Follow the money - is PFI's replacement innovative?

Written by Paris Gourtsoyannis on 5 May 2014 in Feature

Is Scotland’s £2.5bn programme for financing public infrastructure as innovative as it claims?

In ten years time, will visitors arriving in at Glasgow Queen Street Station even recognise the city as the place it is now? The first sketches of a proposed overhaul and expansion of the station itself were published last week, promising a sweeping glass-enclosed terminus to Scotland’s east-west rail axis that will make an embarrassment of the squat 60s concrete bunker that Queen Street is today.

If they turn left on exiting the station and head uphill, those same visitors will arrive at the City of Glasgow College’s new campus, now under construction. The building will bring together the college’s 11 existing sites in a state of the art building that it is hoped will maximise the college’s local economic impact. The next decade is also set to see enhanced public spaces and a renewal of the adjacent shopping centre, bringing together various stands of a strategy for Glasgow’s ‘Buchanan Quarter’.

Each aspect of that strategy is being paid for in a different way. Glasgow City Council is funding improvements to local public infrastructure though tax increment financing, borrowing against an anticipated increase in non-domestic rates, which the Scottish Government has pledged to hand back to the council to pay for investment. Improvements to Queen Street Station will form part of Network Rail’s Edinburgh-Glasgow Improvement Programme, financed by borrowing against rail assets. Finally, the City of Glasgow College’s campus will be funded using the non-profit distribution (NPD) model.


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All three funding programmes – as well as a fourth, the £150m National Housing Trust – are operated in Scotland by the Scottish Future’s Trust. Together, they have a value of over £3bn over a number of years – effectively adding another year’s worth of capital spending to Scotland’s infrastructure buying power. With Scotland’s devolved administration unable to borrow in its own right, the SFT’s ability to leverage in private sector investment and create mechanisms for ‘off balance sheet’ capital spending is crucial to the Scottish Government’s economic strategy.

“I would summarise what SFT does as additionality – bringing that additional investment in; collaboration – how do we get people to work together; and innovation – how do we do things differently?” says chief executive Barry White.

The main way things are being done differently is through the largest of the SFT’s funding mechanisms, and the one that is financing the City of Glasgow College Project: the £2.58bn NPD programme. “There’s a choice: you either do it now through NPD, or you wait many years until the capital budget is available before going ahead,” says White. Coming out of a recession with painfully low growth rates, that decision has been an easy one for the Scottish Government, which has set out an ambitious pipeline of new projects.

NPD was never intended to have the central role it does today. In its 2007 Scottish election manifesto, the SNP’s ambitions for the Scottish Futures Trust were grand. It would effectively act as an infrastructure bank, offering ‘Scottish Futures Bonds’ that would act “as an alternative to the costly and flawed PFI/PPP”.

“We expect the Scottish Futures Trust to emerge as a more attractive source of funding for both national and local projects which will effectively crowd out PFI/PPP over time,” the SNP declared. Crucially, it made the explicit claim that its new “alternative funding mechanism” would provide “better value bonds” that would allow it to “release more money to invest in the frontline”. The job of the Scottish Futures Trust would be “securing better value funding for capital projects”.

Those plans didn’t survive long after the SNP’s election victory. When it was launched in 2008, the SFT was not the funding body that had been envisaged, but in reality an oversight organisation that helped manage infrastructure projects. The ‘alternative funding mechanism’ it managed wasn’t a new set of infrastructure bonds, either. Instead, NPD was heralded as the solution to PFI/PPP.

White says that this is beside the point, as the SFT is delivering on what it was eventually set up to do. “The brief we were given when we were set up was to achieve savings in the range of £100-150 million per annum. Whether that comes through addition investment through things like the National Housing Trust, or that comes through saving money on the schools programme, where we’re building 67 schools for the price of 55, that is what we’ve been asked to do by the government, and that’s what we are doing.”

