The Scottish Government

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1. Executive summary

1.1. Introduction

This document is a strategic business case ( SBC) supporting the creation of a Scottish Futures Trust ( SFT) Initiative, whose delivery will be supported by a new SFT organisation.

The aim of the SFT Initiative is to support the effective planning, funding and delivery of public sector infrastructure investment across Scotland, providing a better deal for taxpayers as a result.

The SFT initiative will be supported by a new organisation established in the public sector, intended to have broad governance representative of central and local stakeholders in public sector infrastructure development.

SFT will commence its activities by:

• Establishing a significant projects review group as a first step towards better quality and more consistent assurance of large and complex infrastructure investments;
• Developing, with a broad range of stakeholders, national strategies for the delivery and funding of schools, housing, waste and flood defences;
• Commencing programme delivery of hub pathfinders, for community based infrastructure;
• Providing guidance, structuring and compliance for ongoing NPDPPP programmes;
• Undertaking further detailed development of innovative asset provision models;
• Commencing development/delivery of a Local Authority bond issue;
• Developing efficient and best value funding solutions, appropriate to individual sectors and projects, using combinations of expertise, NPD structures, programme based delivery models, hybrid funding structures, underpinning and aggregation.

1.2. Context

The proposal for the SFT Initiative has been developed in the light of a new funding relationship between central and local government, the recommendations of the McClelland report, and the drive across the public sector for shared services, to aid not only efficiency but quality of service delivery. Placing consideration of infrastructure investment and delivery into this context is a natural progression of the Government's wider efficiency agenda.

1.3. The Background to SFT

The genesis of SFT rests in a concept whereby the Scottish Government ( SG) would raise additional funding through the issue of public sector bonds, via a trust structure, securing funding at rates cheaper than PFI or PPP. Overall, this was intended to allow the delivery of more infrastructure per available resources.

At this point in time, progression of this solution for accessing additional investment directly by SG is not possible as Scottish Ministers currently do not have the constitutional powers to borrow. However, the SG scoping work in Autumn 2007 identified a number of potential areas across the public sector where the overall aim of the SFT initiative might be achieved through slightly different arrangements. In December 2007 Cabinet agreed to issue a public consultation exercise on that basis, and to commission a SFT business case.

The concept behind SFT was distilled into three principal aims in the Scottish Government's Consultation document of December 2007. SFT would:

• provide lower cost funding for projects and programmes than PFI;
• operate on non-profit distributing principles; and
• continue to provide the additionality of public service facilities investment in Scottish infrastructure through private sector investment.

1.4. Considering SFT as an Initiative: the key SBC Issues

The cost of finance is only one of many factors which determine the overall cost to the tax payer of delivering improved economic and social infrastructure. If the overall infrastructure need and associated impact on the supplier base is poorly planned, individual projects are late in delivery, unreliable, over-budget or expensive to maintain through their life cycle, it can create inefficiencies far outweighing any differential in cost of finance. In short, choices about finance are best taken alongside choices about infrastructure planning, delivery and management routes. The effective management of these inter-dependencies across public sector bodies is at the heart of the Scottish Government's strategy for sustainable and cost-effective infrastructure renewal and expansion.

The Scottish innovation of contracts tendered under principles of Non-Profit Distribution has already pointed the way in which the cost of finance can be reduced compared with PFI/ PPP alternatives and through SFT there is the potential to increase further the benefits of NPD. A core objective of SFT will be to pursue this and other routes to increased efficiency of finance, while maximising overall value for money for the tax payer.

For local government there is less constraint on their ability to borrow than central government. Through the Prudential Regime they can, and do, access funding via the Public Works Loan Board ( PWLB) or commercial lenders. So at a local level the pressing financial issue is less about access to capital, and more about the ability to repay any loans, in other words affordability. Hence at a local government level there is strong alignment with any proposals which drive efficiency to make available resources go further.

There is however always a risk that affordability is confused with "cheapest is best". Public sector procurement of infrastructure has, at times in the past, failed to meet public expectations due to the pursuit of short-term solutions which can carry the unwelcome consequences of false-economies - for example, through the construction of assets that whilst cheap to build are expensive (and so unaffordable) to maintain, or assets which are built with insufficient financial provision for ongoing maintenance and renewal and which steadily fall into disrepair as a result. A crumbling 1960's schools building stock is perhaps the most visible illustration of these points.

