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An expensive game

31 Dec 08

Private funding for public projects has always been controversial. Now research for ICAS finds that it is, at best, extremely dif?cult to get any sort of handle on how much you and I are paying for those roads and hospitals

by Jean Shaoul, Anne Stafford and Pam Stapleton

It has long been recognised that citizens, or at least their political representatives, should be able to see how society’s resources are being used. This is becoming increasingly difficult as an ever greater proportion of public money is spent outside direct state control via various forms of outsourcing, partnerships and sponsorships. It raises questions about whether public expenditure reporting and disclosure can deliver accountability for public monies.

We undertook research for ICAS to understand the implications for accountability to citizens of one of these new policies – the turn to private finance for public infrastructure.

Our aim was to establish the degree to which the reporting of public-private partnerships (PPPs) meets the Treasury’s standard that it should provide accurate, transparent and credible accounts that allow the public to judge the scope, direction and sustainability of public spending and investments.

We examined empirically the financial reporting and disclosure of expenditure on PPPs by the public and private sector partners. We chose the roads sector because it is the largest and most international PPP sector.

The financial viability of roads projects depends on ability to generate sufficient traffic to recover the full costs over the life of the contract, including the cost of debt and equity.

If traffic flows are too low, roads will operate below capacity and be difficult to fund. This necessitates some combination of higher tolls, capital grants and/or public subsidy.

International experience of such projects, which have not been uniformly successful, shows that it is necessary to consider the potential cost of a buy-back of the asset and/or debt guarantees. That is, any contingent liabilities need to be explained and, where possible, quantified.

Consequently, whether government and/or users fund the service, this policy raises questions about how the public sector’s contribution and forms of support are accounted for and disclosed at agency, governmental and national income accounting levels.

We examined six PPP road projects with a combined capital value of £1.3 billion, that is, 40 per cent of the total capital value of signed deals for roads and bridges. The cases include large-scale projects, commissioned by different types of public entities, and embrace a variety of different financing regimes. Some were toll concessions and some were paid for by the state.

We analysed documents that are in the public domain or were requested under the Freedom of Information Act or the Audit Commission Act 1998. These included the annual report and accounts, business cases, contract documentation, official and regulatory reports, business plans, post-implementation evaluations and project reviews. We sought clarification on some points from the public and the private sectors via email, telephone and face-to-face discussions.

We asked several inter-related questions.

What additional problems does the PPP policy create?

The problems surrounding PPPs take several forms.

Firstly, the context in which they operate and the operation of the policy differ from those set out formally in the law, regulations, concessions, licences and government budgets. The result is that the real distribution of risk and costs may fall more on taxpayers and users and less on the financiers than is apparent.

Secondly, PPPs remove public expenditure from the direct control of the public sector and establish contractual relations that commit future governments and taxpayers over very long periods of time.

Thirdly, the adoption by the public sector of the private sector accounting framework means that public sector accounting has become embroiled in issues, particularly in relation to off-balance-sheet liabilities and contingent liabilities, that have been problematic in the private sector.

What reporting and disclosure is needed for public accountability?

There are three inter-related information flows. First is the traditional upward flow from public authority to Parliament. The second is the downward flow of information to citizens, which includes non-financial information about access to services, service performance, and transparency and equity in resource allocation.

PPPs also give rise to a horizontal flow, from the private sector partner acting in effect as a public authority. Information held by private sector companies is crucial for accountability for public expenditure. Without the horizontal flow, upward and downward accountability has little meaning.

For PPPs, the public needs to be able to understand: the basis for and nature of the procurement decision; the costs of contracts; the values of any reported assets and liabilities, including contingent liabilities; the form and amount of any public support; the financial viability of the projects and their operators; and the termination arrangements for completed projects.

Thus accountability to the public implies forms of reporting and disclosure, over and

above the private sector-oriented financial statements, that enable judgements about value for money and the impact of large projects on budgets. Accountability also implies information that is easy to get and understand.

To what extent does current reporting of PPP projects provide public accountability?

1 Information routinely placed in the public domain

Perhaps the most striking finding is how little financial information on PPPs is routinely provided by the procuring agencies.

The public depends almost entirely on a project summary that provides a description

of some key features. Such information has improved in recent years as a result of the Internet, but is very limited with respect to financial information, which may differ across government websites.

The public authorities do not routinely release:

• the original strategic case setting out the reasons and detailed justification for the project;

• information on how competitive tension was achieved;

• the financial case for using private, not public, finance;

• the contracts; and

• information about the costs and performance of the projects, including risk sharing, monitoring costs and any internal reviews, and evaluation after contract termination.

Some information is discovered incidentally via the financial press or questions in Parliament, but this is neither systematic nor easily accessible.

Various public bodies scrutinise the accounts from the procuring agencies, but the level of aggregation makes this difficult. There is no evidence from the scrutineers’ reports that these contracts have attracted their attention.

The corporate structure of the private sector partner is typically a consortium constituted as a special purpose vehicle (SPV). It is largely debt financed with no recourse to its parent companies and operates through a complex web of subcontracting to sister companies. Its accounts contain limited useful financial information, and it is impossible to track public sector monies through the extended supply chain.

2 Additional means of securing information

While the 2000 Freedom of Information (FoI) Act was expected to make government more open, it has proved to be of limited value in the context of private finance contracts. It requires considerable persistence and insistence to obtain information. The way that public agencies respond and their helpfulness and speed of response vary enormously. In part, this is because the officials do not always understand what information is required.

More importantly, FoI proved to be of limited value because the act allows public authorities to refuse to disclose information.

