HUB PROGRAMME DELIVERY OFFICE GUIDANCE NOTE 11/13

Transcription

1 HUB PROGRAMME DELIVERY OFFICE GUIDANCE NOTE 11/13 Guidance on Local Authority Capital Contributions into hub DBFM Projects 27 November 2013 CONTENTS 1. Background & Context Historical Guidance Current Practice Approach to Capital Contributions Impact on Cost of Senior Debt Summary... 5 Page 1 of 6

2 1. Background & Context It is generally accepted that it is better value for money for Local Authorities ( LAs ) to inject either their own existing capital resources or funds sourced from the Public Works Loan Board ( PWLB ) into hub DBFM projects rather than utilising externally sourced finance due to their lower cost of capital. This paper considers the timing of such injection of finance, known as capital contributions, into DBFM projects and identifies issues which should be carefully considered on a project by project basis. Whilst the content of this paper provides guidance, it is for LA project teams to consider the specifics of individual projects in relation to capital contributions and work with hubcos, respective advisers and SFT to deliver the most efficient solution. 2. Historical Guidance There are two pieces of historical guidance which are of relevance to this topic: HM Treasury guidance in the form of Standardisation of PFI Contracts Version 4 SoPC4 ; and Scottish Government guidance from 2006, Use of Capital Injections in PPP Projects SoPC4 Guidance The relevant sections of SoPC4 are and Section states that in the ordinary course of events, no public sector capital contributions should be made to the Project, and no Unitary Charge should be payable, until the Works have been completed and accepted. SoPC4 envisages that only in exceptional circumstances (for instance where the Project frees up surplus land and the Authority is able to sell this and use the proceeds) will an Authority want to make a capital contribution of its own to a Project. SoPC4 states that any approved capital contributions should be kept to a modest size. SoPC4 s concern with large contributions is that they may affect the risk transfer balance and incentives of the Project especially where the Project gets into difficulty. Any contributions should be scheduled to, or towards, the end of the construction period and be linked to acceptance of the Service or other important milestones. Section of SoPC4 states that if there is a construction delay or cost overrun and there is a rescheduling of Senior Debt drawdowns, Authority capital contributions should be withheld until the Authority is satisfied that no drawdowns of Senior Debt or equity are retired behind those of the Authority and that the ratio of private capital to Authority capital is not adversely effected. Where there is an equity bridge facility (with debt being Page 2 of 6

3 provided instead of equity on a temporary basis), Authorities should ensure that the full equity investment remains at risk on a termination (such that normal risk allocation principles are maintained). Authorities should also ensure that levels of subcontract security (bonds, liquidated damages, etc.) remain at the same levels regardless of any public sector capital contribution (i.e. if there is a 10% Authority contribution, sub-contract security levels should still be gauged against 100% costs and not just against the 90% private sector contribution) Scottish Government Guidance The most recent Scottish Government ( SG ) Guidance on capital contributions was issued in It stressed that any capital injection (including direct payments, land contributions, credit facilities and other similar arrangements) must be linked to full service commencement. As with SoPC4, SG agreed that if a strong VfM case could be made they would consider proposals linking injections to project milestones, but only when these milestones represent the full delivery of individual or bundles of facilities. The SG guidance stated that where a Procuring Body commits itself to making injections, such contractual arrangements must not amount to a commitment on the Procuring Body that can be called upon prior to the certification of the relevant facilities and full service commencement therein, including the full operation of the payment mechanism in respect of the relevant facilities. The SG guidance requires that project funders conduct their due diligence in respect of the total debt requirement of a project and commit to providing these funds in full if required. Procuring Bodies should also gauge their bonding/security/subcontract support requirements based on a totally privately financed solution. In modelling the impact of a potential capital injection, Procuring Bodies must consider the private sector delivery structure and take account of potential VAT and other tax issues. All wider issues and consequences need to be factored into VfM considerations and assessed against related affordability benefits. When capital injections from a Procuring Body are structured into projects the related commitments of the Procuring Body will require underwriting. 3. Current Practice The SoPC4 and SG guidance noted in Section 2 was issued many years ago. Whilst the majority of the principles within the guidance remain valid, both documents were issued when central government accounting was linked to UK Generally Accepted Accounting Practice (or UK GAAP ). In 2009, central government accounting moved to International Financial Reporting Standards (or IFRS ). At the same time Treasury confirmed that the budgeting treatment for PFI projects would be on a national accounts basis, not on an IFRS basis, which essentially means that the European System of National and Regional Accounts (or ESA95 ) determines current practice. Implications of ESA95 Page 3 of 6

