What is a private financing initiative (PFI)?
A private finance initiative (PFI) is a way to finance public sector projects through the private sector. PFIs relieve government and taxpayers of the immediate burden of finding capital for these projects.
As part of a private funding initiative, the private company manages the initial costs instead of the government. The project is then rented to the public and the government authority makes annual payments to the private enterprise. These contracts are generally awarded to construction companies and can last up to 30 years or more.
PFIs are used mainly in the United Kingdom and Australia. In the United States, PFIs are also called public-private partnerships.
Private funding initiatives and public-private partnerships
Understanding private finance initiatives (PFIs)
Private funding initiatives were first implemented in the UK in 1992 and became more popular after 1997. They are used to finance large public works projects such as schools, prisons, hospitals and infrastructures. Instead of funding these projects in advance from taxpayers, private companies are hired to finance, manage and complete the projects.
Depending on the type of project, PFI contracts generally last 25 to 30 years. However, it is not uncommon for companies to have contracts of less than 20 or even 40 years. The consortium provides certain services during the term of the contract, which was previously provided by the public sector. The consortium is paid for the work for the duration of the contract on a “no service, no cost” performance basis.
Businesses get their money back through long-term repayments plus government interest. Thus, the government does not have to spend a large sum of money at once to finance a large project.
The termination procedures are very complex, since most projects cannot obtain private funding without having the assurance that the debt financing of the project will be repaid in the event of termination. In most cases of termination, the public sector is required to repay the debt and take ownership of the project. In practice, termination is only considered as a last resort.
Examples of PFI projects
Many of the projects that are the subject of private funding initiatives are infrastructure projects that benefit the public sector. These include highways and roads, transportation projects such as railways, airports, bridges and tunnels. Private sector companies can also be hired to build water and wastewater facilities, prisons, public schools, arenas and sports facilities.
Key points to remember
- A private financing initiative is a way for the public sector to finance projects through the private sector.
- PFIs remove the immediate burden of project funding from governments and taxpayers.
- PFIs are removing the burden of finding capital for these government and taxpayer projects.
- Governments reimburse private companies over time with interest.
- PFIs are generally used in the United Kingdom and Australia. In the United States, they are called public-private partnerships.
Benefits of PFIs
Governments have traditionally had to raise funds on their own to finance public infrastructure projects. If they cannot find the money, governments can also borrow from the bond market, then hire and pay contractors to complete the job. This can often be very heavy, that’s where the PFI comes in.
PFIs aim to improve the timely completion of projects and also to transfer some of the risks associated with the construction and maintenance of these projects from the public to the private sector. Financial advisers such as investment banks help manage the bidding, negotiation and financing processes.
PFIs also improve relationships between the public and private sectors, while providing long-term benefits. Through this relationship, the two sectors can share their knowledge and resources.
Disadvantages of PFIs
A major drawback is that since the repayment terms include payments plus interest, the burden may end up being passed on to future taxpayers. In addition, arrangements sometimes include not only construction but ongoing maintenance after projects are completed, which further increases the future cost and tax burden of a project.
Private sector companies may not comply with relevant safety or quality standards when managing a project.
Criticism of PFIs in the UK
In the UK in the 2000s, a scandal surrounding the PFIs revealed that the government was spending much more on these projects than they were worth for the benefit of the private companies that run them and to the detriment of taxpayers. In addition, PFIs have been criticized as an accounting device to reduce the appearance of public sector borrowing.