At the heart of UK PFI is who provides what ? decided through a process of competitive tendering for projects. In theory this leaves bidders to come up with innovative and imaginative solutions designed to save the government money on the one hand, while delivering a high quality service coupled with the bidders' desire to maximise income.

In the case of healthcare this should translate into high quality buildings, which due to their quality of build and design will have low maintenance costs over the life of the contract. The profit incentive is an inducement to strict cost control, which often doesn't exist in the public sector. PFI has been applied across a wide section of the public services ranging from the military, to education, infrastructure and most controversially health and in particular the UK's National Health Service (NHS), a publicly funded entity. The NHS roughly falls within the heading of social expenditure and this accounts for over two-thirds of the UK government's annual expenditure. In cost terms this is an area where the government is desperate to curtail spending, whether it be the cost of building and equipping new hospitals or reducing the amount paid out in unemployment benefit.

The NHS has been politically controversial for many years. Daily horror stories appear in the UK media about overwhelmed medical staff fighting to keep the system going while patients suffer neglect. The previous Conservative government was accused of running the health service into the ground, while the current Labour administration is keen to be seen improving it.

?There is indeed a lot of upgrading to do in the NHS, there are lots of poorly designed hospitals dating from the 1960-70s. Others need replacing because they've been badly maintained and many are inadequate for modern healthcare requirements,? explained Glasgow-based Andrew Gordon, Chief Executive Officer of PFI developers Canmore Partners.

Also, changing demographics of an ageing population are requiring different types of hospitals and care.

As a means of insuring that the NHS is run in the most cost efficient way, the previous Conservative government divided the running of health service into NHS Trusts. These Trusts also have the responsibility putting out and administering tenders after first agreeing them with the NHS itself. However, bidding for these contracts tends to be an expensive and cumbersome process for the bidders. In some respects that reflects the nature of the projects: The building of hospitals for instance is considered to be more complex and demanding than for most types of public sector contracts.

?You're dealing with very specific and demanding clinical environments, which need to be understood and appreciated,? said O'Brien. In addition, the contracts tend to be all encompassing. A DBFO scheme implies not just the construction of a hospital but also the maintenance. ?You have many different types of services to consider and this can involve a lot subcontractors,? said Bristol-based Iain Fairbairn, a PFI legal specialist with solicitors, Masons.

Under such circumstances the lead contractor has to put a consortium together consisting of companies operating in completely different disciplines, whether it be the supply and maintenance of sophisticated medical equipment or cleaning services. ?With so many players involved there is also an issue of risk of default or poor service from the subcontractors,? added Fairbairn. ?So there is a lot of due diligence work to do.?

There are insurance policies available to offset some of the risk, but these mainly cater for changes in the political climate and not operational matters. Generally the subcontractors have to be financially viable in order to participate in these consortia. Also, the insurance market is still in a developmental stage and it is only increasing turnover from more PFI projects which will see a greater range of products developed at more reasonable prices.

Another issue that a bidder must consider is the cost of tendering for these contracts.

This can be at least £1 million, but can rise to as much £4 million in the final stages. These costs largely preclude smaller contracts.

A very large part of that expenditure is on legal work and advice, but then there fees for other professional services such as those of architects. In some cases professionals have been willing to do these services on a partly contingency basis.

Although bidding for PFI contracts, in particular some of those in the health sector, are expensive, there are nonetheless large benefits to be derived for the victorious contractor. Many of these contracts are for 25 to 35 years and are a guaranteed source of income. ?If the contractor has done his homework and has priced it correctly, these contracts can be profitable and a good source of continued income,? explains Fairbairn.

Although from the banks' point of view there has been some issues over the security of the income from the Trusts. The British government does not issue a formal guarantee saying that if the Trust can't meet its obligations then the Treasury will step and do so. Some argue that if it did, it could get PFI projects done more cheaply as the financing costs would be lower for the contractor.

But cost is not the only issue. According to Fairbairn, if the government issued a formal guarantee to the contractor then the financial outlay being put up by the private sector would show up on the government's books as a liability. This in turn would reflect in the government's outstanding financial obligations and would impede on its ability to stay within the Maastericht Treaty's confines governing GDP to debt ratios. ?The structure of these projects have to withstand the National Audit Office's tests for being classified as off-balance sheet items and must confer with accounting standards such as FRS5,? explains Lewes-based Mike O'Brien, managing director of healthcare contractor, Healthcare Group Ltd.