An important objective of the Scottish Government is to break decisively with this past and to create through SFT a means by which not only will scarce public sector investment finance to go further but, equally importantly, long-term reliable, affordable and good quality infrastructure will be produced. A key role for SFT, therefore, will be to strengthen public sector capability in infrastructure planning, procurement and delivery though the provision of expertise and financial resources which are focussed on best value outcomes, both at the level of individual projects/procurements and also at the level of entire public sector programmes of investment. The use of approved standard form contracts and quality control reviews for key procurements are two examples of the kinds of initiatives already taken by the Scottish Government that SFT will be expected to take forward and embed in the mainstream of infrastructure delivery in Scotland.

In addition, SFT will be expected to take forward government priorities in relation to reducing carbon impact of public sector capital investment.

So, whilst borrowing constraints at a national level, affordability pressures at a local level, and the original objective of optimising funding costs for infrastructure investment have remained core issues in the development of the SFT proposal, these are now seen as only part of a much broader efficiency agenda, scoped to support the drive for improved and best value infrastructure outcomes.

Therefore, in this SBC the case is made for a SFT Initiative, underpinned by the establishment of a new organisation, based primarily on the twin drivers of;

• future infrastructure requirements, and;
• opportunities identified for improved efficiency and effectiveness in infrastructure planning, funding and delivery.

1.5. Infrastructure Need

Infrastructure is regarded as an important plank of national economic growth and accordingly the Government's Economic Strategy recognises the importance of investment in Scotland's economic and social infrastructure. This importance is reflected in the Scottish Budget which has allocations for a capital investment programme, of £3.26 billion, £3.58 billion and £3.66 billion in the three years to 2010-11. In addition, there is spend planned by Local Authorities of £1.2bn over the same period.

Scotland's infrastructure needs are clearly laid out in the Scottish Government's Infrastructure Investment Plan. There are defined and committed resources in place up to 2011: beyond that however the needs are understandably less well defined, although in some sectors there is forward planning available that captures the aspirations for new infrastructure over a horizon of up to 15 years.

Over a 10 year horizon the infrastructure investment requirement is estimated to be close to £40bn.

1.6. The Opportunities for SFT to Support Efficient Infrastructure Investment

Against the backdrop of an infrastructure investment requirement over 10 years of circa £40bn, the need and potential for efficiency in planning and delivery are self-evident.

In this SBC the opportunities for a SFT initiative to improve the efficiency of infrastructure investment have been explored under two main "pillars" of infrastructure investment:

i. Efficient funding;

ii. Effective investment planning, procurement and delivery.

Efficient funding in this context means optimising the best funding solution for any given situation; this may mean use of public capital, private finance, or a combination of the two. SFT could, for instance, co-ordinate the issue of a municipal bond on behalf of a group of Local Authorities. SFT may also use its own risk capital where appropriate. In seeking to deliver the most efficient and best value infrastructure investment, SFT should seek to ensure that any investment is realised through use of the optimal procurement, funding and delivery solution.

Effective investment planning, procurement and delivery means that SFT will be seeking to strengthen public sector capability across the spectrum of infrastructure investment to help achieve cost effective, high quality and sustainable public services.

Through taking a national overview, robust planning and targeted management of investment, and dealflow, SFT will seek to strengthen the private sector response to investment and delivery opportunities, driving improved competition from the supply side, therefore activating an important driver for value and efficiency.

SFT, through its roles in due diligence and delivery support, will be seeking to ensure that key infrastructure projects and programmes are being scoped, governed and managed to the highest standards. To put such activity into perspective, currently a 6 month delay (a fairly common occurrence) on an accommodation project of say £100m capital value, regardless of procurement or funding route, will cost the public sector approximately £3m as a result of construction inflation ¹ alone. This is just one illustration of the significant value in effective and efficient planning, procurement and delivery.

Taken over an annual national investment programme (central and local government) in excess of £3.5bn, the justification for improved public sector support is self-evident.

1.7. Developing Concepts to Support Efficient Infrastructure Investment

The exploration of ways in which the SFT Initiative can meet its objectives has captured many individual ideas and concepts, all with the common denominator of efficient infrastructure investment, or "additionality". These ideas included the original SFT concepts, ideas brought forward during the SFT scoping phase, suggestions made in response to the consultation, as well as other possibilities identified by the SFTSBC delivery team. ². These concepts, were grouped under three headings:

• Private investment outwith controlled public expenditure (as PFI/ PPP has been)
• Private investment within public expenditure
• Efficient planning and delivery

1.8. Private Investment Outwith Controlled Public Expenditure

In tackling any means of providing additional private investment, as well as the constraint of vires, the forthcoming UK change to the International Financial Reporting Standards ( IFRS) currently planned for 2009 must be fully assessed.

