The long legal read: Filling the funding hole

18/09/2019

Ava Zadkhorvash and Jon Hart of award winning law firm Pinsent Masons LLP take a look at potential funding models for highways infrastructure, Regulated Asset Bases and life after PFI and PF2.

Spare a thought for our Treasury civil servants and policy makers. Every now and again, they may be reminded of a time when they turned up for work and the key issue of the day was not Brexit.

Outside the hurly-burly of deal/no-deal, rogues and proroguing, from time to time, other imperatives occasionally rise to the surface, including coming to terms with the state of the UK's infrastructure and how it is going to be paid for.

According to various sources, more than £600bn is due to be invested in infrastructure over the next 10 years, with the Government deciding that around half of the planned investment should come from the private sector. So far, so staggering.

However, there are some gaps in the picture as to what role the private sector may be required to play and how.

The end of PFI?

Less than 12 months ago, a previous chancellor called time on the PFI and PF2 model, particularly the use of the design-build-operate and maintain structure (DBFOM). Under DBFOM, a single consortium would be appointed under a long-term (typically 25 to 30 years) contract, to build a new asset using private debt, and then to operate and maintain it.

The majority of construction risks would be borne by the consortium, flowed down to a design and build contractor, which sometimes would also be an investor in the consortium.

Operational risks would be borne by an O&M contractor and levels of payment to be made by the public sector would be geared to how well the asset performed in practice, measured by a complex contractual mechanism which, depending on individual contracts, would take account of factors such as lane closures, journey times and safety performance.

In a very limited number of cases, the model is adapted to provide that payments to a consortium will be made from a revenue stream (for example tolls) on a ‘concession’ or ‘demand risk’ basis.

DBFOM and its variants lay at the heart of PFI and PF2. In its time, it has been used to build hospitals, schools and housing. In the highways sector, it has been perhaps less widely adopted, but has been used to deliver schemes such as the A1 Darrington-Dishforth scheme and the M25 road widening for the Highways Agency, as was.

There have also been a few examples of concessions – notably the M6 Toll Road. Certain local authorities have used this model for delivery of streetlighting schemes and highway maintenance.

This model and its contractual risk allocation have not been without controversy. On the one hand, there are the examples of Carillion's liquidation, the Aberdeen bypass and Birmingham Highways, which have seen contractors seriously affected by costs and deductions. On the other hand, there have been criticisms from think tanks such as the recent IPPR report into hospitals that there has been poor risk transfer and value for money for the public sector.

As readers will be aware, in the roads sector, Highways England was in the process of procuring two schemes using DBFOM at the time of last October's announcement - the A303 Stonehenge tunnel (above) and the roads for the Lower Thames Crossing (below). For potential tenderers and investors (some of whom had been tracking the projects for a considerable time) DBFOM's demise came as a bolt from the blue.

That said, the Treasury indicated at the time that it was open to looking at ‘other approaches’ for investing in infrastructure, including roads.

In this context, it is also important to mention that the chancellor's pronouncements are limited primarily to England. Both Wales and Scotland are continuing to develop their own project finance solutions, which are similar to DBFOM.

In Scotland, both the M8 and Aberdeen bypass projects have been procured using the ‘Not For Profit Distribution’ Model (NPDM), while the A465 Head of the Valleys scheme is being procured by the Welsh Government's ‘Mutual Investment Model’ (MIM). Both of these models require a successful consortium to provide design, construction and O&M services with the provision of private finance.

Where next?

So where are we now, 12 months later? In the first instance, there is opportunity to consider dispensing with any form of private finance involvement at all. Apparently the Stonehenge project will now be procured following a more traditional engineering procurement route, making use of the tried-and-tested (and usually heavily amended) NEC Engineering and Construction Contract.

As a procurement approach, this is relatively familiar territory, albeit that it lacks one of the often-overlooked benefits of the DBFOM model, of contractually addressing design and construction issues at the same time as long-term lifecycle and maintenance arrangements.

Perhaps as pertinently, from an investment perspective, consideration would need to be given as to whether this kind of approach may be adapted to provide for the use of external private finance – and if so how.

The scrapping of PFI and PF2 has been accompanied by a range of consultations sponsored by the Treasury. The Infrastructure Finance Review published earlier this year looked at the various private financing models already in use and how these ‘could be applied in new contexts’, in a bid to improve the public sector balance sheet, and ensure value for money for the taxpayer.

