Auditors and the Private Finance Initiative (PFI)

PRIVATE PARTY

Extract from Bean Counters: The Triumph of the Accountants and How They Broke Capitalism

Central to New Labour’s election victory was renouncing high taxes and committing to sound public finances. These twin new commitments were enshrined in a self-imposed limit on government debt. But the party had also distinguished itself from the Tories by promising to improve public services that had been starved of investment. This created a fiscal conundrum. How was the extra spending to be funded without extra borrowing? The answer was something called the private finance initiative (PFI), which had been devised by the previous government but used only to a limited extent for some road extensions and a couple of prisons. The new government would put all its infrastructure eggs in the PFI basket, no longer paying for major projects out of taxes or borrowings. Consortia of banks, construction companies and service providers would borrow the money, construct the school, hospital or other facility and then make it available to the relevant public service under a long-term agreement. The magic in the scheme was that the taxpayer’s commitment to pay fees for using the new infrastructure every year, typically for thirty years, would not usually count as government borrowing. The scheme would be ‘off the books’.

Under cautious government rules, such helpful accounting was strictly possible only if the taxpayer was not on the hook if the scheme went wrong. The Tories had accordingly insisted that the private companies bear all the risks of any deal, which had limited PFI’s appeal to the bankers and builders on whose involvement the scheme depended. So when he took office, anxious to deploy PFI for hospital- and school-building programmes, Gordon Brown set about making it more attractive to them. Under a special task force containing two consultants from Price Waterhouse and one from Coopers & Lybrand working on the all-important accounting, the rules were relaxed. 2

Private companies would be able to shoulder fewer risks, while the government would keep its essential off-the-books accounting. Not for the first – or last – time, the bean counters had written the rules of a game they would go on to play very profitably.

The other knotty problem was that, under a long-standing parliamentary principle, large projects could be signed only if they gave value for money. This was tricky when the price to be paid to the private PFI consortia had to include profits large enough to persuade them into lengthy deals and cover private borrowing costs, which were always higher than the government’s. PFI was inevitably far more expensive than the alternative of conventional government funding. To get over this hurdle, a series of spurious reductions would be applied to the sum of future PFI payments when comparing the cost of a proposed scheme with paying for it through government borrowing and taxation. Many were highly subjective, involving estimates of the likely costs of vague matters such as ‘operational risk’. Then there was an adjustment for ‘optimism bias’, on the soon-discredited assumption that traditional procurement ran significantly more over-budget than PFI. There was even a large discount for tax payments that the private companies operating PFI schemes would supposedly make but in reality did not. It was devised by KPMG at the same time as the firm was advising the PFI companies on how to avoid their tax liabilities. This usually involved treating the costs of building schools or hospitals not as an asset on the PFI company’s balance sheet but as an ongoing expense, which attracted greater tax relief. Many of the country’s largest new hospitals were thus taken off both the government’s and the PFI companies’ books, dispatched to an accounting fourth dimension. One Tory MP (and chartered accountant) taunted Gordon Brown with some justification that he had become the ‘Enron Chancellor’. 3

The fiddles achieved the desired result. Over Labour’s first two terms in government, more than 400 deals for infrastructure worth £25bn were signed (the figure now stands at about £60bn worth, costing £10bn a year for another generation). 4

The complex contracts required the services of financial consultants, almost always from KPMG, PwC, Deloitte or Ernst & Young, on each side. Public bodies such as NHS trusts or local education authorities, for whom each deal was a once-in-a-generation event, were especially dependent on their expert advice. The Big Four would ensure that their value-for-money calculations gave the ‘right’ answer and that they kept their scheme ‘off the books’. One accounting academic who advised the Treasury on PFI, later explained: ‘There became an industry in cosmetic presentation of projects.’ 5

A rich industry it was too, with fees for all advisers coming in at around £3m for an average contract, around half of which would typically go to one of the Big Four firms. 6

By 2014, the same academic reckoned that the Big Four had earned £1bn from the private finance initiative. Small wonder they had been so keen to push it in the first place.

