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Jim Cuthbert Margaret Cuthbert cuthbert1.pwp.blueyonder.co.uk

The Handling of PFI Leasing Charges in Government Accounts: the implications of information on how PFI schemes actually behave. Jim Cuthbert Margaret Cuthbert www.cuthbert1.pwp.blueyonder.co.uk. What this talk is about. We are going to look at how PFI schemes are reflected in

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Jim Cuthbert Margaret Cuthbert cuthbert1.pwp.blueyonder.co.uk

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  1. The Handling of PFI Leasing Charges in Government Accounts:the implications of information on how PFI schemes actually behave. Jim Cuthbert Margaret Cuthbert www.cuthbert1.pwp.blueyonder.co.uk

  2. What this talk is about We are going to look at how PFI schemes are reflected in • The departmental accounts of public sector bodies • the National Accounts: and consider whether this makes sense in the light of information on how PFI schemes actually behave.

  3. PFI (alsoknownas PPP) • What is PFI? A public sector client contracts to make regular payments over 25 or 30 years for the provision of a serviced asset, (like a school or hospital). This regular payment, known as the unitary charge, covers both the procurement of the capital asset, and the provision of services during the life of the contract. • PFI is large. In the UK as a whole, contracts had been signed for over 700 projects by January 2009, with a total capital value of more than £60 billion.

  4. Departmental Accounts Produced by individual public sector bodies to standards laid down in Treasury’s Financial Reporting Manual, consistent with International Financial Reporting Standards, (IFRS). National Accounts Picture of whole economy, produced by Office for National Statistics, to principles set out in the System of National Accounts 1993, (SNA93), and the European System of Accounts 1995, (ESA95). Note that different accounting standards are applied in these two contexts: For example, the national accounts take a more restricted view than IFRS about what constitutes a liability: in particular, the national accounts do not recognise provisions for future expenditure or contingent liabilities.

  5. The Key Question The accounting treatment of capital assets in PFI schemes depends on the key question:- Is the capital asset an asset of the public sector, or not? What matters is economic ownership, not legal ownership.

  6. Prior to 2009 The answer to this question, applied in both departmental and national accounts, depended on a risk based assessment: schemes for which the public sector body was deemed to bear the risks and rewards of the asset were counted “on the books” of the public sector. Under this test, the great majority of PFI schemes, by number, were “off the books”.

  7. How are “on book” schemes treated. • In departmental accounts, the accounts score an asset, valued at the relevant concept of fair value as used by the department: and a liability, which will essentially be the written down cost of the capital good. • In the national accounts, “on book” PFI schemes count as an asset in the public sector capital stock, with an equal and offsetting liability in the public sector net debt aggregate. • ONS relied on the judgement of the public sector’s external auditors to decide whether a given scheme was “on book”, and for the valuation of the relevant asset.

  8. What happened in 2009? • The government adopted IFRS for departmental accounting. This means almost all PFI schemes are likely to come “on book” as regards departmental accounts. • But this change does not apply to the compilation of the national accounts, where the former risk based test still applies. So the adoption of IFRS does not necessarily mean that more PFI schemes will be recognised in the national accounts. And, since ONS relied on departmental auditors, it poses a real logistical problem for ONS

  9. Evidence on how PFI schemes actually behave. • Such evidence is very hard to come by, because details of PFI operation are commercial in confidence. • We have acquired, through Freedom of Information, the financial projections for 8 PFI schemes. • These are the detailed projections produced by the operating consortia when the PFI contracts are signed.

  10. What we did with this evidence: (1) • We took the projected stream of annual payments made by the public sector, and stripped out of this payments for services: what is left is effectively the payments being made for the provision of the capital asset. • It is then natural to ask: if the public sector had not gone down the PFI route, how much could it have borrowed for the same cost as this stream of capital related payments? • The answer is: calculate Net Present Value (NPV) of these payments, discounted at National Loan Fund interest rate, (around 5%).

  11. Eight PFI Schemes: Capital Raised, Total Capital Related Payment, and Ratio of Net Present Value of Payment to Capital.

  12. What does this mean? • The NPV of the payment stream is effectively the liability which the public sector has taken on to acquire the use of the capital asset: while it is the capital raised which will appear as the public sector’s liability, both in departmental accounts, and, (for “on book” schemes) in Public Sector Net Debt. The right hand column in the table shows the ratio of the NPV of the payment stream to the capital raised. The fact that the ratios are so much greater than 1 indicates that the true liabilities are understated in the accounts. • Implication The way PFI liabilities are expressed in departmental accounts should be changed, to better reflect the true scale of the liability taken on. • Similarly, the PSND aggregate in the national accounts needs to better reflect the true scale of PFI liabilities: (according to ONS, however, there are technical issues here, which may complicate the solution.)

  13. What we did with the evidence: (2) • As we have seen, ONS are still relying on a risk based assessment to decide which schemes should come “on-book”. • But clearly, the level of profit is relevant to deciding whether risk has been meaningfully transferred to the private sector. If profits are very high, it is more a case of “having a flutter with public money” than real risk transfer. • So we used the PFI projections to look at the projected internal rate of return (IRR) on broad sense equity, and at projected dividend payments relative to the amount of pure equity invested.

  14. Eight PFI Schemes: IRR on Broad Sense Equity, Equity Capital Injected, and Total Projected Dividends.

  15. What does this mean? • Clearly, projected profitability is very high in several of these schemes. (And in fact, the figures in the table understate projected profitability on broad sense equity, since these IRRs are projected to be earned on average amounts of outstanding debt which are much higher than the original investment: i.e., significant amounts of interest are being rolled up.) • Implication. Application of ONS’s risk based test should be broadened to include assessment of projected level of profit, (and amount of equity actually at stake). If this was done, many more PFI schemes likely to come “on book” in the national accounts.

  16. Further issues which mean public sector liabilities likely to be understated • Timing effects. PFI schemes don’t come “on book” until construction phase completed, because up to that point they are regarded as contingent liabilities. But the public sector has already entered into contractual obligations: so the eventual liabilities are “hard contingent” rather than “soft contingent”. • Implications of Treasury underwriting PFI finance given difficulties in credit market.

  17. Does all this matter? • We argue yes. • ONS calculated the asset value of “on balance sheet” PFI schemes included in the PSND for 2009 as £5 billion. This compares with the total capital value of £60 billion at that time for signed PFI deals. • On the other hand, on the basis of the kind of factors identified above, the public sector liability associated with these schemes should probably be more realistically assessed as being significantly greater than the £60 billion figure, rather than the £5 billion. What should have been a significant warning light as we headed into current financial crisis was effectively stuck on “green”.

  18. References on Departmental and National Accounting. • H.M.Treasury, (2009): “Financial Reporting Manual 2009-10”. • Kellaway, M. (2008): “Private Finance Initiative and Public Debt”, Economic and Labour Market Review, Office for National Statistics, Vol 2, No. 5, May 2008. • Maitland-Smith, F (2009): “Government Financial Liabilities Beyond Public Sector Net Debt”, Economic and Labour Market Review, Office for National Statistics, Vol 3, No. 7, July 2009.

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