4 To be deemed to be off-balance sheet for National Accounts purposes, ESA95 requires that, in addition to the project qualifying as a service concession under IFRIC 12, two of the following three risks are transferred to the private sector: Construction risk; and one of Demand risk; and/or Availability risk. It is not expected that demand risk will be transferred to the private sector in any of the projects being procured through the hub programme; therefore the key risks to consider are construction risk and availability risk. Availability risk should be appropriately transferred through a robust and thoughtfully calibrated Payment Mechanism. The project structure should be carefully considered to ensure construction risk is transferred to the private sector. SFT s interpretation of ESA95, which, it is stressed, is not subject to further discussion or interpretation by advisers, is that, as an absolute maximum, 45% of the capital cost of a hub DBFM project can be financed via a capital contribution. Any interim capital payment from the public sector during the construction period will result in a reduction of the risk transferred to the private sector. It follows that, for those projects which are close to, or at, the 45% cap noted above, any capital contributions made during the construction period may result in the project no longer being deemed to be off-balance sheet for National Accounts purposes. This position is unacceptable for revenue funded projects being delivered through the hub programme. Guidance is therefore set out in the following section. 4. Approach to Capital Contributions 4.1. Capital Contribution Greater than 35% of the Capital Cost It is strongly advised that, where projects have in excess of 35% of the capital cost being met through a capital contribution, any such contribution must be made at the end of the construction period with NO payments during the construction period. Whilst it is clearly understood that, from a cost of finance perspective this is not an optimal solution, the need for a project to meet the requirements of ESA95 and not take excessive construction risk takes precedence over the absolute lowest cost of finance Capital Contribution Between 20% and 35% of the Capital Cost Where projects have between 20-35% of the capital cost being met through a capital contribution, a small amount of capital could be injected towards the end of the construction period, with this amount being payable upon certification of the works value carried out to date by the Independent Tester. It is stressed that such a contribution should only be made on the basis that senior funders have the same trigger mechanism for drawdown of debt; to avoid the situation where the public sector s capital is used first, Page 4 of 6

5 thereby reducing the senior debt provider s risk and increasing the exposure of the public sector to project default/termination during the riskier construction period. SFT will support project teams to ensure that projects are structured in such a way as to not adversely affect the risk transfer position Capital Contribution Less than 20% of the Capital Cost Where less than 20% of the capital cost of a project is being met through a capital contribution, for example where Local Authorities are sharing premises within a health centre facility, the injection of capital can be structured earlier in the construction period such that it has a bigger impact on the cost of finance. However, it is advised that this is structured such that it is used to finance physical construction activity (i.e. not the payment of design and other up front development fees) and done on a matched 50/50 basis with senior debt. Hence, once construction activity is underway, the funder s technical adviser monthly certificate is used as the basis to draw 50% of the required sum from the funder and 50% from the capital contribution up to an agreed monthly cap. An example of this methodology is provided in Annex A. 5. Impact on Cost of Senior Debt SFT has tested the approaches set out in Section 4 with members of the funding community who have expressed comfort with each as an acceptable position. It is important however that project teams, hubcos and their respective financial advisers discuss all aspects of potential capital contributions with proposed senior funders to ensure that terms offered do not reflect potential increased risk to the senior debt provider, which would add unnecessary cost to the funding terms offered. 6. Summary The following table summarises the suggested timing of Capital Contributions into hub DBFM projects: Capital Contribution as a % of Capital Cost Greater than 35% (subject to a maximum cap of 45%) Between 20 35% Timing of Capital Contribution Construction completion Towards the end of construction period Pari passu with drawdowns of senior debt Driven by Independent Certifier reports Less than 20% Project specific timing could be earlier in the construction period to generate greater financial benefit. Page 5 of 6

6 Annex A NHS Lanarkshire 3 Health Centre Bundle Example The NHS Lanarkshire 3 Health Centre bundle allows for the following approach: The capital contribution from North Lanarkshire Council ( NLC ) for the Wishaw facility (c. 12% of the overall capital cost) will be made spread over the construction period on a monthly basis; The payments will commence in Month 4 of construction. This is scheduled for when total cumulative expenditure at the Wishaw site is forecast to be 1.7m. Thereafter payments will be on a monthly basis; Capital contributions commence in month 4 to provide protection to NLC to demonstrate that sufficient work has been completed, and value delivered, in an event of default occurring during construction (consistent with previous Scottish PPP projects); Capital contributions will be paid from the Board to subhubco, in accordance with a schedule of payments agreed at Financial Close as long as supported by a Lender s Technical Advisor s Certificate, and recovered from NLC thereafter on the basis of the valuation; The amounts will be deposited within the proceeds account maintained by subhubco; and The funders have stated that they would lend on the basis of the net senior debt amount, rather than the gross, and do not envisage a requirement for a standby facility. This proposal is welcomed as it generates a saving in both arrangement and commitment fees. Page 6 of 6