NPDO model but in a joint venture, with 60% private sector, 20% public sector procurer and 20% local government stake, and with greater transparency.229 CIPFA stated that the borrowing is not currently counted as general government debt.

213. Barclays Private Equity stated that it involved the public sector as both client and joint owner of the delivery mechanisms and could, therefore, overcome any confrontation in the traditional contractual PPP/PFI model.230 It said that much of the separation between private and public sectors breaks down, with both jointly responsible for business case development, options appraisal, etc. Keppie Design stated that it gives an open-book partnering approach to allowing all parties to engage on the design from the earliest point.231 Several witnesses suggested that the proposed Hub model for smaller scale NHS and joint local authority projects in Scotland has similarities, but has not yet been established.232

ProCure 21

214. Mott MacDonald indicated that clients with a regular portfolio of projects are increasingly using framework agreements to deal with supply chain issues, as in procurement models such as ProCure 21 – an initiative of the Department of Health in England.233 The Committee heard from the ProCure 21 programme manager. It is based entirely on public financing, and uses a pre-tendered framework agreement with eight large construction companies, that allows individual health service bodies to call upon these companies without the need for a tender exercise. This typically saves six to nine months in procurement, and has been relatively successful in giving consistency of build quality and delivery to time and budget. Individual projects are agreed on a guaranteed maximum price basis. ProCure 21 stated that its approach has achieved a step-change improvement in the over-run record on publicly-funded projects.234

215. NHS Lothian stated that this initiative offered the possibility of significant reduction in procurement lead times and “certainty of service and cost earlier in the project process”.235 Keppie Design also emphasised that such frameworks allow the private sector partner to be chosen earlier and offer more opportunity for dialogue on design, and generate the best possible solution for a set affordability limit.236 A similar framework is currently being developed by the Scottish health sector, although some witnesses expressed concern at the focus on large 228 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Cols 465-6. 229 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 471. 230 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 425. 231 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 458. 232 However, in Taking forward the Scottish Futures Trust, the Scottish Government announced that the Hub initiative would be implemented as part of the development of the SFT, with procurement expected to commence in December 2008. Available online at: http://www.scotland.gov.uk/Publications/2008/05/19155435/12 [Accessed: 10 December 2008] 233 Mott MacDonald. Written submission to the Finance Committee. 234 ProCure 21. Written submission to the Finance Committee. 235 NHS Lothian. Written submission to the Finance Committee. 236 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 454.

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contractors and questioned whether Scotland has the scale to operate a pre-qualification scheme of this nature.237

Northern Ireland Strategic Investment Board

216. Several witnesses suggested that the centralising management approach of the Northern Ireland Strategic Investment Board (SIB) may be a useful model for Scotland. The SIB is a small company, owned by the Office of the First Minister and Deputy First Minister in Northern Ireland. The Committee took evidence from one of its strategic advisers, and also noted that the Welsh Assembly Government has announced the creation of a strategic investment board, part of the aim of which is to make the right connections between investment decisions across the public sector.

217. The SIB has three main roles: to test the long-term plans of public bodies, including examining and signing off business cases in larger projects and suggesting scheduling of projects to ensure best competition from the market; supporting public bodies to deal with the complexities of the processes to ensure delivery; and, using the large capital programme to drive reform in service delivery. Its role focuses on managing the market, using a mandatory system to capture and co-ordinate the decisions of separate public bodies. It advises the Northern Ireland Executive on the balance of investment between key sectors, and it is then up to individual departments to disaggregate that into the details and timing of individual projects.

Network Rail

218. Network Rail is a private company limited by guarantee. It uses the NPDO model which essentially means that it harnesses private sector disciplines while investing all profit in the railway network. The Committee heard from its Finance Director and Scottish Director. Its financing requirements are principally met by debt raised from the capital markets through regular bond issues. Network Rail Infrastructure Finance PLC, although not a public sector body, is guaranteed by a financial indemnity from the UK Government and is able to maintain a credit rating of Aaa/AAA/AAA.238 Government guarantees allow funds to be raised from a wide range of sources at lowest possible cost. All the money raised from the bonds issued by Network Rail Infrastructure Finance plc, after refinancing and service of debt, is then lent to Network Rail Infrastructure Ltd. Network Rail spent approximately £3 billion on engineering works in 2006. It said that, while its principles have some relevance to an investment programme, it would not be possible to use it for an individual project.239

237 For example, see Robert MacDowall (DTZ), Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 548. 238 The credit rating of a corporation is a financial indicator to potential investors, assigned by credit rating agencies. Three of the main agencies are Standard & Poor's, Moody's and Fitch. They use ratings with letter designations such as AAA, B, CC, with the highest rating being AAA or Aaa. 239 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 543.

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Government guarantees

219. An example of a further model of financing PPP/PFI projects was explored. In France, a substantial amount of the debt capital for PPP/PFI projects is provided by the private sector but this is then underwritten by the government under what is called a cession Dailly.

220. When asked whether it would be possible for the Scottish Government to underwrite debt in this way, Paul Brewer of PWC stated that, “I think that the powers to do that would sit with the Treasury or would be vested in the Scottish Government by the Treasury, but the power to underpin—by which I mean the power to guarantee repayment of a proportion of project debt—currently exists.”240

221. CIPFA Scotland questioned whether such methods would be deemed to be compatible with EU competition laws. No definitive answer was given in evidence and CIPFA believed that, although this model is currently being used by the French government, if this were to be explored as a funding option, the position would need to be clarified.

KEY ISSUES IN THE CURRENT CONTEXT

222. The need for infrastructure investment in Scotland remains huge both to compensate for perceived underinvestment in the past and the scale of future needs. The City of Edinburgh Council stated that “the infrastructure investment that is required goes way beyond affordability constraints”.241

223. The Cabinet Secretary for Finance and Sustainable Growth acknowledged the centrality of investment to the Scottish Government’s purpose of improving economic growth. He emphasised the planned investment of £14 billion over the next three years, with £600 million of capital spending planned in the health sector by 2010, and £1.7 billion in road and rail. The Scottish Government’s Infrastructure Investment Plan, which brings together central and local government plans for the first time, indicates a total of £35 billion public investment in the next 10 years.

224. Throughout this inquiry, a number of generic themes have emerged – both from the comparison of PPP/PFI and conventional borrowing and from the innovative approaches which have emerged to address perceived problems. Witnesses have emphasised these generic themes as being central to the current capital investment context in Scotland and the development of any new policy approach.

Asset management

225. Many witnesses emphasised that choosing between the various funding methods should be secondary to other disciplines and decision processes, such as maintaining an asset register and making sound decisions about asset management for future service needs.

240 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 673. 241 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 330.

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226. This operates on a strategic, national level. The Scottish Council for Development and Industry (SCDI) emphasised that there are several documents that set out the investment needs of the economy, but that greater co-ordination and coherence between them is required.242 Scottish Water and the Scottish Funding Council both emphasised that it is important to target a steady state of maintenance and sustainable reinvestment so that a backlog does not persist and re-appear in the future because of poor attention to maintenance and renewal.243

227. It also operates at the level of individual public bodies. CIPFA suggested that asset management is generally at a very poor level in the public sector, where there is as yet no statutory asset management framework. However, CIPFA itself is currently producing guidance for local authorities, and the prudential code emphasises the importance of asset management. It highlighted recent Scottish Government reviews which found that only 33% of local authorities and 29% of central government bodies reported having an asset management plan.244

228. However, evidence suggested that there is a prize to be secured by the public sector. CIPFA stated that, “any improvement in the strategic and operational management of capital assets could have a real impact on the financial resources available to the organisation concerned”.245 It suggested that the approach should always be one of, “determining corporate aims; translating them into asset aims; translating those aims into asset plans; and from those plans determining the investment, maintenance and disposal.”246

229. The Committee heard evidence of variability in the approaches of different elements of the public sector, and various initiatives to improve asset information. This then needs to relate to wider objectives, providing a basis for investment and disposal decisions and setting priorities – and link the use of assets to other resources, such as the revenue funds for services to be provided through the assets.

230. Angela Scott, from CIPFA Scotland made a number of suggestions to improve asset management in the public sector in a supplementary submission to the Committee. The Committee notes the statement that these suggestions had not been put through CIPFA’s own internal governance procedures and therefore are not to be interpreted as the position of CIPFA. These suggestions were broadly as follows.

Public service officials 231. Responsibility for asset management should be shared by senior managers, and supported by appropriately skilled officers who can work across service departments to deliver a coherent and co-ordinated overall strategy. This could take the form of a high level strategic decision-making group (perhaps at elected or board member level) and a cross-service senior management forum. 242 Scottish Council for Development and Industry. Written submission to the Finance Committee. 243 Scottish Water and the Scottish Funding Council. Written submissions to the Finance Committee. 244 CIPFA Scotland, Asset management, supplementary written submission to the Finance Committee, May 2008 245 CIPFA Scotland, Asset management, supplementary written submission, May 2008 246 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 386.

