Given the tone of initial Government statements, most in the market hoped that this would herald a new and robust pipeline of privately funded infrastructure development in the UK.

Given the guidance’s mandatory 18-month window between appointment of a preferred bidder and financial close, it is also anticipated that this new guidance will shorten procurement timetables, but only time will tell if this discipline has the desired effect.

It is not clear to what extent the new PF2 guidance – if at all – will apply to deals already in procurement, as there is no indication in the new guidance that any existing deals will be affected.

However, there have been suggestions in the press that the PF2 guidance is likely to apply first to the new raft of education projects and a proposed 2,000-inmate prison that the Ministry of Justice is developing, but which is still yet to find a home. Given that the education sector has, over the last few years, been the test-bed for many developments in the market, it is anticipated that PF2 will be rolled out first in this sector.

The key changes

So what do we conclude from the significant degree of consultation that took place and new guidance that resulted? Negative comment has been uncharacteristically muted, and confined primarily to those organisations that have derived their returns from direct equity investments and their ability to extract additional returns from restructuring projects or from sales of equity interests in PPP projects.

The extent to which this new guidance will affect participants in the PF2 market will depend very much on the role that each party performs (whether as a lender, equity investor, subcontractor or other).

The new guidance incorporates a number of developments that have occurred since SOPC4 was first released in 2007, so in this respect the new guidance is merely a consolidation of recent developments since then.

A number of chapters – for instance those relating to competitive dialogue, commitment letters, financial robustness of projects and boilerplate provisions, and so forth – have actually been deleted and the guidance is now far more focused on that areas that in recent years have been the focus of most criticism by politicians and scrutiny by the media.

Most refreshingly, the Treasury has done more than simply pay lip service to the principle that risks should be borne by the party best able to manage or absorb the particular risk – in key areas, the Treasury has taken back risks whose transfer to the contractor was never truly considered to represent good value for money.

However, the final category of changes relating to shareholding structures and equity funding will not only make it more challenging to extract significant equity returns from the holding of shares in these projects and from prudent management of long-term risk, but will also allow for greater public sector scrutiny and transparency, in a way not previously seen in any other PPP market.

The Treasury has been very clear that this last category of changes is meant to be a step-change (rather than merely a evolution) in the way that the private sector should participate in public infrastructure in future.

The changes that have been made to the previous guidance (as encapsulated within SOPC4 and sector-specific standardised documentation) can be classified in two ways:

• changes to the way in which PF2 deals will be structured in future; and

• changes to the terms on which PF2 deals will be carried out.

Structural changes to PF2 deals

From a sponsor’s point of view, the most significant change – and the change that has attracted most media attention – is the involvement of public sector capital in project vehicles.

A new Central Government Unit (CGU) located within HM Treasury is expected to make an equity investment in projects equivalent to between 30-49% of all shareholder capital. This capital will be priced at a market rate and will have the same rights as any private sector investor in the project. In order to avoid potential conflicts of interest, the equity will not come from the procuring authority, but will be invested and managed by the CGU on a commercial basis.

Secondly, it is intended that each project company holds an equity funding competition after its appointment as preferred bidder, in order to encourage longer-term equity investors, such as pension funds, to participate in UK infrastructure developments. It is also anticipated that all investors (the CGU, the development sponsors and the institutional equity investors) will invest a proportionate amount of subordinated debt in each project.

These two key proposals have attracted more criticism than any other of the most recent innovations, particularly as the combined effect of these developments is likely to be further delays to procurement timetables, and increased development costs for sponsors. These developments will also significantly reduce the equity shares that the original sponsors can hold , reducing the financial appeal of such infrastructure projects to many sponsors. We have yet to see whether the likes of John Laing, Innisfree and others in the same position will change their focus going forward.