NPD wasn’t new in 2007 – despite claims to the contrary. The funding system was launched by the Labour-Liberal Democrat administration, but was scarcely used while PFI/PPP was still in vogue. In many ways, NPD is a clone of PFI/PPP, but with a few crucial variations. Unlike PFI/PPP, the private sector consortium contracted to deliver a project doesn’t hold any equity; instead, once construction costs are factored in, revenues flow solely from the interest on the finance offered. Crucially, that means that any surplus or under-spend throughout the lifetime of the project is returned to the public sector owner. NPD is therefore something of a misnomer – it really should be ‘non-surplus distribution.

The political narrative that’s been built around NPD has been designed to allow the Scottish Government and its supporters to declare the Scotland ‘doesn’t do PFI anymore’. But questions have been raised about how different the new funding scheme is from what went before. According to the University of Edinburgh’s Dr Mark Hellowell, a health and social policy lecturer with expertise in PFI/PPP, “these things are basically the same, substantively.”

The key element of NPD deals that allows officials to claim that costs have been ‘capped’ is the lack of any financing through share capital, which made up roughly one per cent of financing under PFI, according to Hellowell. While that eliminates the prospect of any dividends for private sector companies, and means that the interest rate on financing for the lifetime of the contract can be decided ahead of the deal – or ‘capped’ – that doesn’t necessarily mean lenders are accepting lower returns.

“They’ll increase slightly the required interest rate on that loan to cover the fact that they’re not getting dividends, so their overall return will be similar to what it was under PFI, they’ll just get it in a different way,” says Hellowell.

“There’s no earthly reason why you would expect anything different to happen. Why would an investor choose to take a lower internal rate of return just because they’ve changed the basis on which they provide the finance? They’re exposed to the same degree of risk, they’re in the same market, why would they accept an under-the-market return?”

While the information needed to confirm it is unavailable on grounds of commercial sensitivity, Hellowell believes the profits arising for companies involved in NPD projects aren’t significantly different from under the old PFI/PPP regime. Efforts to cap interest returns mean that companies will simply find other parts of the deal to make their margins.

“There’s lots of profits involved in these contracts, just like PFI contracts, because the investors are also picking up the operational element of the project – they’re also the construction company, they’re also the operations and maintenance company – so if you’ve artificially tried to force down one element of their profit, because that’s politically salient, then the margins on the other elements will just increase.

“You’re dealing with the same set of people as exists in the PFI industry. They have certain profit expectations and a certain cost structure, and they don’t just because you’re in Scotland with a different set of policy makers say, go on, we’ll just accept less money.” However, the SFT claims that companies making NPD bids have come forward with lower return rate expectations that before; White says that the upper level used to be around 15 per cent, but is now around 12 per cent.

“I think I’ve seen a big shift in the private sector, and I think this is something that we’ve heavily influenced in Scotland, is that it’s a much more pragmatic industry that’s ready to accept this regulated rate of return rather than the industry of a few years ago that was always looking for unbridled upsides,” says White.

Other changes have been made to the way public infrastructure is procured since the SFT was created that Hellowell says have had a positive impact. Risk management has been improved, and NPD contracts no longer include many of the costly, restrictive support services that blighted the likes of the Royal Infirmary of Edinburgh. Companies involved in building and maintaining infrastructure over its lifetime won’t also be providing cleaning or catering services as part of the same contract, for instance.

“If you speak to people who were dealing with these contracts operationally, one of the issues that you would hear most often was, the school wants to hold additional parents evenings, and the cost of that because the private sector contractor says it has to change the maintenance time or the cleaning time, it was a very significant cost being placed onto the users,” says White. “That has nothing to do with NPD,” counters Hellowell. “They’re just sensible policy measures.”

For the head of the SFT, those aspects of NPD are just as significant as the capping of returns. “In some ways, this is not the headline stuff of NPD – capping people’s returns – but these are really important value for money things that we’ve done, that are very different, but are largely hidden from general view because they’re quite technical.”

He highlights the present of a ‘public interest director’ on the boards of NPD consortia as something “creates a different dynamic, and it creates a different relationship with the private sector. Interestingly, some of the ratings agencies take the view that those projects will actually work better and therefore are more financeable.”