Regulated Asset Base

The Scottish NPDM and Welsh MIM do not appear to be given particularly extensive consideration, but one alternative, well-established, model being increasingly considered by the Government is the Regulated Asset Base (RAB).

RAB accounted for over £160bn of private sector infrastructure investments in 2018, particularly in the water, gas, electricity, telecoms, (and with some tweaks to the model) railways sectors. There has been a lot of interest in the Government's latest consultation, to see if RAB can be applied to the development of new nuclear power stations post-Hinckley C.

In simple terms, RAB uses the following structure:

  • an economic regulator grants a licence (rather than a DBFOM contract or concession issued by a governmental authority) to a private company to operate and maintain an infrastructure asset, providing the company the right to charge a regulated price to users
  • the economic regulator is an independent regulator appointed by statute that will set the price and will hold the company to account, ensuring that end-users are not exploited
  • demand risk is passed to the company as it charges the end-users of the product or service (e.g. users of water utilities)
  • the company agrees to invest certain sums in maintaining and developing the asset by reference to agreed ‘control periods’ – the regulator will look at the value of the underlying asset and will also set the weight average cost of capital (and from this the returns that the company might be making)

And how would this model work with the highways sector? Interestingly, although it was not implemented, in 2013 a consultation was launched to introduce the RAB model to the roads sector.

The proposed model suggested that the Government would initially portion for a user charge within motor taxes in order to help fund the operation and maintenance of the roads network. This would then be outsourced to the private sector, thereby, taking the project off-balance sheet from the public purse.

At the time, the CBI expressed concerns that this type of funding would not be sufficient to meet or cover the future investment needs and warned that the use of toll roads would likely have to be introduced.

Currently, the Office of Rail and Road (ORR) operates in a regulatory capacity in relation to Highways England and the strategic road network (SRN). As the ‘Highways Monitor’, the ORR enjoys certain enforcement powers to require that Highways England complies with Highways England's statutory licences and road investment strategy (analogous to the control periods mentioned above under a RAB) for the SRN.

The missing element here is, of course, the absence of an ‘end user’ in the same way that is the case for, say water utilities: something that was highlighted at the time of the 2013 consultation. Funding for the road investment strategy has been ring-fenced by the Department for Transport (and Treasury). 

While the technology for road user charging continues to develop (and certain optimists may say will provide a solution to the difficulties associated with the Brexit backstop for the Northern Ireland border), there is (obviously) no appetite yet for further developing the regulatory model to bring the highways sector closer to a pure RAB. Indeed, given the criticisms that have been levelled against asset holders in the electricity and water sector, some may argue that the likelihood of an RAB model for roads is further away than ever.

And yet… the question of investment remains and when or if the smoke of Brexit clears some of the affected civil servants may be able to get back to their day job of coming up with some possible solutions.

The National Infrastructure Commission (NIC) recently refined its analytical tool in a bid to ensure that the Government considers broader factors such as whole-life and social impact in their infrastructure procurement models.

Based on five road schemes, the pilot trial was inconclusive. It was not possible, nor realistic to evaluate the relevant costs and benefits of private financing and procurement methods traditionally used.

However, Sir NIC chair John Armitt said that: ‘transforming the nation's infrastructure means mobilising private sector investment alongside that of government’.

STOP PRESS: In last month's column, we highlighted the proposed changes to VAT invoicing – the so-called reverse charging – which would potentially have had a significant impact for both main contractors and subcontractors. The Government has listened to concerns from industry and is postponing the reverse charge to 1 October 2020. This will avoid the changes potentially coinciding with Brexit and will give businesses longer to prepare.

There were concerns that SMEs in particular were ill-prepared for the changes. This still means that the issues highlighted about considering changes to subcontracting arrangements and invoicing systems remain a source of legitimate concern – but now there is going to be a longer period of time to raise awareness and be ready for implementation.