Treatment of shareholder rights

Rather ambitiously, Treasury is already carrying out pre-consultation discussions on the development of a standardised shareholders’ agreement, to be used on all PF2 projects. Treasury will need to tread cautiously in this regard, as each equity investor in the past has had its own preferred form of shareholder agreement which is typically tailored to the respective shareholdings of the initial sponsors and bespoke to each consortium.

In the event that the standardised shareholders’ agreement does not adequately take into account the needs of all relevant equity investors, or if the form of agreement is too prescriptive, it is likely that private sector investors will leave the practical control issues (such as pre-emption, tag along and drag along rights, etc.) to be dealt with in a separate shareholders’ agreement higher up the corporate chain.

According to the current PF2 guidance:

• It is anticipated that there will be three separate classes of shares held respectively by the CGU, the developer sponsors and third party equity

• There will be tag along rights for the benefit of the CGU

• The SPV’s board will be comprised of six directors, two from each class of equity investor

• Decisions of the board will be made by a simple majority vote, with the chairman not having a casting vote

• There will be limited reserved matters for the protection of the CGU and the current guidance, in this respect, seems sensibly restrained

• The CGU may also appoint an observer to the board with no speaking or voting rights (it suggests that this observer will be a representative of the procuring authority or a local representative).

It is this final requirement that we believe could prove difficult to manage, particularly where a project is under-performing or in default.

Contractual developments and PF2 risk allocation

The second class of change in the PF2 guidance relates to the contractual terms under which infrastructure projects will be carried out in future. Anyone involved in the UK infrastructure market over the last three years will recognise that the fundamental changes being made to the terms of PF2 deals correspond directly to the nature of the criticisms levelled at PPP deals in the past. These changes are a direct result of the consultations that the Treasury has held over the last 12 months in the UK and are summarised below.

New approaches to risk allocation. Over a period of many years, those involved in the UK infrastructure market have seen a concerted effort on the part of the public sector to push more project risk on to private sector sponsors and subcontractors.

However, the new PF2 guidance, rather refreshingly, recognises that the transfer of inappropriate risk to the private sector has merely led to such risks being priced in by sponsors, thereby adding to project cost without any real benefit to the public sector.

The new guidance reverses this trend and sets out a number of most sensible ways in which procuring authorities should be assuming risks that can be more efficiently borne or managed by the public sector. In particular, procuring authorities:

• Should warrant title to any sites provided to bidders

• Should make available all site surveys and ensure that bidders are provided with collateral warranties in respect of the survey results

• Are encouraged to warrant any relevant information which cannot be verified by bidders and should warrant the accuracy of such data

• Should consider sharing both latent defect risk and ground conditions risk relating to the relevant site

• Are encouraged to bear a greater proportion of any increased insurance costs during the operational phase

• Are obliged to bear all risks relating to general changes in law requiring capital expenditure during the operational phase.

Further guidance is provided in such areas as indemnity protection, the possibility of authorities effectively self-insuring certain risks, the management and calibration of payment mechanisms and the sharing of risks relating to utilities usage.

It is refreshing that many of the comments made by the private sector over the last ten years or so in relation to the treatment of project risks have now sunk in and the resultant effect should be a general reduction in operating costs and improved affordability. However, the absorption of these risks by the public sector may reduce the ability for well-managed contractors and developers to profit from careful management of such project risk in future.

Treatment of soft services One of the other significant changes in the PF2 guidance is that soft services are likely to be excluded from projects in future (with a limited exception being the custodial sector). It is anticipated that procuring authorities will provide many of the soft facilities management (FM) services that have been a core feature of accommodation-style PPP transactions in the past. These will be provided under the terms of shorter term contracts, with the PPP contractor only providing hard FM.

It is also suggested that a third category of services – minor maintenance services and elective services – might be the subject of call off arrangements and can either be provided by the contractor or by the authority, at the authority’s election.

As a result of the authority taking on responsibility for the provision of soft FM services, it is also acknowledged that the authority will need to be responsible for the provision of these authority services in accordance with an interface rotocol. The guidance also makes it very clear that authorities should bear all responsibility for the risks associated with the provision of these authority services in a way that authorities have previously resisted on PPP deals.

