I’m here with Martin McLauchlan (MM), audit manager, and Graeme Greenhill (GG) senior manager, to talk us through a report on privately financed infrastructure investment in Scotland. Can you explain what this report is about?
GG: The report is basically about how we use private finance to pay for new buildings and infrastructure such as roads and hospitals. So the report looks at things like the decision to use private finance for specific projects, the actual use made of NPD (the Non-Profit Distributing method) and hub contracts. And it also looks at how the Scottish Government is developing new ways of funding public sector infrastructure.
The different types of finance seem pretty complicated. Can you explain what they are and how they’ve worked?
GG: The Private Finance Initiative (PFI) was introduced in the 1990s and that’s the most widely known form of private finance contract. The Scottish Government brought in the Non-Profit Distributing (NPD) method to replace PFI. Both these new models basically involved the public and the private sectors jointly setting up a company to build, operate and maintain the asset for a specified period and that usually means that the company building the asset borrows money from the private sector to pay for it. The public sector then pays an annual charge to the company which covers the borrowing and interest, as well as the company being required to maintain the asset which it has built.
In theory this means that the public sector has a well-maintained building at the end of the contract. The main difference between NPD and PFI was really around the company structure. Under NPD the level of profit for the private sector is capped and there is more public sector control over decision making due to the presence of a public interest director on the company board.
In addition to PFI and NPD, between 2010 and 2012, the Scottish Government also created five hub companies. Now these used both traditional capital finance and private finance to build assets, but they tend to be smaller assets than the big ones that the NPD and PFI concentrates on.
What type of buildings are we talking about here and how many?
GG: Well overall, infrastructure that cost around about £9 billion to build has been used under these contracts. PFI and NPD contracts have been used to build hospitals, college campuses and roads and they’ve also been used to build larger schools – like secondary schools. The hub companies tend to be used for smaller assets. So they‘ve been used to deliver community assets such as primary schools and also health centres.
So where do the five regional hubs fit into all of this?
GG: The five hub companies basically deliver smaller community-based assets like health centres and primary schools. And they can use either private finance where a project company is set up in a very similar way to NPD or PFI, or they can use traditional capital finance. And basically, the hubs are responsible for contracting with builders and the private sector to allow these assets to be constructed.

Given the different types of finance available to the Scottish Government and to local councils, how were decisions made about how to fund an investment in public buildings?
MM: So the main focus of the Scottish Government was on additionality and they have used these contracts in order to build projects that perhaps would not have been delivered or wouldn’t have been delivered until a later date. 
Where we have found there could be more clarity is the decision around what projects utilise these contracts and once that decision is made the Scottish Government has undertaken to provide support to the council or the health board if they use that contract. So at that point the focus for the public body becomes affordability. They are looking at the cost of the annual payments under the contract, rather than whether that represents value for money for the public sector as a whole.
It seems that public bodies in Scotland are going to have to pay far more back than the actual value of the buildings. Is that right?
MM: Yes. These contracts are more expensive. The public sector, if you include PFI, has payments of around £40 billion due over the life of the contracts against assets that cost £9 billion to build. Under NPD and hubs they have built £3.3 billion worth of assets and will pay back around £10 billion.
However, it’s not just value of the building. The annual payments they make cover the cost of construction, they cover maintaining the building over the contract length, other operating costs such as staffing. And also it includes the cost of borrowing and the interest. 
And there is a premium which is why it is important that the Scottish Government can clearly identify what they are getting when they use this and that overall, the combination of traditional capital projects and ones under PFI, NPD and the hubs are providing the optimum mix of investment.
Has there been any assessment of value for money and could the Scottish Government and local councils have looked at other funding options?
MM: Over the period these contracts were used the policy was to provide additionality to look at what projects could only be delivered by using this form of financing.  That is because the Scottish Government had limited options, they had limited grants, and they had financial transactions that could only be used for specific purposes. And they had also had either limited borrowing powers or no borrowing powers.
Similarly, if they chose to support council projects in certain ways, if they did that, it would count against their own budget. So these contracts were used to provide additionality. 
Value for money within the framework takes place at three levels. At the overall programme level, for individual projects, and during procurement.  At the programme level, this is where found a lack of clarity. Whilst the projects are additional and it wouldn’t have happened without the use of the contract, it is not always clear how individual projects were selected to make use of the contracts.
At the project level, value for money is not simply whatever is cheapest. They also look at design and that’s all done in comparison to other projects.
So at project level value for money does not mean whatever’s cheapest. It takes in a range of factors such as design. We can see that that was evaluated during project procurement by going to the open market. Competition drives efficiency and that is how they would look to get value for money.
What has happened to the non-profit distributing model? Why can’t public bodies continue to use this way of funding buildings?
MM: There are national accounting rules set by the United Nations and every country tries to implement them. Within the UK, that is done through the EU currently through what is known as European Systems of Accounts. NPD and hubs were found that in the latest iteration of these rules they were found to be public sector controlled and that meant they would count as public sector borrowing and would add to the UK debt. That meant they were simply no longer allowed additional investment and that is why they will no longer be used.
And the Mutual Investment Model – is this going to be any different?
MM: To comply with the new ESA rules –the European Systems of Accounts – yes it has to be different. What it does is reverse some of the changes that were made from PFI to NPD and the hubs. Ultimately, in order to provide additional investment, we will see less public sector control, less control over potential private sector profits and it also exposes the public sector to potential losses should there be any issues with ongoing projects.
What are you recommending in this report both to councils and the Scottish Government? 
GG: The Scottish Government is introducing two new ways of infrastructure investment, paying for infrastructure investment. The first of these is called the Mutual Investment Model which is basically a variation of NPD and PFI. And the second model is one which will be specifically used for schools. It doesn’t involve private finance, but the Scottish Government will provide money to councils to allow them to repay borrowing charges, based on the councils delivering certain outcomes.
These new funding models present a good opportunity today for the public sector to look at how they are using these contracts and making decisions.
So for the Scottish Government we recommend that they look back at the use of the NPD and hubs to see what could be learned and applied to the new funding models. And we also recommend that they should better report and communicate how they decide on funding for specific projects and the overall mix of projects which are funded either from the private sector or traditional means. 
Looking wider, for all public bodies – they should really take the opportunity to review how they fund and procure projects. There is also a need for councils and the Scottish Government to work together to develop the school model, in particular, to ensure the benefits of this new approach as well as the associated risks are understood.
Martin, Graeme – thank you very much and you can download the full report at www.audit-scotland.gov.uk.