Private Financial Initiative (PFI) has been in used by various UK governments for more than 20 years. In simple terms it allows the private sector to work with the public sector in developing infrastructure projects such as hospitals, schools, etc. In exchange for helping to fund (using private-sector debt and equity, underwritten by the public sector) and build various infrastructure projects, private sector partners are awarded long-term management contracts which we now know to be extremely lucrative. The collapse of Carillion and problems at Capita – two PFI companies in the UK – has prompted a radical approach from the Labour Party.
However, there are serious concerns that the radical approach announced by John McDonnell could seriously undermine investor confidence in the UK property development sector.
We only need to look at the HICL Infrastructure Fund and the International Public Partnership Fund, infrastructure funds listed on the London Stock Exchange, to see the potential returns. These funds have delivered a 120% gain over the last 10 years while maintaining dividend yields between of 4% and 6%. As we have seen with the collapse of Carillion and problems at Capita, the idea that PFI investment was risk-free has been damaged but managed correctly it can be as simple as a financial calculation.
Using debt and equity to fund schools and hospitals, while maintaining debt repayments using long-term management fees, has seemingly left significant surplus in well managed funds. There were specific problems with Carillion and Capita which will become clearer in due course but the politicians are determined to use these issues to kill PFI stone dead.
Taking projects in-house
There is no doubt that particular problems at Carillion have left the current UK government in a very precarious situation with regards to short-term infrastructure spending. This left the public and private sectors scrambling for emergency funds, projects have been put on hold and unfortunately many businesses further down the supply chain will struggle to survive. The Labour Party is now suggesting that all existing PFI contracts will be taken “in-house” and is threatening to terminate long-term contracts with PFI partners.
Many people may believe that taking hospitals and schools in-house, to be managed by the government of the day, is a sensible approach, but how will this impact confidence in the UK property development sector?
Should the government pay compensation?
While nothing has been written in stone, there is a growing belief that the Labour Party will use the socialist movement to terminate existing PFI contracts without compensation (or only partial compensation). In reality the whole PFI era has created a massive “off-balance-sheet debt” for the UK, via long-term management contracts, but it is difficult to justify what would be a smash and grab by the Labour Party.
There will come a time in the future, and indeed Tony Blair’s government was very active in the area of PFI, when a socialist UK government may well require assistance from the private sector. If perfectly legal long-term PFI management contracts are taken in-house and terminated, this must surely increase the risk to the private sector when working with the public sector in the future?
Bizarrely, this could lead to more expensive public/private sector arrangements in the future because the risk of potential default (by any other name) would increase the risk factor. As a consequence, private sector companies would require a larger return on their investment into public/private sector partnerships. It is also worth noting that during the PFI era the UK government has been able to build far more schools, hospitals, etc than it could ever have deemed under old public sector funding arrangements.
An effective default on PFI contracts by any future Labour government would not be well received by the private sector and private investors. As we touched on above, it would actually increase the cost of finance by the private sector in the future because a greater perceived risk would require a greater return to offset this risk. It may make useful soundbites, it may attract some voters but it is worth remembering that Carillion and Capita may be the headline grabbing companies that grew on the back of the PFI concept, but there are many other PFI management companies functioning extremely efficiently.