As the authority will be taking responsibility for soft FM services, the guidance also includes a mechanism for a discrete handover regime, to enable the transition from the construction phase through to full service provision.

The authority’s need for transparency and control In order to address a number of the criticisms levelled at PPP transactions in the past, the new PF2 guidance contains a number of wide ranging control and information rights in favour of the authority.

Given the level of competition between bidders in the UK infrastructure market and the desire over many years by the leading sponsors to protect information relating to their returns, margins and operating costs, these recent developments may be of concern, as they will have the intended effect of reducing the competitive edge for the leading PPP developers. Sponsors should be particularly aware of the following new provisions in the PF2 guidance:

• There are greater disclosure obligations on contractors with respect to share ownership and share transfers, which is presumably in response to the number of less public secondary market transactions in the past

• Contractors will also have far more onerous reporting obligations, which include obligations to report semi-annually on current and forecast levels of equity internal rate of return for the project company and for each shareholder separately; a duty to report on a wider range of information, including staff turnover, pay and disciplinary offences; and the need to produce regular updates on performance of the project, all of which may significantly increase the administrative burden on contractors

• A failure to provide these reports will result in payment deductions, and it is also notable that the Treasury will have the ability to directly enforce the reporting obligations against each contractor

• Sponsors will be required to produce a detailed transaction guide to each project within 20 business days after financial close (which will test even the most organised sponsors and advisers)

• There will be a greater use of customer satisfaction surveys and far greater rights of inspection and review

• Sponsors will be required to carry out efficiency reviews every two to three years, adopting a continuous improvement approach, with the majority share of any savings achieved being payable to the authority.

In addition to these increased levels of transparency and scrutiny, the procuring authority has also been given additional control over the way in which projects are operated on a day-to-day basis. For example:

• Contractors will be responsible for adhering to an employment and skills plan and strategy, as well as detailed equality requirements (of a type which has already been seen in other sectors)

• Contractors will be required to stick to an agreed planned maintenance schedule and the authority will have new rights to accelerate or defer maintenance obligations

• The authority will exercise greater scrutiny over life-cycle management and will be entitled to a share of any savings in lifecycle spending at the end of the contract term

• The authority will have more extensive step-in rights than has previously been seen on most accommodation deals

Not only will these additional obligations place a significant administrative burden on contractors, but it is also expected that these new provisions will test even the most organised authorities, which will need to employ additional resources in order to manage the information flow from PF2 projects.

The underlying message is that procuring authorities will be expected to play a greater role in the running of operational projects and cannot simply sit back and take a hands-off approach until payments are due.

New guidance In addition to the provisions set out above, the Treasury expects to release a standardised output specification and standardised payment mechanism for use on future PF2 projects.

The Treasury has also taken the opportunity to add in a new chapter on capital contributions by the public sector, which it expects may be used more frequently to address affordability constraints, to the extent that authorities have reserves available to meet capital costs of new projects.

The future of PF2

A significant amount of thought and consultation has taken place leading up to the publication of the PF2 guidance. It would therefore be disappointing if the work which the Treasury and other relevant authorities have carried out does not result in a far more active and vibrant pipeline of UK infrastructure projects.

From the author’s personal perspective, many of the reforms relating to risk allocation are long overdue and are a refreshing change to the way in which UK PPP deals have been structured in the past. However, some of the changes, which have been made in response to the perceived excesses of the last few years, seem more onerous or radical than may have been strictly necessary.

It is expected that sophisticated developers will already be looking at their own procurement and contracting strategies to align their approaches with this renewed government guidance and to ensure that they are best placed to capitalise on what should be a revitalised infrastructure market.

For those not already in the UK greenfield infrastructure market, the PF2 guidance opens up an opportunity for institutional equity investors to become involved in the next wave of UK infrastructure deals.