The assumptions on IFRS forecast in the earlier scoping work still require clear definition and the delay of a year in implementation of IFRS may actually postpone clarification of the impact of IFRS on future investment options.

However, one conceptual idea has been developed which aligns with the Government's developing policy thinking, which may provide scope for private investment into health and education outwith public expenditure limits. This concept in outline suggests provision of assets is facilitated via a sponsor entity which is an organisation with a genuine reason for alternative residual use of the assets created on its behalf and is itself a private sector classified body, e.g. provision of schools accommodation by a University or hospital accommodation by a medical faculty. Turning this concept into a successful model will rely heavily on the role of SFT, policy leadership and cross body support within the public sector.

Other areas regarded as having the potential to offer private investment outwith public expenditure limits are from the use of the hub initiative ³, by careful structuring of residual waste projects, or from private sector investment in housing via Registered Social Landlords .

The Scottish public sector also has assets which at present are not used either as collateral for funding purposes, or which might offer potential in terms of further growth in value if developed.

1.9. Private Investment within Public Expenditure

The review of scope for efficiency in private investment within public expenditure has demonstrated potential for effective SFT activity, particularly in relation to reducing the cost of funding whilst maintaining risk transfer to private sector suppliers and funders. Aggregation of demand, conduiting structures and Government underpinning (or guaranteeing) a portion of senior lending have all been explored.

A public sector, grouped Local Authority bond has also been considered. This would be possible because of the borrowing powers of Local Authorities ⁴. Precedents suggest ⁵ that with careful structuring and favourable market conditions, it may be possible to achieve funding close to the levels of PWLB rates, but with the additional benefits for project or programme delivery that come with the rigour of bond finance and private sector management.

1.10. Efficient Planning and Delivery

The efficient delivery agenda is relevant to SFT at two levels:

• there is scope for organisational efficiency in the public sector, supporting;
• improved investment planning, development and delivery of projects, and programmes, perhaps utilising SFT risk capital, as well as streamlined and strengthened quality assurance.

The broad scope and sample of SFT activity outlined above does not necessarily set the boundaries for SFT activities in the future, it does however provide a platform to support its establishment. In the longer term it is envisaged that SFT will develop and respond to the needs generated by the requirements of ongoing infrastructure investment. Additionally were constitutional arrangements to change, then other activities would of course become possible for SFT.

1.11. The Proposal for SFT

The proposal made in this SBC is to deliver the SFT initiative by the creation of an organisation which has the mandate, expertise and access to risk capital which will enable it to improve the way the public sector in Scotland plans, procures and delivers its infrastructure investment. SFT will occupy the (currently vacant) role of being the focal point of joined-up public sector action in infrastructure planning and investment, aiming to capture the bulk buying power of infrastructure investment in Scotland.

In addition, SFT:

• Will work in partnership with other public organisations to be the developer, deliverer and supporter of individual programmes; such as hub, waste and schools;
• Will be tasked to deliver a diverse set of sophisticated procurement/ contracting/financing tasks;
• Will provide the engine room, implementation team, skills retention platform, toolkit provider and corporate memory of Scottish infrastructure investment.

SG's consultation on SFT made clear that its governance should reflect the parts of the Scottish public sector which have an interest in infrastructure delivery. Such broad governance may not be practicable in the immediate development stage proposed below, but would if introduced in due course place SFT in a unique position from which it will be well placed to capture the value inherent in the bulk buying power of Scottish infrastructure investment. One method of collating such broad governance would be an Infrastructure Board for Scotland, chaired by the Cabinet Secretary for Finance and Sustainable Growth, and which would form the oversight board for SFT.

Equally the value of private sector expertise is recognised and the proposal for SFT includes private sector investment and participation in a new SFT Finance and Investment organisation.

1.12. Organisational Efficiency

It is clear that there are many different bodies across the public sector taking an interest in infrastructure planning and delivery, yet it is a fragmented and confusing picture. In commodities procurement positive steps have been taken to drive overall efficiency through the establishment of the Procurement Reform Board, yet this streamlining and aggregation approach has not yet been reflected in infrastructure investment and procurement. Therefore this landscape presents both need and opportunity. Need to simplify and thereby strengthen the public sector approach to infrastructure investment, and opportunity, to find ways to streamline, to share best practice, and to make best use of expert and scarce resource. The creation of the SFT initiative, supported by a new SFT organisation can provide both the catalyst for organisational efficiency (de-cluttering of the landscape), and the platform on which to build simpler, streamlined and more effective planning and delivery of infrastructure investment.

