The ministry of defence's UK Military Flight Training System (UKMFTS) scheme is being hailed as a landmark project, bringing to market for the first time the "integrator" model - signalling the future of the maturing PPP market.

The future success of this groundbreaking new model, showcased in the £635 million (US$1.25524bn) UKMFTS project, has led to it being considered for a number of other major infrastructure projects in the UK and overseas.

The project will provide training from the basic level in schoolrooms right through to flight simulation, and then actual flying hours.

The "integrator" model is where a single entity, either public or private, is responsible for bringing together a series of sub services (including both project finance vehicles and public asset and services) to work towards a cohesive outcome.

The scheme relies heavily on partnering and the UKMFTS team developed an innovative partnering evaluation methodology and partnering model, which has been cited as a new model in HM Treasury's report  - Infrastructure procurement: delivering long-term value  - that was published in March.

The loose nature of the deal allows sufficient flexibility for future packages to be inserted as and when required to meet the needs of the UK armed forces.

The framework allows this to be done incrementally with individual project finance deals being added at a later date, with different contractors and financial institutions.

Colin Exford, team leader of MLA Royal Bank of Scotland (RBS), describes it as "one of the UK's most complex PFI/PPP structures".

Drivers/Rationale

One of the drivers for the government to prioritise this project is that air power is key to the UK armed forces, and without trained aircrew of sufficient numbers and quality, airpower will be restricted - with severe consequences for the military.

UKMFTS is expected to address concerns raised by the National Audit Office (NAO) in its 2000 report  on fast jet training, in providing a modern integrated flight training solution to provide aircrew to meet the needs of the front line.

The PFI route was considered appropriate for the simulator acquisition because of the MoD's track record in closing seven previous simulator PFIs. For future packages, PFI will be used if it provides VFM.

The MoD wished to preserve the benefits secured in each of its previous synthetic training PFI deals, while securing a step change in PPPs by contracting for design, integration and incremental acquisition services, not suited to a simple PFI construct.

In respect of simulators, this is a mature market - however the "integrator" model is new and it has taken time to get both bidders and bankers comfortable.

Background

Between November 2002 and June 2004 the project was at the "convergence" stage, which included discussions and papers between industry and MoD to develop and clarify the basis on which the project would be tendered.

This is itself a novel process for the public sector and was developed by Ian Mawdsley of the MoD and Owain Ellis of Partnerships UK (PUK).

It ensures that the ITN (invitation to negotiate) issued is on market in its key areas and saves time and expense for industry bidders. This is noted by the Office of Government Commerce (OGC) as "best practice" and was used to inform recent guidance on competitive dialogue (CD) procurement.

In March 2005 the ITN was issued and by November 2006, Ascent - a 50/50 consortium of Lockheed Martin and VT Group - was selected as preferred bidder. Financial close was reached on 30 May 2008.

The losing two bidders that also made it to shortlist were:

• Thales
• Bombardier and Halliburton-KBR consortium

The deal that was put to the market in 2005 remains intact, and the MoD team continued to innovate on the key features of the model - as regards to credit quality and termination.

One of the challenges to overcome in getting the project to financial close was the creation of a "wrap direct agreement", which ensures funders of each of the sub-packages get what is due.

Bankability depended on avoiding any cross-default or cross-contamination risk between the sub-projects and this became a crucial part of the UKMFTS "integrator" concept.

A critical aspect of UKMFTS's success is the novel approach to termination which ensures that the contractor is fully accountable for performance of all parts of the service that they own and control, while funders are afforded protection from cross default as a result of failure of other parts of the structure.

Should any part of Ascent's integrated service breach a default trigger, its whole UKMFTS structure (including all of its equity) enters a termination procedure similar to SOPC4, but lenders to non-defaulting funded packages can take comfort that their own contracts will be novated to Ascent's replacement (with a new equity holder), and will not be at additional credit risk.

The MoD maintains the operational risk manifested by the outcome risk of the right number and quality of students.

Project

UKMFTS will train all new pilots for the RAF, Royal Navy, and Army and the Officer and Aircrew Selection to the point when they can join front-line units.

The £635 million (US$1.25524bn) PPP contract included the first package of ground-based training (a simulator for the new Hawk 128 aircraft) that closed for £71.3 million (US$140.942m).