Another reason is that providing a guarantee could arguably defeat part of the purpose of PFI, which is to transfer risk away from the government onto the private sector.

So far no Trust has defaulted and bad Trusts have either been merged or the management has been changed. As far as contractors are concerned there have been no issues of non-payment due to financial insolvency of a Trust. ?Nobody really does any in-depth checking over the financial viability of these trusts as they are seen as implicitly backed by the government,? says Gordon.

Although the government is aware that a lack of explicit financial guarantees is disconcerting to some banks, it has nonetheless gone for a half way house solution. ?The Secretary of State issues a ?comfort letter' stating how important the project is to the government and so on,? says Joe Philips, a Director of PFI equity provider, Noble & Co. These comfort letters do provide some reassurance to those involved and there is a general perception in the industry that letting a Trust go bankrupt and default on its obligations to the private-sector is inconceivable. To allow such an outcome would be disastrous to the government's plans of involving the private sector in financing, building and modernising public infrastructure.

The real issue for potential contractors when looking to tender for a bid is the quality of the Trust's management. How capable are they of handling the bidding process? How likely is the project to go through, once the tender has been won? How much red tape is involved in the process and how fast or slow will the tendering process be?

Given the time and expense involved in these tenders, these are all very valid questions. Fortunately, through a process of trial and error, the contracts and the bidding procedures have become more standardised. For instance, it is highly unlikely for a project to be cancelled once it has got to an advanced bidding stage. In addition, the government PFI teams involved in putting out and managing the tenders have become more aware that by dragging out the process they are wasting both government time and money.

With many of the uncertainties gradually being resolved a significant market is beginning to emerge around PFI projects. Industry participants reckon there is some £2 billion of NHS deals being done with a further possible £15 billion in the pipeline. The latter figure is particularly difficult to estimate as the NHS's needs seem almost infinite and the number of projects is limited only by how much the government is willing to spend. UK banks, in particular Lloyds TSB, have been the first to back PFI as it is home territory. Now that it is becoming more established and better understood, foreign banks are becoming involved. Examples include Dai-Ichi Kangyo and Nomura Securities. PFI projects have a particular appeal to Japanese banks as they involve long-term loans along with a degree of security. However, a number of foreign banks that have been involved and have decided it was not for them; one of which was Netherland's Rabobank as well as a German Landesbank.

Generally a special purpose corporate vehicle is created to carry out and manage the project. Usually it is financially structured with up to 15% equity along with some mezzanine, with the balance being senior debt. Bonds are also becoming a more popular method of financing. According to Philips the senior debt bonds can command a spread of 90 to 120 basis points over LIBOR. ?I also expect to see many of the loans packaged into bonds and sold onto the market,? he adds. Gordon agrees and states that it is likely that many of the smaller PFI deals are likely to get parcelled into bond issues, therefore releasing capital for further projects. On some of the original PFI deals, the returns were considerable. Equity tranches have been earning annual returns of 12-16%, which is arguably high for low risk projects. However, low risk has to be defined in terms of default risk, which is very low. The real risk to the equity holder is inherent in the contractor's ability to fulfil the contract without serious cost over runs.

The government has naturally caught onto the fact that some of the early PFI deals were very profitable for the pioneers. However, this is changing fast as the market matures and competition intensifies. ?Getting the money is not really an issue. There are plenty of providers out there,? said O'Brien.

?Contractors are starting to put in much more competitive bids and therefore the return on equity isn't going to be quite so high,? said Philips.

For instance, Continental European contracts such as Bouygues of France have entered the market and are likely to put pressure on local firms such as Amec, John Laing and Costains. ?The Continental Europeans have quite lot of experience with these types of contracts and are going to be aggressive players,? said one industry source.

There is also more competition among the equity providers with around five to six, which are active in the UK market. This includes group Noble & Co, Edison, the Mill Group and Roche. ?There is certainly no shortage of equity finance,? says Philips.

It is beginning to look as if the government is gradually getting what it wants from PFI; and greater competition would insure that. On the other hand, the private sector is seeing diminishing political and contractual uncertainties, but will have to put greater focus on operational costs.

Competition insures ever diminishing margins for error. Both government and financiers therefore need to pay more attention than ever on the quality of participants in the various bidding consortia.