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232. The Committee recommends that this should be pursued by the Scottish Government

Scottish Government 233. In Wales, a Strategic Capital Investment Panel has been established. This is an independent advisory body supported by a dedicated fund of over £400 million that will be allocated to capital investment projects over the next three years. It will provide advice to the Ministerial Strategic Capital Investment Board, which will be chaired by the Finance Minister, to achieve best value and support the delivery of the One Wales programme.

234. The submission suggested that this model could be examined further to consider whether it would work in Scotland.

235. The submission also suggests that the Scottish Government’s review of its own estate (which resulted in a recommendation that it should develop a central point for co-ordinating the re-use/co-sharing of vacant/under-used space across the government estate) could be taken further and extended to the whole of the public sector.

236. The Accounts Commission requires local authorities to produce and publish certain performance information that relates to property - in particular the percentage of the road network to be considered for maintenance, and indicators relating to school occupancy levels.

237. The UK’s public sector audit agencies have worked together to develop indicator sets for measuring the value for money performance of five core functions, one of which is estate management. The submission suggests that if the Scottish Government were to require the whole of the public sector to compile these indicators, it could be a better way of reporting to the public and it would also build up a bank of benchmarking data which could be used to aid comparisons.

238. The submission states that benchmarking is absolutely essential to maximising efficiency, and improving methodologies. The performance of the property portfolio needs to be assessed and monitored on a regular basis to ensure continued effectiveness, particularly if there are any changes to the way services are delivered, changes in the location of jobs or changes in the property markets. This process needs continually to assess property performance against service delivery requirements, and changes to priorities identified within the corporate property strategy.

239. In July 2005, HM Treasury issued a letter to all UK government departments (including the then Scottish Executive) setting out details of the requirement to use E-Pims. This database has been developed to record all central government civil estate information, enabling it to be viewed as a whole. At the time, the decision was taken not to make E-Pims mandatory and the results from the survey undertaken suggests that there is fairly limited use of E-Pims. The submission suggests that the Scottish Government could consider making E-Pims mandatory and exploring how access could be widened across the rest of the public sector.

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240. The submission states that it is better if hearts and minds are won over when attempting to raise standards. However, as a measure of last resort the submission suggests that consideration could be given to developing a statutory asset management framework. The submission considers that the advisory note developed by the Best Value Taskforce to consider asset management under best value was not statutory guidance and that this contrasts with the statutory guidance which was developed to support community planning.

241. The Committee recommends that these issues should be pursued by the Scottish Government

Parliamentary Committees 242. The submission makes some suggestions for parliamentary committees to consider to help to raise standards of asset management.

243. One of the recommendations of the Scottish Government’s review of asset management is “to ensure all parts of Scottish Government have an asset management plan in place”. The submission suggests that, when subject committees report to the Finance Committee at Stage One of the current budget process, they could be asked to comment on the existence and robustness of asset management plans which support the intention to spend capital resource.

244. The Committee will consider this idea in the context of its current review of the Budget Process

245. The Hansard Society in 2006 published The Fiscal Maze: Parliament, Government and Public Money.247 The publication considers how the way that government spends money and delivers services has changed dramatically in recent years. It argues that such changes place a responsibility on both government and parliament to ensure that up to date mechanisms are in place to ensure full accountability. The Society acknowledges that PPP/PFI has presented a challenge to both government and parliament. The submission notes that the development of the Scottish Futures Trust may prove equally challenging for undertaking scrutiny. The publication points to the need for more systematic parliamentary scrutiny, which is pro-active rather than reactive and seeks to ensure that lessons learnt from mistakes are translated into improvements in PPP/PFI systems. In particular, it states “consideration of PFI projects by departmental and other select committees should be extended” and that commercial confidentiality should not be used to block full parliamentary scrutiny.

246. The Audit Committee receives the results of the national value for money studies undertaken by Audit Scotland. Audit Scotland is currently undertaking a national study looking at asset management, due to be published in 2009. The submission suggests that the findings of the study could be reinforced if subject committees made use of them to challenge officials on their performance as well as using them as a tool for challenging during the budget process.

247 Alex Brazier and Vidya Ram. (2006) The Fiscal Maze: Parliament, Government and Public Money. The Hansard Society, London. Available online at: http://www.hansardsociety.org.uk/files/folders/587/download.aspx [Accessed: 10 December 2008]

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247. The submission suggests that, in examining the Scottish Government’s Efficiency Delivery Plans and outturn reports, committees could seek evidence of the pursuit of better asset management.

248. Finally, the submission suggests that, in light of the government’s own review of asset management, the Finance Committee could seek evidence of action on the part of the Scottish Government in taking forward its own recommendations with regard to the Scottish Government estate.

249. The Committee signals that it will pursue this issue.

Conventional public borrowing

250. Under Section 66 of the Scotland Act 1998, Scottish Ministers may only borrow money from the UK Government, and may only borrow for the purpose of meeting a temporary shortfall in the Scottish Consolidated Fund or providing a working balance in the Fund. Local authorities can fund capital projects under the prudential borrowing regime (described at paragraph 19) and they can borrow money, either on the open market (which has rarely been used) or through the Public Works Loans Board.

251. A similar prudential borrowing framework is not in place for any other parts of the public sector in Scotland. The Scottish Public Finance Manual explains that public bodies can be given borrowing powers and that any such powers would be set out in the relevant enabling legislation (for example, section 3(7) of the Transport (Scotland) Act 2005 states that Regional Transport Partnerships can borrow money for capital investment.) The Manual states that the powers to borrow—

“may include borrowing from Scottish Ministers or any other person or body - subject to the consent of Scottish Ministers. In addition the circumstances under which sponsored bodies may borrow money and the terms and conditions applicable, as agreed with the Scottish Government, should be set out in the necessary framework document e.g. a Management Statement / Financial Memoranda. However, there should be a presumption that all borrowing - excluding agreed overdrafts - should be from Scottish Ministers via portfolio budgets authorised by Budget Act. Terms more costly than borrowing from Scottish Ministers would not be acceptable.” 248

252. While the required investment is much greater than could be afforded through any one funding method, CIPFA suggested that prudential borrowing has not reached its full potential because so much government emphasis and subsidy has been directed towards PPP/PFI in recent years. It argued that the current policy development phase offers an ideal opportunity to examine the operational effectiveness of the prudential framework.249

248 The Scottish Government. Scottish Public Finance Manual (updated 2007). Available at: http://www.scotland.gov.uk/Topics/Government/Finance/spfm [Accessed 11 November 2008] 249 CIPFA Scotland and CIPFA Directors of Finance Section, joint response to the Scottish Government’s Scottish Futures Trust consultation.

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253. There was some support among witnesses for examination of a substantial extension of the role of prudential borrowing. Evidence to the Committee explored the scope for the extension of conventional borrowing - both in terms of expanding the overall capacity of borrowing, and in terms of extending borrowing powers and the prudential framework approach to public bodies other than local authorities. Unison argued that, as the revenue costs of borrowing have to be met whether public or private finance is used, if an authority can afford to pay the unitary charges associated with PPP/PFI, then it can afford to pay the cost of conventional borrowing provided it has applied the prudential framework.250 It suggested that, “The best way forward is conventional finance within a competent asset management regime”.251 As alluded to in paragraph 154, questions were raised as to whether the flexibility in contracts that is desired by Unison to minimise costs could actually be achieved under conventional procurement where the service itself could be an inhibitor of change.252 BT Scotland argued for continued flexibility in models, stating that the danger of prescribing a particular approach is that, “we would be forced into a purchaser-supplier arrangement and we would lose some of the innovative risk-sharing models that have delivered benefits and continue to do so.”253

254. Having a prudential borrowing regime available would allow NHS boards and other agencies of central government a wider range of funding options to assess. The Committee received advice from the Parliament’s Directorate of Legal Services that suggested that there is no legal impediment to giving prudential or other prescribed borrowing powers to Scottish statutory bodies. As described above, while the borrowing powers of the Scottish Ministers are restricted in terms of section 66 of the Scotland Act, legislation in the Scottish Parliament could set out new borrowing powers for other statutory bodies and has done so in some cases. However, the Scottish Government has said that facilitating broader access (for example, by health boards) to the Public Works Loans Board is one option that was “parked” during development of the Scottish Futures Trust254 after a shortlisting stage where concepts were analysed by assessing the degree of risk against five key criteria – vires, accounting treatment, state aid, EU procurement rules and ONS classification.255