Conflicts of interest proliferated, the bean counters often advising public bodies on signing deals with companies that were also their clients for auditing and consulting services. And with the government’s task force recommending ‘success fees’ for advisers, including the major accountancy firms represented on the task force, the incentive was to get the deal done. There is no trace of any advice that a scheme wouldn’t be such a smart idea. 7

Getting the contract through often involved blatant manipulation, with the cost of a PFI deal usually ending up just a few pounds better value than the publicly funded alternative. In one case reported by the National Audit Office public spending watchdog, a new £130m hospital at West Middlesex had at first appeared to be more expensive to build under PFI. But the trust’s adviser, KPMG, had convened a series of ‘risk workshops’ to identify some more convenient risks associated with the public sector alternative. Hey presto, the PFI deal came out slightly cheaper. 8

The accountancy firms naturally became highly protective of their new golden goose. When critics attacked the early hospital deals – on which financial engineering took precedence over design quality, and extra costs immediately led to fewer beds for the sick – New Labour’s friends at Arthur Andersen & Co. stepped in with a study, in 1999, concluding that PFI schemes came in cheaper than others. It was soon discredited, mainly because it ignored large cost escalations after schemes had been agreed but before they were signed. 9

The leading PFI consultant, PwC, rode to the rescue with another supposedly ‘independent’ report. It was no more than a summary of testimonials from officials who had signed PFI contracts and were not about to admit they had thrown the taxpayer’s money away. Yet it became an official endorsement. When Prime Minister Blair was confronted in Parliament in 2002 with PFI’s shortcomings, he simply referred his questioner to ‘the PricewaterhouseCoopers report on the PFI, which found that it was excellent value for money’. 10 It certainly was for the bean counters, who as so often were paraded as independent authorities on areas from which they were getting very rich.

Meanwhile, the holder of the national public purse strings, Gordon Brown, was ensuring that Whitehall’s biggest investment decisions would be taken by PFI consultants from the Big Four firms rather than civil servants who might be more circumspect. KPMG’s head of infrastructure, Dr Timothy Stone, a former physical chemist who moved into consulting through Arthur Andersen and was known by some as the ‘sage of PFI’, became especially powerful. He could be found variously in the Department of Health’s commercial directorate, at the education department advising on the schools rebuilding programme, on the government’s ‘sustainable procurement’ task force and as permanent adviser to the Ministry of Defence on the biggest PFI scheme of them all, a £10bn project for in-flight jet-refuelling aircraft. ‘I wear many hats,’ the KPMG man would later admit. 11

Special PFI units inside the key government departments across Whitehall were all handed to consultants on secondment from the Big Four. In 2005, PwC bean counter Richard Abadie took over the central Treasury PFI Unit for a couple of years, delivering a 30% growth in the number of deals signed. 12

A few years later, back running PwC’s private finance practice (and having been succeeded at the Treasury by a Deloitte bean counter), Abadie was summoned by a sceptical committee of MPs. Would he ‘be willing to submit some aggregate numbers for the amounts of money [PwC] have earned on PFI in this country over the last 10 years?’ asked one. ‘Probably not,’ replied Abadie. ‘I believe that is commercially confidential.’ 13
Just like the other accountants’ ramps, even if the public were paying a heavy price, PFI was a private affair.


DISASTER MANAGEMENT

In 2008, after a five-year delay, the jet-refuelling scheme on which KPMG’s many-hatted Dr Stone had advised eventually went ahead. It soon became clear that the 27-year Future Strategic Tanker Aircraft contract had lumbered the armed forces with overpriced planes that weren’t even fit for ‘high-threat areas’: something of a drawback in military aircraft. The fiasco prompted one of the National Audit Office’s most damning reports on a major public contract, complete with the ‘not value for money’ black spot. The deal, said the watchdog, had been struck ‘without a sound evaluation of alternative procurement routes to justify why the PFI route offered the best value for money’. 14
 Since KPMG’s top PFI man had been in charge, this wasn’t too surprising.

In 2010, the outcome was summed up by the chairman of Parliament’s public accounts committee at the time, Sir Edward Leigh. ‘By introducing a private finance element to the deal,’ he concluded, ‘the MoD managed to turn what should have been a relatively straightforward procurement into a bureaucratic nightmare.’ 15

Still, a ‘bureaucratic nightmare’ is a consultant’s dream, and with the taxpayer handing over £10m for ‘finance, tax and accounting advice’, once again the bean counters led by Dr Stone came out on top. Nor did the affair harm the head of the MoD’s PFI unit who had signed off the deal, Nick Prior. By the time the extent of the waste was exposed, he had stepped through the well-oiled revolving door between Whitehall and the PFI industry to be Deloitte’s ‘global head of infrastructure’. There he rejoices in the role of ‘lead client service partner’ for the Ministry of Defence. 16

