Waste – Better off without PFI?
Having recently closed Lincolnshire Council's
residual waste project which was funded 100%
through prudential borrowing, Didar Dhillon of
Pinsent Masons questions whether procuring
authorities are actually better off without
PFI credits.
Introduction
Whilst Defra has concluded that there is sufficient treatment
capacity available to satisfy the 2020 landfill diversion targets,
many local authorities have been left facing the potentially
crippling effect of spiralling landfill tax and disposal costs. The
unprecedented strain on the public purse, the repercussions of the
Comprehensive Spending Review and the lingering liquidity issues
in the financial market have rightly drawn into question the
viability of PFI. Indeed, the recent withdrawal of PFI credits for 7
waste projects was widely seen as the final nail in its coffin.
Looking back 18 months, many commentators were asking
whether PFI was capable of delivering value for money when
private sector borrowing terms were bordering on unaffordable
and lenders (rather than procuring authorities) were dictating the
terms of the project. Today, the financial market has softened and
we have seen some new entrants – but the fact remains, PFI
subsidy (or revenue support in Scotland and Wales) does not
stretch far enough to compensate the escalating costs of PFI
projects and the too easily tolerated delays that typify bank
financed deals. Here we consider the benefits of prudential
borrowing as a "banked" alternative that has the potential to
provide much needed support for struggling local authorities.
Tangible Benefits?
In summary:
•
Accelerated procurement timetable: LCC achieved
contract award 24 months after issuing the OJEU notice.
An impressive feat when you factor in the resource hungry
competitive dialogue procedure and the untested nature of
this procurement strategy. As we all know, time is money!
•
Cheaper cost of borrowing: Notwithstanding the recent
Public Works Loan Board rate rise, a large gap remains
between the cost of private sector borrowing and the cost
of public sector borrowing. In addition, prudential
borrowing does not attract the arrangement fees, agency
fees, commitment fees and due diligence costs that
significantly inflate the cost of private sector borrowing.
In short, prudential borrowing maximises the benefits of
corporate finance without having to deliver double digit
project returns.
•
Alternative risk allocation model: Wherever possible, LCC
sought to eliminate PFI type risk pricing by adopting an
open-book pass through model. For example, by removing
the sharing concept for Qualifying Change in Law, the
contractor provided the pricing benefits of not having to
assume a cash reserve and a change in law facility. LCC
recognised that once the exposure had crystallised (subject
to mitigation and the like), they could fund the increased
cost more economically than the private sector. Operating
outside of the WIDP programme enabled LCC to drive out
savings through an alternative risk profile.
Who needs PFI?
Recognising the fierce competition for PFI credits and the
potential impact of DEFRA’s strict PFI criteria on Lincolnshire
County Council’s (LCC) preferred procurement strategy (i.e. LCC
site with the benefit of detailed planning permission), LCC
withdrew from the WIDP programme and concluded that it
could procure value for money without PFI subsidy. A bold
statement, but the proof is certainly in the pudding. Two years
on, LCC reached contract close on its 150,000 tonne residual
waste project, which is the first project to be funded 100%
through public funds (reserves generated through savings and
prudential borrowing from the Public Works Loans Board).
Having secured detailed planning permission, the new facility
should be operational in late 2013. By way of comparison,
Gloucestershire County Council (which was in the same bidding
round as LCC and is broadly the same size) secured WIDP
approval in October 2008 and is yet to formally announce their
CFT shortlist – arguably, some 8 to 12 months away from
contract award without planning permission.
Continued on next page
•
Robust security package: In its role as funder, LCC was able
to secure an enhanced security package (well beyond market
precedent) to underwrite the increased risk to the public
purse. Significantly, such security was backed by entities of
substance and was not tempered by the recovery risk issues
associated with limited recourse project finance vehicles.
A new form of contract...
The prudential borrowing model necessitates a new form of
contract. For LCC, we developed a bespoke form of contract
that effectively weaved together an EPC type construction
contract with a familiar WIDP long term service contract.
This was not straightforward and the key challenges were:
•
reconciling the very different payment profiles during the
works period and the services period;
•
securing extensive yet practicable monitoring and testing
regimes for both pre and post acceptance of the new facility;
•
harmonising the works and the services compensation on
termination provisions;
•
recognising the relatively "thin" nature of the service charge
and rethinking the sole remedy and associated provisions;
and
•
achieving long term incentivisation.
Not right for all?
Let's be clear – prudential borrowing may not be appropriate
for all types of waste procurement. The "no service, no fee"
protection under the project finance model should not be
underestimated, particularly where relatively new or untested
technology is to be procured. By prescribing EfW moving grate
technology, LCC considered itself to be on relatively safe ground.
There is no reason why this approach cannot be applied to the
procurement of MRF, AD or MBT facilities. Where concerns do
exist (for example, autoclave technology), the risks may be
mitigated by requiring contractors to corporately finance the
construction and then refinancing the debt via prudential
borrowing following issuance of the acceptance certificate.
We recognise that some local authorities may simply not have
the borrowing headroom to access the advantages outlined
here given the need to balance all the competing service
delivery requirements that may call on a self-financing
approach. However, the benefits of prudential borrowing can
equally be applied to alternative funding models such as local
authority bond financing or other long term institutional
funding models.
LCC has clearly demonstrated that procuring authorities no
longer need to accommodate overly cautious funder
requirements, or concern themselves with WIDP's deliverability
agenda – the focus now is simple, value for money.
Now road tested and "banked", we are confident that this new
form of contract provides a credible alternative to PFI and
delivers value for money.
If you would like to discuss the potential of using prudential borrowing or other forms of public sector financing to procure waste
facilities please contact Didar Dhillion:
Didar Dhillon
Senior Associate, Pinsent Mason LLP
T: +44 (0) 121 335 2932
E: [email protected]
Didar specialises in PFI/PPP projects and has particular expertise in local authority collaborative procurements and public sector
borrowing in the waste sector. His current experience includes advising Lincolnshire County Council on its publicly funded residual
waste project; Peterborough City Council on their publicly funded integrated waste programme; and five local authorities in South
Wales on their joint residual waste project. Didar previously advised the sponsors, Viridor-Laing, on the Greater Manchester Waste
Project. In addition, Didar prepared the suite of template procurement documentation for the Competitive Dialogue Procedure for
the Welsh Assembly Government.
© Pinsent Masons LLP 2011
This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered.
LONDON
OTHER UK LOCATIONS:
DUBAI
BEIJING
BIRMINGHAM
SHANGHAI
BRISTOL
HONG KONG
EDINBURGH
SINGAPORE
GLASGOW
LEEDS
MANCHESTER
T 0845 300 32 32
Pinsent Masons LLP is a limited liability partnership registered in England & Wales (registered number: OC333653) and regulated by the Solicitors Regulation Authority. The word 'partner', used in relation to
the LLP, refers to a member of the LLP or an employee or consultant of the LLP or any affiliated firm who is a lawyer with equivalent standing and qualifications A list of the members of the LLP, and of those
non-members who are designated as partners, is displayed at the LLP's registered office: 30 Crown Place, London EC2A 4ES, United Kingdom. We use 'Pinsent Masons' to refer to Pinsent Masons LLP and
affiliated entities that practise under the name 'Pinsent Masons' or a name that incorporates those words. Reference to 'Pinsent Masons' is to Pinsent Masons LLP and/or one or more of those affiliated
entities as the context requires. Further information about us is available at www.pinsentmasons.com
www.pinsentmasons.com