Public sector over-paying for equity investment in PFI, says spending watchdog

The National Audit Office has expressed concern that the public sector is paying more than it should for equity investment in PFI projects.

In a report, Equity investment in privately financed projects, the watchdog urged public authorities to make sure that they have clear evidence they are paying a fair price for private sector funding, and risk equity in particular.

The NAO report acknowledged the role equity investors had played in helping deliver infrastructure projects through PFI.

But the watchdog said investors should be rewarded for taking risks. Typically these are the costs of bidding, that their contractors fail to perform, or that other project costs the investors bear the risk for are higher than envisaged.

However, the NAO pointed out that investors can limit their risk by passing it on to contractors. It also highlighted how “the government is a very safe credit risk and many projects such as hospitals and schools are repeat projects”.

The report said that the Treasury and Whitehall departments had failed to gather systematic information to prove the pricing of equity is optimal.

The NAO pointed to three potential inefficiencies in the pricing of equity:

• the time and costs of bidding;
• minimum rates set by investors, “which sometimes do not reflect the actual risks the project will face”; and
• bank requirements.

Public authorities have not had the skills and information to challenge investors’ proposed returns, the NAO added.

In three projects reviewed by the watchdog, the NAO said around 1.5% to 2.2% of the annual service payments were “difficult to explain in terms of the main risks investors said they were bearing”.

The report also highlighted how investors selling shares in successful projects early had made high annual returns – typically between 15-30%. It recommended that the Treasury explore alternative investment models as part of its current review of PFI.

Amyas Morse said: "PFI projects benefit from secure cash flow from the public sector. Public sector authorities should have clear evidence they are paying a fair price for private sector funding, and risk equity in particular, considering the stable environment that PFI generally provides.

"The Chancellor plans to reform the PFI model. The Treasury review should give closer scrutiny to the returns investors are getting from PFI projects and take account of the areas we have identified where there is scope for savings."

The NAO report can be downloaded here.