Further packages of training (ground-based and live flying and the associated aircraft) will be incrementally acquired up to an estimated total value of £6 billion as required.

The "integrator" model was conceived by Ian Mawdsley and Sue Dowdeswell of the MoD working with Richard Dyton and Kim Walkling of Simmons & Simmons, Tim Stone and Nick Hopkins of KPMG and Owain Ellis of Partnerships UK.

The project is ground-breaking in many respects, the first of which is that Ascent will be providing the overall training design, it will procure the assets required and deliver the training programmes of courses and classes - from chalk-and-talk to aircraft simulators.

Another aspect is that the aircraft for live flying training are likely to be provided via PFI-like sub-contract packages let by Ascent in competition.

Finally, Ascent takes outputs from the sub-contract packages, inputs into the training programmes and integrates them into a training service - and is rewarded for the successful delivery of training by means of a course completion and incentive fee.

Financing

The main innovation in the financing of the project is the upside-down nature of the funding, which does not involve an overall Finco, but requires funding at the sub-contractor/service provider level.

Funding goes in at the sub-contract package level - i.e. not to Ascent - to maintain competition on the funding of the later packages.

To make the project bankable given that the senior lenders have a private sector counter-party, the contract structure involves a "wrap direct agreement" that regulates and protects the distribution and credit quality of monthly payments via a trustee and a paying agent to relevant parties.

To incentivise the contractor to meet the outputs it has a layered payment mechanism which enhances the partnership but meets the needs of third party funders: it segregates risks to focus the contractor's incentives on each distinct part of their role, and embeds discrete PPMs closely aligned to PFI to ensure that third-party funded packages have risk allocations very similar to SoPC4 and which can be funded at PFI cost of capital. 

KPMG's role as financial adviser to the MoD was critical in structuring this aspect.

The key to the transfer of performance risk is a novel layered payment mechanism which at the lowest level resembles traditional PFI goes on to incentivise good overall design and ultimately working in partnership to meet the overall aims of the system.

The permitted competition of funding of future packages, and clarity in the pricing of increments is such that pricing of existing commitments would not be reopened at each step in the incremental acquisition programme.

The MoD required that financing included facilitated incremental acquisition without impediment from existing third party lenders, and permitted a liquid market retendering procedure at "integrator" level - in order to facilitate post-default survival of commercial construct.

The first two would be excessively difficult through a single funding facility which grew with incremental acquisition.

The initial increment has demonstrated that there is liquidity for funding well structured PFI deals, and future packages structured similarly to that for the SPV should be similarly attractive to funders.

Conclusion

Given the complexity of the structure and the degree of separation of the funder from the authority, the financial close of this deal is a success. The MoD and Ascent were able to reach agreement on a range of complex issues and obtain funding from RBS.

While market conditions are tight, this demonstrates that there is still an appetite for good quality projects when the participants on both the purchase and provider side have good credit ratings and a track record in delivery.

The innovative nature of the project means that there were a number of challenges to be met in deriving the exact mechanics of the deal.

The UKMFTS project provides a whole new model, the "integrator" - for complex procurement, in terms of providing:

• a clear and unified contractual framework which allows for future growth and development
• a contracting structure which gives funders the necessary security over payment whilst still permitting competitive incremental acquisition, a contractual foundation for a partnering relationship which is clearly defined and incentivised via the payment mechanism

In terms of replication of the "integrator" model, possible applications exist within defence and has possibilities in health, transport and other sectors - both in the UK and overseas.

It could be considered for any substantial transformational infrastructure-based service programme that seeks to preserve the fundamentals and risk allocation discipline of PFI.

It is particularly suited to conditions where, as a result of the extended duration of change, and need to integrate a number of interconnected, but fundamentally discrete, sub-projects, simple PFI is not fit for purpose.

Ian Mawdsley, said: "I have on my desk Frank Lloyd Wright's [US architect] quote that goes - 'to be a man is to be a non-conformist'.  UKMFTS has occupied seven years of my life and every concept has had to be derived from scratch and sold to a wide range of stakeholders, bidders and funders.

"This is the product of a team which has worked long hours and overcome some seemingly insurmountable challenges. Financial close is only the end of the beginning, but I believe we have put in place a framework that has the potential to continue to provide the UK with the best military flying training in the world.

"The integrator model and work we have done in partnering will, I believe, be of significant benefit to future public sector procurement." 

The project at a glance