Inevitably, there is an ‘independence angle’ in the debate on how Scotland’s public infrastructure is paid for. While the UK Government made ample use of PFI/PPP across the country, the development of ways to get capital spending off government balance sheets made particular sense in post-devolution Scotland, which currently doesn’t have its own borrowing powers.

Following the election of the Conservative-Liberal Democrat coalition in 2010, with the recession doggedly stretching on, a freeze on capital spending south of the border quickly became a political weapon wielded by the SNP. Scotland can only maximise on the economic growth created through capital investment if the shackles on its borrowing powers are removed, ‘Yes’ campaigners argue.

Wary of the impact that argument could have on the referendum, the UK Government has held out the prospect of Scotland being able to issue its own bonds if it votes ‘No’ later this year albeit at a higher rate of interest. Whatever country those Glasgow daytrippers emerge out of Queen Street Station into a decade hence, the city around them could look very different – as could the way it is paid for.

 

Changing the way people think of further education

When they’re completed in August 2016, the new City of Glasgow College campuses – there are in fact two sites being build – will represent the next step in the Scottish Government’s further education regionalisation programme.

The at times controversial reform, which has seen the number of colleges in Scotland drastically reduced, was intended to create institutions of scale and excellence. City of Glasgow College, which had over a year’s head-start on most of the other mergers across Scotland, is the first to have its new status reflected in its physical footprint.

City of Glasgow inherited 11 campuses from its three predecessor colleges, including buildings that were between 50 and 150 years old. In two and a half years’ time it will have two: one by the Clyde, housing the college’s nautical programmes, and a main campus in the centre of Glasgow, a stone’s throw from Queen Street Station and George Square.

Taken together, the two sites with a capital cost of £193m, represent the single largest NPD accommodation project ever undertaken in Scotland, putting it on par in terms of scale with the £180m Royal Infirmary of Edinburgh, built under PFI/PPP and opened in 2003. Compared to that unhappy project, however, the expectation is that thanks to an improved procurement process under NPD, the end user should enjoy a much better experience.

So far, that end user has no complaints. “This whole process has been very participative. We’ve had excellent support from the Scottish Futures Trust and the Scottish Funding Council, and indeed the Scottish Government,” says college principal Paul Little. Unlike the restrictive PFI/PPP contracts of the past, the City of Glasgow College project has been flexible in accommodating the demands of its eventual occupants. “We feel the voices of students have been listened to, that the staff have been involved in the design process, that experienced educationalists have influenced that design, and that the design is a purpose-built solution to fulfil our vision. It’s not an off-the-shelf solution that’s been imposed on us. We’ve been allowed to craft this vision over many years.”

Little says that in anticipation of the new campus design, the college piloted different uses of is existing buildings to see how best to use space in the new ones. As a merged college, City of Glasgow has recently added new student union and advice facilities and services, and has been able to inform the new building design based on those experiences. “If you have the opportunity to build from scratch, you can take advantage of the very latest education technologies and designs for learning. We’re trying to pioneer the classrooms and offices of the future,” says Little.

Many of Scotland’s colleges enjoyed an injection of redevelopment spending in the past decade, producing a number of impressive new buildings, but City of Glasgow’s will be the first to reflect the regionalisation policy. It will be the biggest single further education site in Scotland, and as such will go some way towards achieving the change in perception around FE that was the Scottish Government’s ambition. It will look and feel like a university, and ministers hope that will be reflected in the quality of its outcomes and the significant role it will play in its local economy.

“We’re very mindful that it’s a once in a lifetime opportunity to have a purpose-built, state-of-the-art, future-proofed, technology-enabled new campus to allow us to fulfil our inspiring vision for the college post-merger, to deliver world-class learning for Glasgow, for Scotland and for the international community,” says Little. “We believe that the campus will allow us to do that, and to redefine what people think about college education.

“NPD isn’t PFI/PPP – I’ve had previous experience of those and I would say that the public sector has come an awful long way in learning from the past,” says Little. “The process is much more in favour of the end user than it ever was.”

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