Is non-profit distributing PPP dead? Long live PF2?
Welsh Government has committed to three infrastructure projects using the Non-Profit Distributing ('NPD') Model – the redevelopment of the Velindre Cancer Centre; dualling of sections 5 and 6 of the A465; and the 21st Century Schools Project.
As previously reported, the NPD model had to be placed on hold in both Wales and Scotland (where it was originally developed) due to the decision by the Office of National Statistics that an NPD scheme (the Aberdeen Western Peripheral Route) had to be given a public 'on balance sheet' classification. This means that the project is added to government debt and deficit figures and counts against capital budget, which can make projects unviable.
It appeared for a while that that the Scottish Government had found a structure for their 'Hub' projects which would allow NPD to continue.
However, new definitive guidance from the EU's statistical office ('Eurostat') has ruled firmly against NPD in its current form, throwing into doubt whether the initiative can continue at all.
What is NPD?
The Non-Profit Distributing ('NPD') model is simply an alternative funding structure for public-private partnership ('PPP') projects that would previously have been carried out under the Private Finance Initiative ('PFI'). It could be adopted by any public authority in the UK (subject to normal approvals processes) and does not require any new legislation.
Many of the perceived problems with PFI stemmed from the private sector receiving surplus 'windfall' profits on top of their anticipated rate of return, and also loss of public control over public sector assets.
Therefore, what NPD sought to do was to create a structure under which –
- The private sector takes a fixed rate of return
- The public sector has greater control and transparency over the special purpose vehicle ('SPV') delivering the project, usually through a 'golden share' giving enhanced voting rights on key issues
- Surplus profits are not distributed to the private sector. Instead, they can be returned to the public sector, used to pay off debt, or invested in more or higher-standard services or infrastructure.
However, it was these very factors which led the UK's Office of National Statistics ('ONS') to consider whether NPD schemes were actually public-owned schemes and therefore 'on-balance sheet'.
What did the ONS decide?
In July 2015, a review by the Office for National Statistics of an NPD project (the Aberdeen Western Peripheral Route), resulted in the project being given a public 'on balance sheet' classification.
ONS’ decision was largely founded on the degree of control exerted by the Scottish Government in the Aberdeen case. The 'golden share' appears to have been a key factor in ONS’ decision as to whether an SPV is classified as being subject to public or private sector control. ONS was also of the view that the public sector’s share of the rewards of (100% in later NPDs) was too great for the assets to be classified as belonging to the private sector. ONS specifically commented on the fact that in the Aberdeen case, all of the surpluses were to revert to the Scottish Government.
Scottish Government's 'Hub' solution
For a while, it seemed as though a solution had been found that would allow NPD to continue, as Scottish Government agreed with ONS a revised structure for the regional 'Hub' projects. This involved SPVs for Hub schemes being owned as follows:
- 60% by the private sector partner
- 20% by a charity
- 10% by Scottish Futures Trust (an executive arm of Scottish Government); and
- 10% by the procuring authority.
On 29th September 2016, Eurostat issued its definitive guidance on the classification of PPP schemes. The advice is written in conjunction with the European Investment Bank and the European PPP Expertise Centre, therefore it can be seen as authoritative, as it is not just a piece of statistical guidance written in isolation, but taking into account the views of PPP investors and practitioners.
The guidance examines 16 key 'themes' of PPP projects such as design and construction risk, operation and maintenance, payment mechanism and government influence. It sets out with considerable clarity whether particular types of treatment in each of these areas have no effect on balance sheet classification, a moderate, high or very high effect, or would automatically result in an 'on balance sheet' classification.
In respect of the crucial areas (for NPD) of capping the private sector return and retaining a significant degree of public control over the asset, Eurostat state –
- Any share by the public sector in savings from the operating/maintenance budget will automatically mean that the PPP is on balance sheet
- A right to require refinancing (which was part of the role of the 'Public Interest Director' in some NPD schemes) will automatically mean that the PPP is on balance sheet
- As regards the public sector sharing in profits, the ability to do so is strictly constrained –
- An entitlement to a share of 50% or more automatically leads to the PPP being on balance sheet;
- An entitlement to a share of less than 50% but more than one third is of very high importance to the statistical treatment;
- An entitlement to a share of one third or less but more than 20% is of high importance;
- An entitlement to a share of 20% or less but more than 10% is of moderate importance; and
- An entitlement to a share of 10% or less does not influence the statistical treatment
- Any imposition on the private sector of a cap on revenues will automatically result in the PPP being classified as on balance sheet. This includes any indirect methods such as capping through demand-based operational payments or providing for expiry once a specific level of return is achieved
- If the public sector retains veto or approval rights over important decisions of the SPV (other than the usual permitted areas such as change of control, changes of key personnel or subcontractors, refinancing, etc), this can mean that the PPP is deemed to be government-controlled, even where the public sector holds a minority share or no share at all in the SPV.
What does this mean for future PPP projects?
The Eurostat guidance appears to mean that NPD in its current form will be unworkable, since any form of profit-capping, any significant profit sharing, and/or any attempt to exercise anything more than residual control over the SPV, will lead to an 'on-balance sheet' classification.
It appears that the only circumstances in which Eurostat will accept an off balance sheet classification are where practically all of the risk and reward and all control (except over residual matters) sits with the private sector. It therefore appears that the only way in which off-balance sheet treatment can be secured is by reverting to a more 'traditional' PFI-style model.
This begs the question of whether it is worth Wales putting any further money into developing a Wales-specific PPP model, since there already exists a market-acceptable, bankable solution in the form of PF2. Creating a new contract which does not deliver the aims of NPD could be reinventing the wheel and is likely to generate extra costs (through banks passing on the cost of their due diligence into the new contract) and market uncertainty.
What is the effect of Brexit?
It would be tempting to think that, by leaving the EU, the UK would escape the constraints of Eurostat and the ESA10 accounting code. However, similar standards apply via international codes which the UK is likely to have to adopt in order to participate in the WTO or to secure trade agreements with other nations. For instance, Australia has recently been going through similar issues in relation to classification of their PPP projects. Therefore, Brexit is unlikely to present an answer.
How can we help?
We have been advising on PPP infrastructure projects since the start of PFI (including Bute Avenue Cardiff, one of the first PFI road projects). PPP and other major infrastructure projects we have worked on include: student accommodation PPPs at Aberystwyth, Plymouth, Bangor and Exeter Universities; Healthcare PFI/PPPs including St David's Hospital Cardiff, imaging and diagnostics PPPs in Cardiff, Leicester, Peterborough, Belfast and Canada; the Department of Health's Independent Sector Treatment Centres PPP programme; social housing/elderly care schemes including Neath Port Talbot CBC's partnership with Gwalia/Pobl; regeneration and leisure partnerships; and preliminary advice on the Velindre Cancer Centre. To find out how we can help with your PPP projects, please contact Simon McCann.