255. Extending borrowing powers would likely require new primary legislation and may have consequences for Treasury funding for the Scottish Consolidated Fund. As set out above, the Scottish Public Finance Manual notes that the borrowing powers in the relevant enabling legislation will be limited to borrowing from Scottish Ministers or with their consent. Under the Treasury’s Statement of Funding Policy it appears that ultimately the Treasury can take borrowing into

250 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 505. 251 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 517. 252 Scottish Parliament Finance Committee, Official Report, 13 May 2008, Cols 516-517 253 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 378. 254 Written answer by John Swinney MSP on 6 June 2008 to parliamentary question S3W-13249 255 Scottish Government, Taking Forward the Scottish Futures Trust, May 2008

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account in the amount it provides to the Scottish Consolidated Fund under section 64 of the Scotland Act 1998.256

256. CIPFA also stated that, although the limit of the potential for prudential borrowing may not have been reached, it has to be viewed in the context of whole government borrowing in the current devolution settlement.257 Audit Scotland stated that, if the Treasury considers that the plans of local government require too high a level of borrowing, it can impose a UK-wide limit for one or more years on the amount of capital investment to be funded through borrowing – although it has never yet done so. It is not clear how or at what level these constraints might be imposed. The Cabinet Secretary for Finance and Sustainable Growth, however, stated that he is not aware of any specific ceiling and, “that is not my understanding of how the Treasury acts.” He emphasised that, “the only constraint on local authority borrowing capacity is affordability within the individual authority”.258

257. The Committee notes that borrowing powers are already available to local government in Scotland, and could in theory be extended to other public bodies. The Committee notes the restriction set out in the Scotland Act on borrowing by Scottish Ministers and the apparent uncertainty on the consequences of extending such powers for the amount of funding provided to the Scottish Government under the current Statement of Funding Policy. The Committee further notes the uncertainty about the extent to which there is scope to extend the existing prudential borrowing regime without a restriction being imposed by HM Treasury.

258. The Committee urges the Scottish Government to seek clarification from the UK Government on the scope to extend the existing prudential borrowing regime, both in terms of the amount borrowed and the bodies capable of undertaking such borrowing.

Variations and joint working within the public sector

259. Several witnesses indicated that variations between public bodies in several respects, including governance structures, powers, funding practices, and accounting and tax treatment mean that they have different levels of flexibility in their capital investment options. These rules appeared, to some witnesses at least, to hamper the ability of the public sector to work together – particularly on larger projects where the alignment of funding is critically important. Witnesses suggested a number of points that may be worthy of examination.

260. Edinburgh city council said that local authorities’ ability to sell assets below market value, with ministerial consent, is regarded as an important flexibility in the provision of joint projects or in assisting the objectives of public sector partners. However, it appears that a requirement to dispose of assets at the best price that

256 HM Treasury, Funding the Scottish Parliament, National Assembly for Wales and Northern Ireland Assembly: Statement of Funding Policy, October 2007. Available online at: http://www.hm-treasury.gov.uk/d/pbr_csr07_funding591.pdf [Accessed: 10 December 2008] 257 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Cols 382-3. 258 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 583.

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may be reasonably obtained may constrain the ability of other parts of the public sector to co-operate.259

261. NHS Greater Glasgow and Clyde emphasised that there is an increasing need for public sector partners – particularly health and local authority services – to co-locate services or provide joint premises or facilities. However, Glasgow City Council stated that local authorities have a different VAT status to NHS or other central government bodies, and so it may be more difficult for a health board to take the lead on a particular joint project if it involves items that attract VAT.260 Margaret Cuthbert and Dr Jim Cuthbert also stated that the NHS’ unique VAT position meant a bias to PPP/PFI, with VAT on new build recoverable under PPP/PFI, but not under public financing.261

262. CIPFA, however, suggested that the constraints on joint working may be more perceived and cultural, or due to factors such as different planning horizons, than actual. It emphasised that, “Until we move forward on joint asset management planning, it will be unclear whether technical barriers to funding exist, although I would not have thought that any of those barriers would be insurmountable.”262 Unison suggested that, even within existing constraints, a flexible approach in joint working could bear fruit - such as, for example, local authorities applying borrowing powers to a project while NHS boards provide revenue funding.

263. The Committee considers that the current framework makes it difficult for joint working and joint funding to take place and, therefore, recommends that the Scottish Government liaises with the UK Government to determine why various bodies must operate under different regimes and whether it is possible to simplify the current system.

Managing market capacity

264. Several issues emerged related to the theme of how the public sector can manage the way in which projects are offered to the market in order to ensure optimum delivery and value for money. Many witnesses stated that Scotland has been a market leader in PPP/PFI, and has a concentration of private sector skills and capacity geared towards it, with substantial local supply chains established to facilitate the market.263 In this context, any potential hiatus in the pipeline of deals coming to the market is a concern, especially given the long lead time that projects have in procurement. There are distinct issues in relation to competition for construction of projects and competition for financing them.

Construction 265. Dr Iain Docherty argued that it is particularly important to retain the construction chain as, “wages in Scottish companies may be more directly

259 For example, see NHS Greater Glasgow and Clyde, Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 334. 260 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 359. 261 The Royal Edinburgh Infirmary: A Case Study on the Workings of the Private Finance Initiative, Margaret Cuthbert and Jim Cuthbert, 2008 262 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 390. 263 For example, see Bank of Scotland. Written submission to the Finance Committee.

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recycled into the economy than investor profits”.264 PWC said that smaller contractors may remain, but questioned whether, “if some of the bigger players choose not to work in Scotland…we will necessarily get the best out of them.”265

266. Several witnesses suggested that the costs of the competitive dialogue procedure, combined with the uncertainties of the NPDO model, have increased the need for a certainty of forward deal flow. Robertson Group, however, said that, “we will certainly put many of our resources, scant as they are, outside Scotland”.266 As noted earlier in this report, although bundling of projects under PPP/PFI can result in cost efficiencies, this approach may be problematic for smaller businesses, although there was some evidence that they are still part of the supply chain and engage in joint ventures to secure tie-up with the critical skills of the larger companies.

Finance 267. Evidence was given to the inquiry during April and May before the recent difficulties in the financial markets. However, even then McGrigors emphasised that there is now a very competitive world-wide market for investment and capital projects, with the PPP/PFI model and its variants developing in 97 countries267, and that investment is particularly mobile globally and will look for the most stable and predictably best returns.268 PWC said that banks, “will disinvest from markets if they do not see a great deal of activity and will be relatively hard to tempt to invest again”.269 Bank of Scotland stated that several companies are already viewing it as more difficult to do business in Scotland and have signalled that they will not bid for any more projects here.270

Forward planning 268. Any private sector involvement in public sector capital investment – whether simply as construction contractors under a traditional procurement or in a partnership including the finance and operation of a facility – requires the ability for the private sector to align its forward plans and investment decisions with a clear context of what the public sector is trying to achieve. Scottish Water emphasised that, “the more certainty that we can provide in the marketplace, the more we will see such huge benefits as we have seen in terms of improved efficiency and delivery.” It stated that the aim must be to “give as much predictability to the market as possible to avoid boom and bust in any element of the delivery chain while trying to get consistency of workload into the design community and the construction community.”271 However, the extent to which forward visibility of workload is managed pro-actively is unclear. It is difficult to give this forward certainty while working within three-year spending review periods, and individual public bodies alone cannot create this flow.

264 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 449. 265 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 422. 266 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 469. 267 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 405. 268 McGrigors. Written submission to the Finance Committee. 269 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 420. 270 Bank of Scotland. Written submission to the Finance Committee. 271 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 344.

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269. McGrigors argued that developing new approaches to capital investment is not as important as the need for certainty in the market to retain a supply chain that provides enough competition to help ensure maximum value for money, and that efforts should be focused on enhancing competition.272 Transport Scotland also stated that, if enough contractors are not attracted into the market, value for money will be difficult to achieve regardless of the funding model.273

270. The Committee recommends that every effort is made to ensure that public bodies maintain a steady flow of capital projects to provide a regular supply of project opportunities for the construction industry and that there is sufficient transparency to ensure that the construction industry is aware that such opportunities exist.

Skills

271. Throughout the inquiry, there has been wide consensus that the skills of the public sector are vital to ensuring value for money is achieved in capital investment, regardless of the procurement and funding model. The centrality of appropriate contract negotiation, particularly given the long length of many capital–related contracts, was a recurring point. Scottish Water emphasised the need for a range of skills, from procurement to contract management – including claim management and performance management – over the whole life of a project to ensure that the public sector maintains a strong hand.274 Addressing this issue is also a central theme of the Scottish Futures Trust, discussed at paragraph 280 below.