They may refuse on the grounds that such information is commercially sensitive. Since some do provide the information, this begs the question why such information is commercially sensitive in some authorities and not in others. In some cases, the public authorities released the information requested, but with significant parts, such as termination clauses, cut.

They may also refuse on grounds of cost. One agency refused all requests for information on these grounds.

The variations between authorities made it difficult to avoid the conclusion that some used the exemptions to refuse to disclose information that could quite reasonably have been provided.

The act does not apply to the private sector. It gives the Lord Chancellor power to designate private sector companies as public authorities if they deliver public services under long-term contracts such as PPP, bringing them or the relevant parts of them under the act. He has not done so.

The Audit Commission Act 1998 provides that while annual local government audits are being prepared, the public may request financial information, including information relating to private sector contracts, and question the authority’s auditor. This provision does not appear to be widely known about or used.

We tried to use this facility in the case of a local authority contract, but the authority refused to proceed via this mechanism, offering to provide information required informally. It provided some contextual information, but the financial information it provided was limited, incomplete and did not match information that has become publicly available elsewhere. It took the authority more than a year to provide the key documents requested.

More information is forthcoming when the level of popular opposition to a project, for example the Skye Bridge, provides the impetus for press articles and/or investigation by the National Audit Office (NAO) or its regional counterparts.

3 The reporting framework

The public sector has adopted a framework of reporting intended to meet the needs of shareholders. Information of value to citizens, specially in relation to actual against expected expenditures, estimates of future expenditures, risk transfer, and contingent liabilities, is not reported in the annual report and accounts.

The private sector has long recognised that the presentation of consolidated accounts for large diversified organisations is problematic for shareholders because it disguises the risk profiles of individual segments.

This is now being replicated in public sector consolidations where departmental accounts made up of numerous public authorities may disguise the risks involved in the turn to private finance.

The lack of information from public authorities means that the main source of financial information on the cost of a project is the SPV’s financial statements, but these too have their limitations.

First, while the SPVs and their sub-contractors should be the source of horizontal accountability, their reporting is limited and opaque.

Second, their complex group structure means that there is little disclosure of related party transactions. The web of sub-contracting and the accounting regulations that permit close companies to hide behind the “corporate veil” makes it impossible to see where public money is going, and difficult to assess total returns to the private sector.

Furthermore, although the public authorities and the NAO have the right to examine the books of accounts relevant to the contract throughout the extended supply chain, there is no publicly available evidence that they have done so.

4 The cost of private finance

The cost of using the private sector as financial intermediaries is significant.

The cost of finance constitutes the main expenditure in roads projects. But the additional annual cost of private over public finance on these projects, assuming the same level of debt, is conservatively estimated at between 8 per cent and 40 per cent of revenues.

The additional total cost of the completed projects, the Dartford Crossings and Skye Bridge, was similarly estimated very conservatively at 7 per cent and 25 per cent of revenues respectively. This must affect the public authorities’ budgets and create affordability problems.

According to a Highways Agency official writing in Public Finance/Infrastructure Finance: Credit Survey of the UK Private Finance Initiative and Public-Private Partnership for Standard &

Poor’s in 2005, annual commitments under PPP appear to take a disproportionate total of the budget.

The additional cost is attributed to the cost of risk transfer, but a lack of information means that the public cannot assess whether such costs are commensurate with the benefits to the public sector or the risks to the private sector.

Information is lacking about original bids, expected and actual traffic flows, expected and actual payments, any penalty deductions, the cost of operating and maintaining roads, contractual performance and any contractual changes. Despite this, there has been no examination of the additional cost of private finance after the fact by public authorities or watchdogs. At the very least, the high cost attributable to risk transfer raises questions as to whether appraisals of the use of private finance for public infrastructure are appropriate.

Conclusion

These findings are important because other forms of private finance are proliferating. Thus, the problems we have identified go far beyond the cases cited.

Furthermore, the scale and nature of the problems identified in a sector such as roads, whose projects are large and visible, are likely to be found elsewhere. For projects in local authorities and non-departmental public bodies where reporting is more diffuse, accountability issues may be even more problematic.

The lack of consistent, comparable and understandable financial information in the context of PPP makes it difficult for public sector stakeholders to understand where public money is going, how it is being used, and the extent of future commitments and liabilities.

This makes it all but impossible to gauge the implications for future government expenditure and, perhaps more importantly, the government’s implicit debt, which is clearly mounting.

This is not to say that there were ever any “good old days”. Rather, the increasing expenditure outside the direct control of the public bodies creates additional reporting problems that make scrutiny, control and thus accountability difficult, if not impossible, creating the potential for waste, mismanagement and fraud.

Under such conditions, the government increasingly rests on shaky economic and financial information that will ultimately undermine the basis of its activities and policies.

Finally, and most importantly from the perspective of this study, the absence of clear financial information makes it impossible for the public to participate in an informed debate about public and fiscal policy.

The authors are from:

Manchester Business School, where Jean Shaoul is professor of public accountability,

Anne Stafford is a lecturer in accounting and finance, and Pam Stapleton is professor of accounting.

The executive summary and full research report can be downloaded free from www.icas.org.uk/research

The research was funded by the Scottish Accountancy Trust for Education and Research.

Two free debates on the findings and recommendations of the report are to be held in association with the Economic and Social Research Council. They will be chaired by Alan Thomson, ICAS vice-president, and will be followed by a drinks reception.

They will be in London at 4.30pm on 4 February; and in Edinburgh at 4.30pm on 12 February.

For further details, please email research@icas.org.uku

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