Highways jobs

Engineer HDC/S38

Competitive Salary
We are looking for an enthusiastic, committed, and experienced highway engineer to join our successful Highways team. Wakefield, West Yorkshire
Recruiter: Wakefield Council

South London Waste Partnership (SLWP) Director

£96,192 - £108,213 per annum
This is a highly visible, senior role, working with local government chief officers as well as sub-regional and regional organisations.  London (Greater)
Recruiter: South London Waste Partnership

Grounds Maintenance Operative

£19,312 - £20,493 per annum
This position is Seasonal/Fixed Term from 22 March to 29 October 2021. Sandwell, West Midlands
Recruiter: Sandwell Metropolitan Borough Council

Head of Highways

£53,984 - £63,449
You will have a proven track record of success in delivering effective highway services and substantial capital programmes as... Kirklees, West Yorkshire
Recruiter: Kirklees Metropolitan Council

Vehicle Technician x2

£24,982 - £29,577 per annum
These positions are fixed term contracts for 12 months with the prospect of a permanent role once the Class C Driving Licence has been obtained.  Sandwell, West Midlands
Recruiter: Sandwell Metropolitan Borough Council

Commercial Vehicle Technician

£30,000 per annum
We are seeking a fully trained HGV technician to work as part of the team who maintain the Council's fleet to the highest standards.  Chelmsford, Essex
Recruiter: Chelmsford City Council

Clerk of Works

£32,234 - £35,745
We are looking for someone who... Warrington, Cheshire
Recruiter: Warrington Borough Council

Executive Director of Place, Economy & Environment – West Northamptonshire Council

Up to £140k
Be part of shaping the future Northamptonshire
Recruiter: North Northamptonshire & West Northamptonshire

Director Public Protection and Licensing

circa £123k
At Westminster, we are passionate about the place and the people who live, work and visit here. City of Westminster, London (Greater)
Recruiter: Westminster City Council

Senior Data Centre Engineer

£41,952
The successful candidate will have a BSc in relevant discipline, or equivalent industry experience. Camden, London (Greater)
Recruiter: Camden London Borough Council

Lead Network Engineer

£46,756
We are going through exciting new changes, which require the need for Lead Network engineers who can redesign, architect, document and... Camden, London (Greater)
Recruiter: Camden London Borough Council

Community Protection Regulatory Officer

£26,112 per annum, rising to £28,785
The successful applicant will provide support to the team’s Environmental Health Officers while also benefitting from their experience and guidance. Chelmsford, Essex
Recruiter: Chelmsford City Council

Grounds Maintenance Supervisor

£26,112 per annum, rising to £28,785
The successful candidate will show enthusiasm and a commitment to effectively deliver excellent service to... Chelmsford, Essex
Recruiter: Chelmsford City Council

Drainage Engineer & Senior Drainage Engineer

£32,234 - £35,745 (Engineer), £35,745 - £39,880 (Senior Engineer)
Lincolnshire County Council has exciting opportunities for a Drainage Engineer (x1) and Senior Drainage Engineer Lincolnshire
Recruiter: Lincolnshire County Council

Principal S106 & CIL Officer (Infrastructure Planning)

£43,860 - £46,839 p.a. inc.
To be successful in this role, you will bring strong S106 & CIL collection experience, be able to... Wembley, London (Greater)
Recruiter: Brent Council

Head of Built Environment

£67,036 - £76,613 per annum
The post holder will deliver the effective strategic improvement, co-ordination and management of the planned... Bradford, West Yorkshire
Recruiter: City of Bradford MDC

Highways Maintenance Engineer

£30,492 - £32,851
We are looking to recruit a suitably qualified and experienced Highway Maintenance Engineer to join our Key Projects Team at... Worcestershire
Recruiter: Worcestershire County Council

Street Cleaning Operatives / Drivers

£21,795 - £22,995 Per Annum
We are looking for hard working, motivated, reliable people to join our team. Barnet (City/Town), London (Greater)
Recruiter: Barnet London Borough Council

Senior Infrastructure Design Engineer

£35,745 - £38,890 per annum
Do you want to work in an innovative, positive team that shapes and develops the places we live and work in? Telford, Shropshire
Recruiter: Telford & Wrekin Council

Sustainable Travel Delivery Specialist

£32,234 - £34,728 per annum
Are you passionate about Active Travel and Sustainable Transport? Telford, Shropshire
Recruiter: Telford & Wrekin Council

Highways Presents

Highways on Fridays

Register now!

Latest Issue

latest magazine issue

Also inside:

Big Interview: IHE President Stephen Webb

ADEPT Traffic Managers' Conference

Legal: JV or not JV?

View the latest issue

Latest Video