272. There is an issue about developing the skills in the first place. The Scottish Funding Council emphasised that, for most senior managers in the public sector, a major infrastructure investment may be a once-in-a-career event. However, several witnesses suggested that the public sector’s understanding of risk and the management disciplines required for major projects has been enhanced by its experience of working with PPP/PFI, and has changed the attitude of the construction market to contract risks. Increased focus on issues such as project development, management of the pipeline of projects and consideration of whole-life costs can now be applied to improve delivery of projects under all procurement methods. However, there appears to be little more recent empirical evidence of whether this is in fact happening in practice.

273. Trades unions suggested that the skills issue must not be seen as a qualitative difference between the public and private sectors. The BMA stated, “why is the public sector so bad at project management that it does not deliver on time and goes over budget? The same companies are building and designing the structures as under PFI. What is it about public sector procurement that lets building companies and contractors get out of control when they are not allowed to get out of control under the PFI model? It is all about project management.”275

272 McGrigors. Written submission to the Finance Committee. 273 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 344. 274 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 355. 275 Scottish Parliament Finance Committee. Official Report, 13 May 2008, Col 510.

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274. Dr Iain Docherty also emphasised that the skills are available in the public sector and can be aligned with successful project delivery, citing Transport for London as an example, saying, “it has the best concentration of skilled financial, engineering and transport professionals of any equivalent body in the UK, and it has the capacity to lever its powers”.276

275. However, witnesses also said that the public sector can struggle to retain these skills in the face of competition from the private sector, necessitating constant re-learning. Various solutions, including buying-in teams for specialist advice on particular projects, were suggested. Health Facilities Scotland argued that, “there are good, well-experienced individuals working in the public sector, but we are not investing enough in them, nor are we doing enough to retain them.”277

276. The issue of having the requisite skills in the private sector was also raised. Paul Brewer from PWC argued that “for the tier of projects at the next size down from the big civil engineering projects—roads, bridges, hospitals and so on—that directly attract the interests of the global players, many of the smaller construction groups in Scotland could play a valuable part in the delivery supply chain, but they may not have the top-end skills to deliver projects effectively. We need people who have those skills to manage the supply chain. If some of the bigger players choose not to work in Scotland, we will still have the contractors who can deliver the infrastructure, but I would question whether we will necessarily get the best out of them.”278

277. Throughout the inquiry there was discussion of the merits of centralising skills in a Scotland-wide body – while recognising the trade-off that might have to be made with local accountability and potential disconnect with the other public sector staff (e.g. the nurses and teachers who are delivering the services). CIPFA highlighted a number of substantial initiatives that are underway to centralise skills and bring together procurement practices across different elements of the public sector, but suggested that it is not yet clear what role they could play in improving capital investment practices.279 Several witnesses also suggested that co-operation could usefully move beyond the already substantial sets of rules, guidance and model documentation to find a way to share practical experience and knowledge.

278. A further theme was that any transition to a new capital investment approach risks a period of teething problems, mistakes and poor value contracts during the learning curve – which appears to have happened when PPP/PFI was less well developed and before improvements in central guidance had been put in place. The way in which knowledge is retained and effectively transferred within the public sector is essential if past experience is to be used to overcome that potential problem. This issue highlights the importance of options appraisal being as rigorous and credible as possible, with all costs associated with a deal included and the test incorporating detailed exploration of the range of benefits and

276 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 443. 277 Scottish Parliament Finance Committee. Official Report, 15 April 2008, Col 357. 278 Scottish Parliament Finance Committee Official Report, 29 April 2008, Col 423. 279 Scottish Parliament Finance Committee. Official Report, 22 April 2008, Col 391.

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disbenefits.280 Similarly, it highlights the importance of the transparency of contracts.

279. To ensure a steady flow of capital projects from public bodies, it is also important that there are sufficient skills within the public sector and the Committee recommends that every effort is made to ensure that there is and will continue to be sufficient skills capacity in the public sector.

THE SCOTTISH FUTURES TRUST

Introduction

280. In its manifesto for the 2007 Scottish election, the SNP proposed the creation of a Scottish Futures Trust (SFT) “as an alternative to the costly and flawed PFI/PPP”. It suggested that a not-for-profit Trust issuing ‘Scottish Futures Bonds’ would “emerge as a more attractive source of funding for both national and local projects which will effectively crowd out PFI/PPP over time”.

281. At the time of the Committee launching its inquiry the Scottish Government had not published any further details on this proposal. It published a consultation paper on the SFT in December 2007, after the Committee’s call for evidence for its inquiry had closed. This meant that respondents to the Committee could not comment in any detail on the SFT plans. On 20 May 2008, the Scottish Government then published a strategic business case, entitled Taking Forward the Scottish Futures Trust. As this came at the end of the Committee’s initial programme of oral evidence, witnesses had not been able to comment on this.

282. Nonetheless, several witnesses made supplementary written submissions to the Committee on the SFT and were able, in oral evidence, to relate a number of key generic themes to the development of the SFT and recommend where and how it might direct its efforts. The Committee also had the opportunity to take evidence from the Cabinet Secretary for Finance and Sustainable Growth after the publication of the strategic business case. On 9 September the Committee also recalled a number of witnesses representing different sectors to take further evidence specifically on the SFT. It also invited all previous witnesses to make further submissions on the strategic business case.

283. The Cabinet Secretary explained that the proposed SFT is about securing less expensive funding, but also “a new approach to the organisation and packaging of infrastructure investment opportunities in Scotland”. He said that it had three key components: reliance on the use of the NPDO model for financing projects; providing central expertise in project development; and aggregating projects to guarantee efficiencies in risk, finance and delivery arrangements.281 He said that these features should combine to save in the region of £100 million to £150 million per annum – 3% to 5% of capital investment spending.

284. The strategic business case explains that two new SFT organisations are likely to be set up in separate phases, with a wide range of possible roles. The first 280 CIPFA Scotland and CIPFA Directors of Finance Section, joint response to Scottish Futures Trust consultation. 281 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Cols 560-1.

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part of the organisation is to be a public sector entity, focusing on providing effective procurement as a developer and co-deliverer of projects and programmes, and a focal point of expertise that can offer quality assurance, guidance and standardisation. One of the objectives of this first company will be to take forward the development of the second, expected to be established in 2009-10 as a private sector entity, possibly a limited liability partnership joint venture between the public sector and private sector investors. The role of the second company will be to act as an investor of risk capital and an aggregator or conduit for funding. On 10 September 2008, the Cabinet Secretary announced the establishment of the SFT as a company limited by shares, wholly owned by Scottish Ministers, directed by an agreed and published management statement but operating at arms length. He made no mention in that statement of a second element of the SFT to be established later.282

285. Many witnesses emphasised that the level of detail in the strategic business case does not yet allow clear judgements to be made on the merits of the SFT. Much of the document indicates that it is simply discussing options, with several cases where considerable further examination is required before it is clear whether they are viable or, indeed, whether they meet regulatory requirements. While there was some interest in the potential for the SFT, Unison expressed concern that the Scottish Government is “establishing a new quango with most of its important work barely sketched out”.283

286. The potential for achieving one of the three key components of the SFT - applying the NPDO model more widely - is discussed at paragraphs 193-207 above. The evidence on other elements of the SFT focused on three main issues: securing better value funding, operating as a centre of excellence, and managing a pipeline of projects to the market. To a significant extent these issues are intertwined. Governance and accountability issues arising from these issues also formed a major theme in the evidence.

Securing better value funding

287. The strategic business case states that, “The SFT is unlikely to be a direct funder of projects in the short term” but will aim to use various methods, including underpinning and aggregation, “to be an arranger of funding that is cheaper than PFI”. It also suggests that the SFT will “reduce the costs of existing contracts”, although there is no further detail on how this will be approached.

288. The SFT consultation paper stated that “the Government would like to see the initiative provide for individuals to make tax-exempt investments in Scotland’s infrastructure”, but acknowledged that there is no power to do this within the current devolution settlement. The Scotland Act 1998 does not permit the Scottish Government to borrow to fund long-term investment, and it cannot offer the tax-free incentive for bonds. The strategic business case was, therefore, developed in the knowledge that this option is not feasible at present.

282 Scottish Parliament. Official Report, 10 September 2008, Cols 10599-10604. 283 Unison Scotland. Supplementary written submission to the Finance Committee on the SFT.

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289. The SFT strategic business case states that commencing development and delivery of a local authority bond issue will be an early activity of the SFT. The Cabinet Secretary said that the SFT itself cannot issue bonds, but “will provide the expertise to bring local authorities together to launch a Scotland-wide municipal bond” to reflect the shared interest that local authorities have in, for example, renewing the schools estate.284 He stated that, while individual local authorities would find bond issues challenging, providing a platform through the SFT to aggregate demand offers “a realistic and tangible opportunity to use the powers” and would give it formidable advantages of economy of scale.285 However, he acknowledged that this depends on the degree of interest that individual local authorities show,286 and it is not clear what the incentive for authorities may be.

