In November, the Chancellor announced he wanted to reform the much-maligned (but still used) Private Finance Initiative (PFI), admitting that it can be “too costly, inflexible and opaque”. So the Treasury is looking for ideas for “a new approach” which needs to deliver lower costs and better value for money, make more effective use of private sector innovation and skills, improve flexibility and transparency, get projects built to time and budget and create the right incentives to manage risk.

Could the solution be SFI - the Social Finance Initiative?

To find out, we need to understand the problem. Criticisms of the current PFI scheme include:

  • private investors making too much money out of the scheme
  • perverse incentives when projects are accounted for ‘off balance sheet’ even when the taxpayer still retains a liability as financing costs are higher than government borrowing
  • risk is not really transferred to private partners
  • problems with the way costs and benefits for projects are calculated
  • refinancing gains accruing only to the private sector (once famously called the “unacceptable face of capitalism”)
  • lengthy and costly procurement which discourages competition and leaves the usual suspect contractors
  • a lack of accuracy and transparency on assumptions, data and estimates of time and costs

So over time, new PFI models have evolved in seeking to address some of these criticisms. For example, a non-profit distributing (NPD) model pioneered in Argyll & Bute was structured to ensure returns to private investors were capped. By replacing equity investment with a combination of senior debt and junior debt (mezzanine, subordinated or preference shares) any profits would be recycled via a charity for the benefit of the local community.

This model won awards and interestingly, the Government’s own PFI experts reported other benefits emerging from the NPD model, including

  • improved governance with independent stakeholder directors from the local community acting as guardians of the public interest and with levers over behaviour beyond contractual terms
  • improved alignment of long term public and private sector interests
  • more stability of long-term ownership and control
  • greater stakeholder acceptance

So perhaps the promise of the model lies not with the debt vs. equity issue but with the control and governance of the scheme?

You may have never heard of your Local Improvement Finance Trust (LIFT) or your Local Education Partnership (LEP). But these and other dry and anonymous Special Purpose Vehicles (or SPVs) are created within PFI schemes to take on various project management responsibilities. These joint ventures may be controlled by a combination of private investors, construction firms, facilities management companies - and with a minority interest held by public authorities.

But what if an SFI model reformed PFI so that the financial vehicles at the heart of the scheme were themselves social enterprises?

Instead of an invisible management vehicle, the ownership and control of your local school or hospital would be held by a business with a social mission, independent from both private and public sectors, with an asset lock and dividend cap and with surpluses principally reinvested in the community.

Could this model deliver…

  • lower costs and better value for money? Yes – as investor returns are capped and profits are principally reinvested delivering greater value for money for the taxpayer
  • greater innovation and  flexibility? Yes – through governance which ensures control and ownership is more independent from the state and private investors
  • increased transparency? Yes – through regulated CIC or charity reporting requirements
  • the right incentives around risk and delivery to use the private sector more effectively? Yes – through rewarding private partners for delivering what they are good at and not for refinancing wheezes (PFI insiders have themselves acknowledged the benefits of independent Directors controlling refinancing)
And perhaps more excitingly, this model also starts to prise open the door to another Treasury goal - to captivate a wider range of financing sources. Greater citizen and stakeholder engagement could in turn offer the potential for the kind of community investment we are increasingly seeing with renewable energy projects, football clubs and community shops.

If the state can’t afford to invest in our local school or hospital, and if private investors’ terms are unaffordable, then what are we going to do about it?