Private financing of Scotland’s infrastructure

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The National Audit Office recently published a report looking at the role of the Private Finance Initiative (PFI) and its replacement, PF2, in funding infrastructure investment.  What role do similar financing initiatives play in financing Scotland’s infrastructure?

Private financing explained

PFI and PF2 are forms of public-private partnership (PPP), whereby the private sector finances the upfront capital costs of the project, such as a school or hospital. Once the project is completed and in use, the public sector makes annual payments to the private sector contractor to cover construction costs, interest costs and maintenance/service charges, usually for 25-30 years. The payments come out of public sector revenue budgets (as opposed to capital budgets), so this allows more investment to be undertaken than might otherwise be possible by only using traditional financing methods.

Scotland’s use of private financing

In Scotland, PFI is no longer used, but has been replaced with an alternative model known as the ‘non-profit distributing’ (NPD) model.  This is another form of PPP and was introduced by the Scottish Government in 2007, with some modifications aimed at limiting the excessive profits that had been a much-criticised feature of the early PFI projects.

Between them, PFI and NPD have funded over 100 projects in Scotland, with a combined capital value of almost £9 billion. This includes 58 school projects and 45 hospitals and other health facilities. [Note that an individual school PPP project can involve multiple school buildings within a single contract.]

Total number of PFI and NPD projects in Scotland by sector

Criticisms of private financing

A criticism often levelled against both PFI and NPD projects is that the repayment costs way exceed the value of the project. For the 129 projects that have been privately financed in Scotland, repayment costs will total £39.7bn, more than four times the capital value of the projects.

However, bear in mind that these repayments often cover more than just the construction costs and interest costs. They will include the costs of maintaining the building (or other asset) and may also include other services, such as cleaning and catering, although this is less common with more recent projects.  Also, these additional costs need to be weighed against the alternative which, in many cases, may have been not having the building at all.  Without using private financing, it is likely that many of these projects would not have been able to go ahead, as the traditional capital budget would not have been able to fund these projects upfront.

Improvements over time?

Governments have responded to the criticisms of excessive costs of private financing and have taken action to improve the contracting arrangements associated with PPP projects. In the UK, this led to the introduction of PF2 and, in Scotland, to the introduction of NPD.  One simple indication of the effectiveness of these changes is the fact that repayments for the more recent NPD projects are just over 3 times the capital value of the buildings, compared to 5 times the capital value for earlier PFI projects.  However, as noted above, this could in part reflect the fact that newer contracts have fewer additional services (cleaning, catering etc.) included.

Managing the repayments associated with PPP projects

Whatever improvements are made to contracting arrangements, governments are still committed to the repayments associated with existing projects. For Scotland, these repayments amount to £1.2bn in 2017-18 and outstanding repayments total £29bn over the period to 2047-48, when current commitments will end.

Repayments profile of PFI and NPD projects in Scotland

The Scottish Government has committed to spending no more than 5% of its budget on repayments associated with PPP financing and other long-term investment commitments (such as borrowing repayments). On the basis of current projections, it will spend around 3.9% of its budget on such repayments in 2017-18, peaking at just under 4.3% in 2020-21.  Any new PPP projects or borrowing would put pressure on this measure.

Future use of PPP in Scotland

European accounting rules changed in 2010 and were formally introduced in 2014. These changes meant that the Scottish Government had to change the way it treated NPD projects in its accounts and had to include the full capital costs associated with the projects upfront in its budget.  These changes mean that NPD projects need to be funded out of the traditional capital budget, which stands at £3.4bn in 2018-19.  The Scottish Government is not currently considering any new NPD projects.  It has however, adapted the contracting arrangements for smaller ‘hub’ projects, some of which continue to be privately financed.  This includes mainly smaller community health facilities and schools.  It remains to be seen whether the Scottish Government will continue to use NPD financing for major infrastructure projects or whether it will turn to alternative means of financing, such as using the extended borrowing powers introduced following the Scotland Act 2016.

More radical options?

Concerned over the burden of repayments and perceptions of poor value for money, some are pushing for more radical action over the use of private financing. The Labour Party, both in Scotland and south of the border, has called for private sector contracts to be bought out and returned to the public sector.  The costs of any such action are unclear and would depend on the conditions built into each individual contract and whether there are break clauses.  There are some examples of PFI contracts being bought out in England (see NAO, p32), and a few examples in Scotland, such as the buy out of the Skye Bridge PFI contract in 2004.  The Scottish Government considered in 2009 whether it could terminate the contracts for parking charges in three PFI hospitals in Scotland, but determined that this would costs “tens of millions” and opted not to pursue this.

Nicola Hudson, Senior Researcher, Financial Scrutiny Unit, SPICe