290. As noted at paragraph 25 above, local authorities do have power to issue bonds, but have not found them to be the cheapest source of capital. Keppie Design also stated that, while bond financing can be competitive, the fees required to ensure that bonds are rated as investment grade are high.287 CIPFA said that the power does exist for two or more local authorities to issue bonds jointly, but that this has limits and raises the issue of how security for the bonds will be handled.288 Unison emphasised that introducing new financing models tends to imply a learning period during which value for money may be compromised, and Edinburgh city council stated that bonds appear to have no particular benefit over access to the Public Works Loan Board.289 PWC acknowledged that, while the PWLB will inevitably be a cheaper source of funds, bonds bring the added benefit of the discipline of external due diligence.290

291. The Cabinet Secretary indicated that the aspiration of the SFT to bundle funding does not necessarily mean bundling of contracts.291 However, it is not clear how, if risks have been dealt with in a particular way in the bundling arrangement to secure the cheapest funding, they can then be dealt with differently in individual contracts and retain discipline at the project level. It is also unclear whether any approach to aggregation of funding will have to be confined to a single project-type or sector, such as schools, rather than operating more widely across the public sector. The Scottish Funding Council explained its approach to developing an aggregated central borrowing facility for colleges and universities through a framework agreement with a panel of up to four private lenders – with the possibility of reducing the cost by using guarantees by the Council.292

292. The business case also states that a potential aim is for the second SFT organisation to have an investment fund to co-invest in NPDO projects. In principle, many witnesses welcomed the possibility of a cheaper finance-raising mechanism. Dundas and Wilson suggested that a joint public/private financing of

284 Scottish Parliament. Official Report, 28 May 2008, Col 9019. 285 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 585. 286 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 581. 287 Keppie Design. Written submission to the Finance Committee. 288 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 669. 289 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Cols 674 and 670. 290 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 668. 291 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 583. 292 The Scottish Funding Council. Supplementary written submission to the Finance Committee on the SFT.

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projects could be appropriate, if the SFT operated in a similar way to the European Investment Bank, raising money from the capital markets and lending on favourable terms.293

293. However, many expressed uncertainty about how cheaper finance can be achieved. CIPFA stated that there has been no assessment provided by the Scottish Government of the markets’ views of the credit-worthiness of the SFT. It stated that, “We fail to see how…the SFT will provide opportunities for securing cheaper funding costs.”294 The Bank of Scotland also stated that it is not clear how a private entity would achieve the AAA credit rating that would be required to secure the cheapest private finance.295 Unison expressed concern that the “details of how investment will be raised from the private sector has not been explored in any detail”.296 Several witnesses also emphasised the current global difficulties in accessing debt capital and suggested that, in its financing aspirations, the SFT must be looking to the future when this is easier. Glasgow City Council said that, whatever models of finance the SFT may pursue, the key issue for it is whether Scottish Government support for the cost of borrowing will be maintained in a way similar to the former level playing field support.297 PWC indicated that the overall level of Scottish Government support was not within the remit of the group developing the strategic business case.298

294. The business case acknowledges that finance raises “challenging policy issues” and a great deal of further work is required. There has been no explanation to date in evidence to the Committee of how any other methods of government underpinning of project finance might be developed, although witnesses suggested that this would be a competent approach for the Scottish Government to take. The business case also notes that compliance with several regulatory regimes – including EU state aid rules – will need further consideration in respect of any government financial guarantees. CIPFA suggested that any new vehicle for financing will have to be examined very carefully by the Office of National Statistics and require examination and agreement by Eurostat on whether it should count as part of government debt or not.299 It also said that any form of central government guarantee to a private company to reduce borrowing costs would have accounting treatment consequences. It is also not clear how the SFT will minimise the added cost of tax liabilities on any surpluses it earns if it is in the private sector.300

295. Witnesses suggested a number of innovative models of combining private finance with government guarantees or underwriting of some kind, mentioning Transport for London and approaches in France and Australia. McGrigors

293 Dundas and Wilson. Written submission to the Finance Committee. 294 CIPFA Scotland and CIPFA directors of finance section, joint response to the Scottish Government’s Scottish Futures Trust consultation. 295 Bank of Scotland. Written submission to the Finance Committee. 296 Unison Scotland. Supplementary written submission to the Finance Committee on the SFT. 297 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 678. 298 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 679. 299 CIPFA Scotland, Government deficit and debt, supplementary written submission to the Finance Committee, May 2008 300 CIPFA Scotland and CIPFA Directors of Finance Section, joint response to the Scottish Government’s Scottish Futures Trust consultation.

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acknowledged that any kind of government guarantee will undoubtedly deliver a lower cost of finance. However, the key issue is that the extent to which risks are transferred must be very carefully scrutinised in any guarantee model. Barclays Private Equity emphasised that, if the issue is to secure the lowest overall costs and best project outcome, this does not necessarily mean focusing on the lowest initial cost of capital but looking at all the cost elements over the life of a project.301

296. The Committee’s view is that there is insufficient information to judge whether the SFT will be a mechanism for delivering improved value for money.

The SFT as a centre of excellence

297. The Cabinet Secretary emphasised the importance of the SFT acting as a central best practice agency and repository of key procurement and project management skills. He stated, “I am not confident that the public sector in Scotland has the necessary skills to evaluate risk on a like-for-like basis with experienced players in the private sector.”302 The SFT is, therefore, designed to ensure effective application of negotiation skills, and ensure that projects are undertaken on a more securely founded financial basis than may previously have been the case. These aims accord closely with the findings of Audit Scotland’s recent report on the management of major capital projects.303 Barclays Private Equity also agreed that harnessing, retaining and refreshing the capacity of public bodies in a dynamic market had been a perpetual issue over the last 15 years, but not yet significantly improved.304

298. A number of roles are possible under a centre of excellence theme. Witnesses emphasised their uncertainty as to the balance that may eventually emerge between centralising skills and enhancing those in individual public bodies, and between the SFT being an advisory and support body and it having a decision-making role. Dr Jim Cuthbert suggested that a model akin to the Northern Ireland Strategic Investment Board, with a central role to scrutinise proposed deals, would be useful.305 However, there is no information to date on how option appraisal will be applied in a centralised SFT model. Witnesses generally favoured an advisory, co-ordination and quality assurance role for the SFT rather than any direct stake in procurement. Canmore suggested that “a Scotland-wide centralised procurement body… will not work here”, although it did see the merit in a body to transfer best practice.306 The Cabinet Secretary, however, stated that one of the key aspects of the SFT company’s memorandum of association will be to procure public infrastructure.307

301 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 672. 302 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 575. 303 Audit Scotland. (June 2008) Review of major capital projects in Scotland. Edinburgh: Audit Scotland. Available online at: http://www.audit-scotland.gov.uk/docs/central/2008/nr_080624_major_capital_projects.pdf [Accessed: 10 December 2008] 304 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 684. 305 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 448. 306 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 488. 307 Scottish Parliament. Official Report, 10 September 2008, Col 10599.

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299. Several witnesses suggested that experience shows that financial incentives or legal obligations would be required for individual public bodies to adopt its approaches.308 Evidence also focused on the need for clear contractual arrangements so that the SFT’s accountability for its quality of service is clear, and to avoid the frustration of the SFT potentially coming between clients and bidders and hampering direct communication.309

300. There was also some concern expressed by witnesses as to whether the SFT would genuinely provide anything additional to existing central resources, such as the Scottish Government’s Financial Partnerships Unit, Scotland Excel310, the Scottish procurement directorate and Partnerships UK (in which the Scottish Government has an equity share). Unison queried the cost of establishing – contrary to general Scottish Government policy to reduce the number of public bodies - a new organisation, with significant salaries implied by the funding estimates.311 Canmore stated that existing bodies could already provide several of the proposed roles of the SFT, such as spreading of best practice or co-ordination of shared infrastructure.312 CIPFA also argued that the SFT would not offer anything that is not otherwise capable of being achieved through a combination of the prudential code, effective asset management and good procurement practices.313 However, PWC suggested that, in this role, the SFT would be accountable to a wide range of public stakeholders, compared to the current Financial Partnerships Unit’s accountability solely to the Scottish Government and that it could apply the skills to all capital procurement not just that involving private finance.314 The Cabinet Secretary also said that existing initiatives are not focused on the same strategic infrastructure projects as the SFT.315 He described the SFT as a focal point to encourage collaboration and as a “reference point”, which he said is a significant gap in current arrangements.316

301. The Committee notes the Scottish Government’s intention for the SFT to be a centre of excellence but believes that there is insufficient information to judge whether this will be the case.

