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Government-backed infrastructure schemes failed to meet UK Guarantees criteria, says watchdog

Privately financed infrastructure projects have won government financial backing despite failing to meet the Treasury investment criteria, a report from public spending watchdog the National Audit Office (NAO) revealed today.

Three of the first five schemes to receive government guarantees under the Treasury’s UK Guarantees Scheme had “non-investment grade” credit ratings, the National Audit Office (NAO) report reveals. These were the Drax biomass scheme, Sustainable Development Capital’s Energy Efficiency SDCL EE project and Ineos Grangemouth chemical facility (see box).

The UK Guarantees scheme was launched in summer 2012 to pump prime projects that were struggling to win the confidence of financial institutions during the economic downturn.

The first guarantee was issued in April 2013 and by December 2014 the Treasury had agreed guarantees worth £1.7bn, excluding interest, to seven projects, with a guarantee for one more on standby. A further 39 projects have prequalified for a guarantee. The NAO studied five projects – Mersey Gateway, Northern Line Extension, Ineos Grangemouth chemical facility, Drax Biomass and SDC EE – that had guarantees signed off between 2012 and August 2014.

Treasury’s criteria for UK Guarantees projects and key findings of the National Audit Office (NAO)

  1. Nationally significant, as identified in the government’s National Infrastructure Plan 2011 as updated from time to time.
    The Sustainable Development Capital’s Energy Efficiency (SDC EE) project failed to meet this criteria.
  2. Ready to start construction within 12 months from a guarantee being given and having obtained (or about to obtain) necessary planning and other required consents.
    The Northern Line Extension did not meet this criteria.
  3. Financially credible, with equity finance committed and project sponsors willing to accept appropriate restructuring of the project to limit any risk to the taxpayer.
    This was deemed not applicable to the Northern Line Extension project and SDC EE failed to qualify.
  4. Dependent on guarantee to proceed and not otherwise financeable within a reasonable timeframe.
    The NAO said there was insufficient evidence to say whether the schemes would have gone ahead or not without a guarantee. Previously NCE reported that Mersey Gateway, which has secured a guarantee of £257M, did not need the guarantee to enable it to go ahead.
  5. Good value to the taxpayer, assessed by the Treasury to have acceptable credit quality, no present unacceptable fiscal or economic risks and able to make a positive impact on economic growth.
    The watchdog has revealed that by the Treasury’s own credit risk rating – which is aligned to those of respected credit rating agencies Standard & Poor’s and Moody’s – rated three of the first five at “non-investment grade”

Promised guarantees have meant the Treasury was “in effect the second most active lender to new UK infrastructure projects in 2014”, according to a statement from the watchdog.

But it added: “The NAO found that the Treasury does not apply its eligibility criteria strictly, since it has not put in place objective tests to check whether projects genuinely need a guarantee.”

The watchdog lauded the Treasury for assembling an experienced commercial team and internal governance systems to measure and manage risks to the taxpayer but questioned the taxpayers’ exposure to risk. “The NAO does not […] have full confidence in the reliability or completeness of market benchmarks to measure actual risks to the taxpayer,” it said.

The report confirms engineers’ suspicions soon after the scheme’s launch that it would simply benefit projects that had already secured funding (NCE 6 September). One of the four key criteria states that projects should be “dependent on a guarantee to proceed and not otherwise financeable within a reasonable timeframe”.

A year after the guarantee scheme’s launch, Treasury announced it would be extended for two years until December 2016. UK Guarantees has £40bn total guarantees limit, excluding interest. Prequalified projects to date equate to £24bn, including £17bn that has been provisionally allocated to Hinkley Point C.

“The UK Guarantees scheme was introduced as a response to tough financial market conditions for infrastructure finance,” said NAO head Amyas Morse. “Market conditions are now much less difficult but the scheme is still supporting lending for new infrastructure projects.

“The Treasury takes a narrow view that guarantees are value for money if the fee covers the risk. It is good that Treasury has a formal governance process and commercial specialists to help evaluate, manage and set a price for risks to the taxpayer.

“However, we question whether this approach can measure long-term risks to taxpayers reliably. As market conditions improve, the Treasury should ensure that it is rigorous and objective in ensuring that guarantees for projects are genuinely needed and that the projects supported bring significant public value.”

Box: National Audit Office key recommendations

  • As market conditions improve, the Treasury should ensure that its eligibility criteria for this scheme include a rigorous and objective assessment that guarantees are needed. This should be reviewed annually.
  • The Treasury must report to Parliament, annually, on the level of risk associated with guarantees. Guarantees transfer risk to the public sector.
  • The Treasury should develop an additional pricing methodology based on an appropriate capital charge to reflect the use of the national balance sheet and other costs associated with the scheme. The watchdog said that, based on approved schemes and projected take up until it closes in December 2016, the extra cost of using guarantees over direct lending could be between £35M and £120M a year.
  • The Treasury should ensure that the expertise within Infrastructure UK is complemented by expert challenge from outside Infrastructure UK.

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