Availability and Performance Model
Tue 13th November 2012
Description and overview
The model which forms the basis of the PFI model is very much a "green field model".
It is most used where the public sector wishes to introduce private finance into infrastructure without end user cashflows or where the end user cashflows are sufficiently uncertain to service the finance for the capital costs.
Essentially this is the favoured model for social infrastructure.
The model will require some adaptations for institutional finance particularly around areas of risk.
Construction risk is the most obvious example where the emerging Pensions Infrastructure Platform has stated it will not take construction risk although the progress of the "Early Stage Fund" is not known.
Otherwise the construction will need to be financed from a mix of equity and development finance or with the risks guaranteed in whole or part by the public sector (possibly via credit enhancement through an injection of equity).
The current lending climate will probably require a greater loan to equity ratio than currently in place with the potential consequent increase in cost.
Otherwise any shortage of development finance from commercial banks may need to be covered by the public sector.
This would be achieved through its own funding or a local authority through prudential borrowing (being on a fully commercial basis to avoid State Aid issues).
The public sector in such a structure will take the risk of ultimate contractor failure subject to any contractor security.
If a separate development finance facility is used the development finance will need to be subsequently refinanced by the Infrastructure Fund.
It will be very difficult (particularly in volatile markets like the present) to tie down the cost of finance from the Infrastructure Fund.
There will therefore be a refinancing risk which will need to be borne by the public sector and/or may result in a significant increase in overall cost of the project.
It is unclear to what extent the Infrastructure Fund will accept risks during the operational period.
These will include availability and performance risks. The Infrastructure Fund could seek additional contractor coverage for those risks (whether the building contractor or service provider depending on the nature of the risk, but more likely the former).
Again there will be a price for this which will ultimately fall on the cost of the project.
Ultimately for certain risks (probably confined to complex engineering risks) the public sector may have to guarantee payment notwithstanding the occurrence of the risk.
The risk for the Infrastructure Fund could be mitigated by the fund by holding a portfolio of different projects with different risk profiles perhaps with the potential for the public sector to guarantee base returns.
Risk to the fund could also be alleviated by additional equity in the special purpose company to act as a "buffer", although again with an adverse impact on project costs.
- Design, build, finance and operation risks transferred to the private sector;
- Contains incentives for delivery on time and at a fixed price;
- Availability regime requires maintenance of the infrastructure over the length of the contract together with lifecycle renewal;
- With appropriate contractor or public sector coverage the Infrastructure Fund will be reasonably de-risked;
- Infrastructure Fund does not take construction risk;
- Probably on balance sheet in accordance with IFRIC12 but not public sector debt under ESA95 (although any arrangements ensuring repayment of debt may affect this position).
- A more complex structure due to financing a leveraged special purpose company on a project finance basis;
- Construction risks may be retained in part;
- Refinancing risk may be retained by public sector;
- Certain risks around compensation on termination may be retained by public sector;
- Potentially less incentive on private finance to step in and take charge of project in difficulty;
- Potential additional costs of increased equity provision and risk retention.
The value for money element of private finance transactions (PFI) has historically been difficult to measure. Whilst the overall long term costs are inevitably greater this is offset by the requirement for the infrastructure to be maintained for the length of the contract.
Alternative funding through Infrastructure Funds will be achievable but the de-risking required by the funds will inevitably increase risk and cost for the public sector.
There will be other areas which may need to be addressed particularly around the arrangements for compensation on termination.
There may need to be a split between the construction and operation period with a guaranteed base repayment of debt rather than the current HM Treasury required approach of a retender.