Even with PFI and the big accountancy firms’ role in it largely discredited, the scheme remains another gift from the taxpayer that keeps on giving to the bean counters. When hospital trusts saddled with overpriced PFI contracts inevitably ran into trouble after a few years, the Big Four would be back on the scene selling remedies for the ill-effects of their own snake oil. By 2013, the biggest health PFI scheme, a £1.1bn redevelopment at St Bartholomew and Royal London, was eating up £120m a year of the trust’s budget, plunging it into a deficit of around £50m and forcing thousands of job cuts. In came PwC as ‘turnaround’ specialists, even though the same firm had advised the trust on signing the PFI deal in the first place seven years earlier. Back then, even the trust’s chairman had admitted: ‘If this was the private sector, you’d be in jail. This is what got Enron into trouble. It’s all off the balance sheet. It’s cloud-cuckoo land, Alice in Wonderland stuff.’ 17
Yet not only did PwC go on to earn fees for the remedial financial advice, they then sold the hospital a ‘sustainable operational efficiency and improvement programme’. While the hospital cut thousands of jobs, the firm was shortlisted – without irony – for a Management Consultancies Association award in the ‘performance improvement in the public sector’ category. 18

Across Britain, the bean counters continue to clean up from the financial mess left by PFI bills that will demand payment before doctors’, nurses’, teachers’ and armed forces personnel’s wages for another generation. In 2013, six years after PwC told Peterborough hospital that a £400m PFI scheme was ‘competitive, robust and demonstrate[s] value for money’, the public accounts committee labelled it ‘catastrophic’. By this time PwC was back in there earning £3m a year from telling the trust how to deal with the £45m annual deficit caused by the contract. 19

Up in Northumbria, Deloitte advised the trust running Hexham General Hospital on how to buy itself out of a financially ruinous PFI deal that KPMG had advised it on back in the late 1990s. So expensive had the contract turned out that the trust could pay the PFI company tens of millions of pounds in compensation and still save money. 20

PFI became a huge public sector money-spinner for the Big Four accountancy firms and played a key role in ensconcing them in Whitehall. Once inside, they began creating a more enduring legacy. It would go well beyond the bricks and mortar and into the transformation of public services themselves.


Notes:

2. The consultants on the PFI task force were Ben Prynn and David Goldstone from Price Waterhouse and Tony Whitehead from Coopers & Lybrand.

3. Hansard, 2 April 2003, Col. 285WH.

4. From PFI summary data published annually by HM Treasury.

5. Comments from Professor David Heald, Aberdeen University, in Radio 4 File on 4 programme ‘The Accountant Kings’, broadcast 4 March 2014.

6. Public Accounts Committee report, HM Treasury: Tendering and Benchmarking in PFI, 27 November 2007.

7. Treasury Taskforce Technical Note 3: How to Appoint and Manage Advisers to PFI Projects,
https://ppp.worldbank.org/public-private-partnership/sites/ppp.worldbank.org/files/documents/How%20to%20Appoint2017%20and%20Manage%20Advisers
accessed 9 March 2017.

8. The PFI Contract for the Redevelopment of West Middlesex University Hospital, National Audit Office, 21 November 2002.

9. Professor Allyson Pollock, then of the Centre for International Public Health Policy at the University of Edinburgh, produced a number of papers taking apart the ‘evidence’ of those linked to PFI schemes. A good summary of the flaws of the Arthur Andersen report can be found in her evidence to Parliament’s Health Select Committee on 14 April 2000, available at
http://www.publications.parliament.uk/pa/cm200102/cmselect/cmhealth/308/308ap30.htm; accessed on 16 September 2016.

10. Hansard, 30 January 2002, Col. 286.

11. Evidence of Dr Timothy Stone to House of Lords Economic Affairs Committee inquiry into Private Finance Projects and Off Balance Sheet Debts, 13 October 2009.

12. Based on 47 deals signed in 2004/5 and 61 signed in 2007/8, data from HM Treasury ‘current projects’ dataset.

13. Evidence to House of Commons Treasury Select Committee on Private Finance Initiative, 14 June 2011.

14. ‘Delivering the Multi-role Tanker Aircraft Capability’, National Audit Office, 30 March 2010.

15. BBC report, 30 March 2010, http://news.bbc.co.uk/1/hi/uk/8593788.stm.

16. Nick Prior, LinkedIn profile, accessed 16 September 2016.

17. Reported in Andrew Hankinson, ‘NHS Boss Dubs PFI “Alice in Wonderland stuff”’, Construction News, 22 September 2005, and in Private Eye magazine, issue 1200, December 2007.

18. https://www.mca.org.uk/library/documents/PI_Pub_-_PwC_with_Barts_NHS.pdf.

19. Public Accounts Committee report, Hinchingbrooke Health Care NHS Trust, Peterborough and Stamford Hospitals NHS Foundation Trust, 7 February 2013. The background to the 2007 signing of the contract given in report by Caroline Molloy on Open Democracy website, 19 September 2013, https://www.opendemocracy.net/ournhs/caroline-molloy/peterborough-hospital-nhs-and-britains-privatisation-racket; accessed 18 September 2016.

20. Gill Plumber and Sarah Neville, ‘NHS Trust Becomes First to Buy out its PFI Contract’, Financial Times, 1 October 2014.