Managing a pipeline of projects

302. The strategic business case suggests a variety of central roles for the SFT in managing the flow of public projects to the market, improving planning and modelling tools and acting as an expert broker. Although there are many different roles of this nature possible, the main strand discussed by witnesses was 308 See, for example, supplementary written submissions to the Finance Committee on the SFT by McGrigors and Canmore. 309 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Cols 682-3. 310 Scotland Excel was launched in April 2008 as a centre of expertise for local authorities in Scotland, launched in April 2008. It aims to raise procurement standards by working with Scottish local authorities and suppliers to secure best value and collaborative contracts, provide more streamlined services and reduce duplication. 311 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 688. 312 Canmore Partnership Ltd. Written submission to the Finance Committee. 313 CIPFA Scotland and CIPFA Directors of Finance Section, joint response to the Scottish Government’s Scottish Futures Trust consultation. 314 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Cols 683 & 686-7. 315 Scottish Parliament. Official Report, 10 September 2008, Col 10607. 316 Scottish Parliament. Official Report, 10 September 2008, Col 10600.

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aggregating projects for presentation to the market. This also relates directly to the issue discussed at paragraph 268 above on the management of market capacity in the context of any delays during the transition period to a new model.

303. The Cabinet Secretary stated that the SFT will be involved in large national projects but will also “operate at a higher level of aggregation so that the market will not have to respond to a large number of individual projects that are procured by many public organisations”.317 He described this approach as “a logical and complementary response” to initiatives in other areas of public procurement, resulting from the McClelland report.318 He also stated that, while aggregation may be an important approach, it would still provide the opportunity for smaller Scottish businesses to participate in the process.319 He stated that he expected collaboration to be able to deliver projects more quickly, thus reducing the impact of construction inflation, and to realise economies of scale on elements such as insurances and financial advice. Canmore suggested that, in the current global financial context, there are perhaps excessively high expectations of co-ordination being attached to the SFT.320

304. Partnerships UK strongly advocated a programme-level approach to investment, stating that, while individual projects dictate certain solutions, where there is a programme of projects, “you will miss out on an additional element of value for money unless you analyse the programme as a whole”. It gave the example of investment required to address waste management obligations and said that, “The worst possible outcome would be if all six or eight were to launch into the market at the same time”.321 Network Rail agreed, stating that a programme that transcends individual public bodies offers “the great prize” of dealing with both public sector skills shortages and private sector capacity issues.322 McGrigors also stated that, in the relatively small Scottish context, presenting comparatively homogeneous projects to the market will bring benefits.323

305. While recognising the potential benefits of exploring aggregation of buying power, several witnesses emphasised that there must be “good operational reasons behind decisions to co-ordinate investment programme management and delivery”.324 Ian Wall stated that considerable care needs to be taken to ensure that aggregation does not lead to increased complexity, reduced flexibility or diseconomies such as delay to individual projects. He related this to the discussion on the risks of bundling projects (see paragraph 206 above on the NPDO model), saying that, “the more things are packaged up, the more difficulties there will be

317 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 561. 318 Scottish Executive. (March 2006) Review of public procurement in Scotland – Report and recommendations. Scottish Executive. Available online at: http://www.scotland.gov.uk/Publications/2006/03/14105448/24 [Accessed: 10 December 2008] 319 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 582. 320 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 687. 321 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Cols 536-7 and 548. 322 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 546. 323 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 680. 324 Scottish Funding Council. Supplementary written submission to the Finance Committee on the SFT.

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with averages, lack of clarity and so on.”325 McGrigors also said that clarity was required on how aggregated finance could deal with issues of risk, liability and accountability, such as whether the failure of an individual project should default the aggregate financing.326

306. McGrigors also expressed concern that a new structure would risk both slowing down delivery of projects and make investment in Scotland less attractive.327 Forth Electrical Services argued that developing a new model, with its likely reiterations as ideas develop, risks “throwing away a lot of good work to move to something completely different” and the possibility that a workable new model could take three to five years to become established.328 Quayle Munro also emphasised that, “if we want to deliver projects quickly…we must definitely focus on structures that are already known.”329

307. The Cabinet Secretary acknowledged concern to ensure a steady flow of work to the market. However, he emphasised that the scale of infrastructure investment meant that, while the SFT is being developed, numerous opportunities still exist and there is a “strong pipeline of projects to guarantee that we capture market interest”.330 McGrigors also suggested that by focusing, at least initially, on the NPDO model, the SFT can have twin benefits of providing, “visibility through capped returns but in a structure that is not too different from that in the rest of the market.”331

308. The Committee believes that there is insufficient information to judge the role of the SFT in managing a pipeline of projects.

Governance and accountability issues

309. The ways in which aggregation of financing and management of the market are approached are inextricably linked to issues of governance and accountability. The proposed centralisation of some public sector planning, development and delivery issues and the proposed aggregation of funding both raise issues about the relationship between the SFT and the governance structures of individual public bodies. The proposed organisational structure of the SFT itself – particularly the possibility of a second private sector organisation - also raises issues about public accountability. Lynn Brown from Glasgow City Council asked, “when a project is approved, who will be accountable for its being delivered on budget and on time?”332

310. The application of any ‘bulk buying’ approach, and the centralising of procurement skills, raise issues about how the operation of the SFT will interact with the need to maintain local control of service objectives and prioritisation, and how it will address the issues relating to flexibility discussed in relation to PPP/PFI

325 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 544. 326 McGrigors. Supplementary written submission to the Finance Committee on the SFT. 327 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 408. 328 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 487. 329 Scottish Parliament Finance Committee. Official Report, 6 May 2008, Col 489. 330 Scottish Parliament Finance Committee. Official Report, 27 May 2008, Col 567. 331 Scottish Parliament Finance Committee. Official Report, 29 April 2008, Col 420. 332 Scottish Parliament Finance Committee, Official Report, 9 September 2008, Col 690.

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above. It is not clear whether the SFT will include the development of any mechanism to make decisions such as prioritising between competing projects. CIPFA said that the governance issues are a particular weakness of the strategic business case, and Glasgow City Council also said that there was a risk of democratic deficit at the moment.333 PWC pointed out that governance considerations had not been part of the remit of the group developing the strategic business case.334

311. The key point emphasised by several witnesses is that any arrangements must be such as to allow public bodies to be able to fulfil their own statutory responsibilities for financial management and accountability. NHS Greater Glasgow and Clyde said that public bodies must retain responsibility for “developing service specification(s), deciding upon a preferred service model, setting an affordability envelope, ensuring value for money and committing to a contract”.335

312. The consultation paper suggests that the SFT may actually own some of the capital assets, but there has been no further detail on how this may operate. Dundas and Wilson said that the practical or operational benefits of separating ownership from use and occupation are unclear.336 It is also unclear how any central ownership would be intended to relate to an individual public body’s accountability arrangements or accounting requirements. NHS Greater Glasgow and Clyde stated “the division of responsibilities between SFT and commissioning bodies would require to be carefully defined so that there was no overlap, gap or inappropriate transfer of responsibility for delivery. In essence, Public Bodies should retain ownership for developing service specification(s), deciding upon a preferred service model, setting an affordability envelope, ensuring value for money, and committing to a contract for providing the service/building which was being commissioned. In terms of governance, the CEO of the Public Sector Body would be accountable to their Board for ensuring that each of these processes was carried out appropriately to the required standard.”337

313. The Northern Ireland Strategic Investment Board said that its approach works because local authorities there do not have a role in commissioning capital projects such as schools etc.338

314. Audit Scotland expressed some concern that the governance arrangements need “to be particularly robust given the public nature of the activities of the SFT but bearing in mind the expected lack of direct government control”.339 The SFT consultation paper stated that the change to application of IFRS would likely make it more difficult to design a SFT “which would continue to provide the additionality of investment in public service facilities”. This is one of the reasons for locating the

333 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Cols 688 and 690. 334 Scottish Parliament Finance Committee. Official Report, 9 September 2008, Col 689. 335 NHS Greater Glasgow and Clyde. Supplementary written submission to the Finance Committee on the SFT. 336 Dundas and Wilson. Written submission to the Finance Committee. 337 NHS Greater Glasgow and Clyde. Supplementary written submission to the Finance Committee on the SFT. 338 Scottish Parliament Finance Committee. Official Report, 20 May 2008, Col 555. 339 Audit Scotland. Written submission to the Finance Committee.

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second organisation in the private sector. However, it raises some uncertainty over how this can, therefore, have the appropriate accountability and public ethos. Unison expressed concern that the strategic business case emphasises the need to ensure “sufficient private sector influence over decision making” in its desire to attract private investment.340

315. The Committee believes there is insufficient information to comment on the accountability and governance issues related to the SFT.

Overall conclusion

316. The Committee believes that while it is the Scottish Government’s view that the SFT will become a more attractive source of funding for national and local projects, that has yet to be proven. The Committee believes that the current economic climate may make it more difficult to introduce a new funding model for capital projects. The Committee, therefore, recommends that no infrastructure projects, national or local, should be delayed or postponed pending the introduction of the SFT funding.341

340 Unison Scotland. Supplementary written submission to the Finance Committee on the SFT. 341 The Committee divided on a proposal to insert the following paragraph before paragraph 316: “The Committee found no clear evidence that a separate limited company, the Scottish Futures Trust, is required to deliver better co-ordinated, managed and delivered infrastructure investment. Neither did the Committee receive clear evidence that any other funding option is to be available offering better value for money separate to all existing NPDO, PPP, prudential borrowing and traditional capital financing methods and believes any function to deliver better value for money and efficiency should be carried out by central government as part of its existing drive for better value for the public purse.” The proposal was disagreed to on a casting vote. For: 4 (Jackie Baillie, James Kelly, Jeremy Purvis and David Whitton), Against: 4 (Derek Brownlee, Joe FitzPatrick, Alex Neil and Andrew Welsh), Abstentions: 0.

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ABBREVIATIONS USED IN THE REPORT

A+DS Architecture + Design Scotland

AME annually managed expenditure

BMA British Medical Association

CHA Cordale Housing Association

CIPFA Chartered Institute of Public Finance and Accountancy

DEL departmental expenditure limit

EIS Educational Institute of Scotland

IFRS International Financial Reporting Standards

LIFTS local improvement finance trusts

NAO National Audit Office

NPD(O) non-profit distributing (organisation)

ONS Office for National Statistics

PPP public-private partnerships

PFI private finance initiative

PSC public sector comparator

PSND public sector net debt

PWC PricewaterhouseCoopers

PWLB Public Works Loan Board

SCDI Scottish Council for Development and Industry

SFC Scottish Funding Council

SFT Scottish Futures Trust

SPV special purpose vehicle

TME total managed expenditure

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GLOSSARY OF KEY TERMS

Competitive dialogue The competitive dialogue procedure is a new procedure introduced in the public sector procurement directive (2004/18/EC). It is for use in the award of complex contracts, where there is a need for contracting authorities to discuss all aspects of the proposed contract with candidates.

Credit rating An indication by a Credit Rating Agency of an entity's long-term or short-term credit worthiness. A long-term rating of Aaa/AAA is the most credit worthy (e.g. the UK Government). BBB represents the minimum investment grade rating.

Equity Ordinary share capital invested in the project company by the sponsors and any third party investor. Typically equity has the last claim upon the project's income, hence the highest risk and is therefore the most expensive source of finance.

Framework agreements

This enables contracts for individual projects to be “drawn off” from the framework or mini competitions to be held amongst framework contractors without the need for full pre-qualification, tendering and contract negotiation.

Hub initiative Setting up local joint ventures (local hub companies) supported by national delivery (hub Scotland), hub and its resulting infrastructure is intended to be the focal point for pulling together various local services, as well as providing the efficient procurement framework which makes such developments possible.

Junior/subordinated debt

A class of debt that is subordinate to another class of debt issued by the same party. Junior debt is more risky for an investor to own, but it pays a higher rate of interest than debt with greater security.

Non-profit distributing organisation (NPDO)

Variation of the standard PPP model that is 100% debt funded and which pays no equity returns to the shareholder. Instead surplus revenues are recycled via a charity for community use.

Off-balance sheet funding

Any form of funding that avoids placing owners' equity, liabilities or assets on its balance sheet.

Public-private partnership (PPP)

A type of delivery where public and private sectors work together to deliver public infrastructure. There are now many forms of PPP around the world which cover a wide variety of working arrangements including joint venture

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and PFI.

Private finance initiative (PFI)

The Private Finance Initiative (PFI) is a type of PPP project and was launched in 1992 to open up opportunities for more private sector involvement in the provision and modernisation of public services. PFI involves the public sector procuring services to the quality standards it requires, instead of procuring a capital asset or other equipment then operating it itself.

Prudential borrowing From 1 April 2004, local authorities are free to determine their own capital programmes for investment in assets central to the delivery of quality public services, such as schools, housing and roads. In doing so, authorities must have regard to the Prudential Code, which requires that plans are affordable, prudent and sustainable. To supplement central government support, local authorities are able to incur self-financed (prudential) borrowing, if affordable.

Public sector comparator

The net present value of the costs associated with a public sector capital project adjusted for a risk factor under a traditional procurement. This is used to compare against the costs associated with a PFI scheme to determine the most cost effective method of procurement.

Public Works Loan Board

The Public Works Loan Board is a statutory body operating within the United Kingdom Debt Management Office, an Executive Agency of HM Treasury. The Board's function is to lend money from the National Loans Fund to local authorities and other prescribed bodies, and to collect the repayments.

Refinancing gains The gains associated with refinancing loans from banks for a lower interest rate once the project is signed.

Secondary equity market

The market for the onward sale of a PFI equity stake to another party.

Senior debt A bond or other form of debt that takes priority over other debt securities sold by the issuer. By having the first call on funds, it is less risky and therefore cheaper.

Special purpose vehicle

A limited company established to secure funding and deliver private finance projects.

Supplementary business rates

Supplementary business rates (SBRs) would give councils the power to levy an additional supplement on the national business rates within their area. The funds generated could then be used to enable prudential borrowing and

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other forms of capital financing.

Supported borrowing An element of revenue funding provided by the Scottish Government to cover debt charges on borrowing for a notional amount of capital expenditure each year.

Tax increment financing scheme (TIF)

TIF is a tool to use future gains in taxes to finance the current improvements that will create those gains. When a public project such as a road, school, or hazardous waste cleanup is carried out, there is an increase in the value of surrounding property and often new investment (new or rehabilitated buildings, for example). This increased site value and investment creates more taxable property, which increases tax revenues. The increased tax revenues are the "tax increment." Tax increment financing dedicates that increased revenue to finance debt issued to pay for the project. TIF is designed to channel funding toward improvements in distressed or underdeveloped areas where development would not otherwise occur. TIF creates funding for public projects that may otherwise be unaffordable.

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ANNEXE A: EXTRACTS FROM MINUTES

3rd Meeting, 2007 (Session 3), Tuesday 11 September 2007

Work programme and working practices: The Committee agreed to adopt the work programme and working practices agreed at its away day.

4th Meeting, 2007 (Session 3), Tuesday 25 September 2007

Inquiry into the methods of funding capital investment projects: The Committee considered its approach to the inquiry. The Committee agreed an initial remit and timetable for the inquiry, to issue a news release and general call for evidence and to write to the Cabinet Secretary for Finance and Sustainable Growth seeking details on the timetable and scope for development of the proposed Scottish Future’s Trust and whether legislation would be required. The Committee agreed to defer detailed consideration of its oral evidence programme until early 2008. The Committee agreed, in principle, to seek to appoint an adviser for the inquiry and that SPICe (and any adviser) be asked to prepare a detailed briefing paper on different funding models. The Committee further agreed to delegate authority to agree the specification for the adviser to the Convener and Deputy Convener. The Committee also agreed to delegate to the Convener responsibility for arranging the SPCB to pay, under Rule 12.4.3, any expenses for witnesses in the inquiry.

6th Meeting, 2007 (Session 3), Tuesday 30 October 2007

Inquiry into the funding of capital investment projects – appointment of adviser (in private): The Committee agreed a ranked list of candidates for the post of adviser in connection with its inquiry.

7th Meeting, 2008 (Session 3), Tuesday 11 March 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee agreed an evidence programme and potential witnesses for the inquiry.

9th Meeting, 2008 (Session 3), Tuesday 15 April 2008

In attendance: Nathan Goode and Marianne Burgoyne (Committee Advisers on its inquiry into the methods of funding capital investment projects).

Decisions on taking business in private: The Committee agreed to take item 6 in private and to consider the evidence heard on its inquiry into the methods of funding capital investment projects in private at future meetings.

Inquiry into the methods of funding capital investment projects: The Committee took evidence, in a round-table discussion, from—

Riona Bell, Director of Funding, Scottish Funding Council;

Lynn Brown, Executive Director of Financial Services, Glasgow City Council;

Douglas Griffin, Director of Finance, NHS Greater Glasgow and Clyde;

Peter Haggarty, Assistant Director, Health Facilities Scotland;

Guy Houston, Director of Finance and Corporate Services, Transport Scotland;

Donald McGougan, Director of Finance, Edinburgh City Council; and

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Finance Committee, 8th Report, 2008 (Session 3) — Annexe A

Douglas Millican, Finance and Regulation Director, Scottish Water.

6. Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence heard to date, in order to inform the drafting of its report

10th Meeting, 2008 (Session 3), Tuesday 22 April 2008

In attendance: Marianne Burgoyne (Committee adviser on its inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

Iain Duff, Chief Economist and Policy Manager, Scottish Council for Development and Industry;

Martin Southern, Senior Consultant, BT Scotland;

Russell Frith, Director of Audit Strategy; and

Angela Scott, Head of CIPFA in Scotland.

11th Meeting, 2008 (Session 3), Tuesday 29 April 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee Advisers on the inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

Paul Brewer, Partner, Public Private Advisory, PricewaterhouseCoopers;

Amanda Methven, Partner, Planning and Projects Group, Dundas and Wilson C.S. LLP;

Jenny Stewart, Head of Infrastructure and Government, KPMG;

Michael Watson, Partner, Banking, Energy and Infrastructure and Procurement, McGrigors LLP;

Nigel Middleton, Managing Director, Barclays Private Equity;

Darryl Murphy, Managing Director, Infrastructure Finance, HSBC;

Iain Wales, Head of Structured Finance for the UK and Ireland, Dexia Public Finance Bank;

Dr Jim Cuthbert and Margaret Cuthbert, Public Interest Research Network, University of Strathclyde;

Dr Iain Docherty, School of Business and Management, University of Glasgow;

Mark Hellowell, Research Fellow, Centre for International Public Health Policy, University of Edinburgh; and

Jan Love, PPP Forum.

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Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence sessions to date, in order to inform the drafting of its report. The Committee also agreed to write to the Rt. Hon. Yvette Cooper MP, Chief Secretary to the Treasury, asking her to reconsider her decision to decline the Committee’s invitation to give evidence on its inquiry.

12th Meeting, 2008 (Session 3), Tuesday 6 May 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee Advisers on the inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

Gareth Hoskins, Board Member and Scotland's Healthcare Design Champion, Architecture and Design Scotland;

Alan Ledger, Project Director, Mott MacDonald;

David Stark, Managing Director, Keppie Design;

Steven Tolson, Director, Ogilvie Group Developments;

Ian Rylatt, Managing Director, Balfour Beatty Capital;

Alan Fordyce, Managing Director, Robertson Capital Projects

Andrew Gordon, Chief Executive, Canmore Partnership Ltd;

Jo Elliot, Deputy Chief Executive, Quayle Munro; and

Dylan Fletcher, Group Board Director, Forth Electrical Services Ltd.

Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence sessions to date, in order to inform the drafting of its report.

13th Meeting, 2008 (Session 3), Tuesday 13 May 2008

In attendance: Marianne Burgoyne, Grant Thornton (Committee Adviser on its inquiry into the methods of funding capital investment projects)

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

Jon Ford, Head of Health Policy and Economic Research Unit, British Medical Association;

Dave Watson, Scottish Organiser, Policy, UNISON; and

Ken Wimbor, Assistant Secretary, The Educational Institute of Scotland.

Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence sessions to date, in order to inform the drafting of its report.

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Finance Committee, 8th Report, 2008 (Session 3) — Annexe A

14th Meeting, 2008 (Session 3), Tuesday 20 May 2008

In attendance: Nathan Goode and Marianne Burgoyne (Committee Advisers on the inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

Dougald Middleton, Head of Transport and Distribution, Ernst and Young;

Bryan Smail, Head of Treasury and Investment and Project Director, Falkirk Council;

Bruce West, Head of Strategic Finance, Argyll and Bute Council.

Inquiry into the methods of funding capital investment projects: The Committee took evidence, in a round-table discussion, from—

Michael Gerrard, Deputy Chief Executive, Partnerships UK;

Stephen Gibson, Director, Cordale Housing Association;

Robert MacDowall, Director, DTZ;

Ron McAulay, Director for Scotland, and Fred Maroudas, Director of Finance, Network Rail;

Martin Spollen, Strategic Adviser, Northern Ireland Strategic Investment Board;

Ray Stephenson, Programme Manager, ProCure21, Department of Health;

Ian Wall, former Chief Executive, The EDI Group Ltd.

Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence sessions to date, in order to inform the drafting of its report.

15th Meeting, 2008 (Session 3), Tuesday 27 May 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee’s Advisers on the inquiry into the methods of funding capital investment projects)

Inquiry into the methods of funding capital investment projects: The Committee took evidence from—

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth, Dr Andrew Goudie, Chief Economic Adviser and Director General Economy, and Sandy Rosie, Director of the Financial Partnerships Unit, Scottish Government.

Inquiry into the methods of funding capital investment projects (in private): The Committee considered the main themes arising from the evidence sessions to date, in order to inform the drafting of its report.

16th Meeting, 2008 (Session 3), Tuesday 10 June 2008

Decision on taking business in private: The Committee agreed to take item 6 in private.

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6. Inquiry into the methods of funding capital investment projects (in private): The Committee considered its approach to the inquiry. The Committee agreed a list of witnesses for a further evidence session on the Scottish Futures Trust in September, and to seek further written evidence on the Scottish Futures Trust from all witnesses who have given evidence to the inquiry.

19th Meeting, 2008 (Session 3), Tuesday 9 September 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee advisers on the inquiry into the methods of funding capital investment projects)

Decisions on taking business in private: The Committee agreed to consider evidence heard and any draft reports on its inquiry into the methods of funding capital investment projects in private at future meetings.

Inquiry into the methods of funding capital investment projects: The Committee took evidence, in a round-table discussion, from—

Paul Brewer, Partner, Public Private Advisory, Price Waterhouse Coopers;

Lynn Brown, Executive Director of Financial Services, Glasgow City Council;

Andrew Gordon, Chief Executive, Canmore Partnership Ltd.;

Donald McGougan, Director of Finance, Edinburgh City Council;

Dougald Middleton, Head of Transport and Distribution, Ernst and Young;

Nigel Middleton, Managing Director, Barclays Private Equity;

Angela Scott, Head of CIPFA in Scotland;

Dave Watson, Scottish Organiser, Policy, UNISON;

Michael Watson, Partner, Banking, Energy and Infrastructure and Procurement, McGrigors LLP.

20th Meeting, 2008 (Session 3), Tuesday 16 September 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee advisers on the inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects (in private): The Committee considered the evidence heard to date on the inquiry and agreed to consider a draft report at its next and future meetings.

21st Meeting, 2008 (Session 3), Tuesday 23 September 2008

In attendance: Marianne Burgoyne, Grant Thornton (Committee Adviser on the inquiry into the methods of funding capital investment projects).

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report and agreed to consider it further at its next meeting.

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22nd Meeting, 2008 (Session 3), Tuesday 30 September 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report and agreed to consider it further at its next meeting.

23rd Meeting, 2008 (Session 3), Tuesday 7 October 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report and agreed to consider it further at its next meeting.

24th Meeting, 2008 (Session 3), Tuesday 28 October 2008

In attendance: Nathan Goode and Marianne Burgoyne, Grant Thornton (Committee Advisers on the inquiry into the methods of funding capital investment projects)

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report, and agreed to consider a revised draft, in private, at its next meeting.

25th Meeting, 2008 (Session 3), Tuesday 4 November 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report. Various changes were agreed to, and the Committee agreed to consider a revised draft, in private, at a future meeting.

27th Meeting, 2008 (Session 3), Tuesday 18 November 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report and agreed to consider a revised draft at its next meeting.

28th Meeting, 2008 (Session 3), Tuesday 25 November 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report and agreed to consider a revised draft at its next meeting.

Record of divisions in private:

Derek Brownlee proposed that all methods of finance should be considered equally on their merits.

The proposal was agreed to by division. For: 5 (Jackie Baillie, Derek Brownlee, James Kelly, Jeremy Purvis and David Whitton); Against: 3 (Joe FitzPatrick, Alex Neil and Andrew Welsh); Abstentions: 0.

29th Meeting, 2008 (Session 3), Tuesday 2 December 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee agreed to defer consideration of a draft report until its next meeting.

30th Meeting, 2008 (Session 3), Tuesday 9 December 2008

Inquiry into the methods of funding capital investment projects (in private): The Committee considered a draft report. Subject to a number of changes, the report was agreed to. The Committee also agreed arrangements for publication of the report.

Record of divisions in private:

Jeremy Purvis proposed to insert the following paragraph before paragraph 316:

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Finance Committee, 8th Report, 2008 (Session 3) — Annexe A

“The Committee found no clear evidence that a separate limited company, the Scottish Futures Trust, is required to deliver better co-ordinated, managed and delivered infrastructure investment. Neither did the Committee receive clear evidence that any other funding option is to be available offering better value for money separate to all existing NPDO, PPP, prudential borrowing and traditional capital financing methods and believes any function to deliver better value for money and efficiency should be carried out by central government as part of its existing drive for better value for the public purse.” The proposal was disagreed to on a casting vote. For: 4 (Jackie Baillie, James Kelly, Jeremy Purvis and David Whitton), Against: 4 (Derek Brownlee, Joe FitzPatrick, Alex Neil and Andrew Welsh), Abstentions: 0.

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