1.13. SFT Organisational Form

There were a number of "givens" in developing SFT's organisational form, as were stated in the Government's SFT Consultation Paper:

i. Although SFT may be private sector classified, it had to have an embedded public sector ethos;

ii. It had to adopt NPD principles.

At this juncture the core constraints of vires, EU procurement, State Aid and accounting treatment have to be considered carefully in relation to organisational and corporate form.

Adopting the "form follows function" approach, and taking the givens and core constraints into account, the approach to developing the organisational form for SFT was to build it around the core functions/ activities identified for SFT. These functions suggested that the business activities of SFT fell into two distinct camps: SFT as an investment planner, quality assuror, developer or deliverer of projects/ programmes, and SFT as finance arranger and/or investor in projects.

Reflecting the different nature of these business activities, the impact of the core constraints cited above, and taking into account the views expressed in responses to the SFT consultation led to the proposal to split SFT into two organisations, with key elements retained within the public sector;

• SFT Development and Delivery ( SFT D&D) sitting in the public sector, and;
• SFT Finance and Investment ( SFT F&I) (subsequently) sitting in the private sector, likely to be a Joint Venture between the public sector and private sector investors, possibly constituted as a Limited Liability Partnership (and probably to be Financial Services Authority regulated).

The organisational structure suggested for SFT is set out in Figure 2 below. This diagram also indicates the requirement for further detailed work and development, and therefore a longer gestation period, to establish SFT F&I. It will be one of SFT D&D's objectives to take forward the formation of SFT F&I.

Figure 1. Proposed Organisational Structure for SFT

1.14. Added Value of SFT

A new organisation must necessarily be subject to rigorous budgeting and monitoring of its own cost-effectiveness. Accordingly, a decision to proceed with SFT will trigger development of a detailed business plan against which the performance of SFT can be measured.

At this stage, some preliminary estimates of costs and target benefits of the SFT initiative have been made which will allow a decision to establish SFT.

SFT estimated costs are based on a combination of set-up and running costs (set-up over a 2 to 3 year period). The assumption is that SFT is a small, high value added organisation, starting with less than 10 core staff, and perhaps increasing through the establishment of SFT F&I over 3 to 4 years to having 20 staff. Where workload outstrips capacity then it is envisaged that SFT would operate a flexible resourcing model; drawing on available resources within the public sector, or commissioning work from the advisory community.

At this early stage the potential quantifiable benefits of the SFT Initiative have primarily been based on targeting efficiency savings across the infrastructure investment programme. The scope for efficiencies rests in a combination funding, strategic forward delivery planning, strengthened procurements, and a programme approach to delivery, as has been explained above. It is not envisaged that SFT as an organisation will direct or control the whole infrastructure investment programme, rather SFT is an initiative to be supported by the whole public sector. The ability of SFT as an organisation to influence efficiency and financing cost savings will vary across sectors, however as an initiative spanning the whole infrastructure investment programme the potential benefits have been considered on a programme basis.

Following consideration of impact across the investment programme, and its key sectors, it is considered a reasonable aggregated target benefit is within the range of 3-5%. This target benefit will be derived from a Scottish investment programme of circa £3.5bn per annum, and approaching £40bn over 10 years.

Based on these assumptions, and recognising a lead-in period during 08/09 and 09/10, the targeted net benefit across the public sector could build to £100 to £150m per annum. Given the modest organisational structure proposed, this could reflect a benefit : cost ratio in excess of 20:1.

As part of the more detailed business planning stage for SFT the costs and benefits of SFT will be further refined. It is also expected that the SFT, by learning key lessons from previous PFI/ PPP contracts, will be able to maximise the benefit to the public purse.

1.15. Implementation of SFT

SFT as an initiative is envisaged as ramping up its activities over time, or via a development path, and this theme recurs as SFT as an organisation moves forwards in implementation.

As with any new body or venture which requires broad consensus from within the public sector, a great deal of time and effort will be required securing buy-in from all the public sector organisations affected by the establishment of SFT. Equally, infrastructure investment affects the private sector: funders, investors, contractors and advisers who all play crucial roles in forming the market and the machinery that delivers infrastructure. The consultation carried out December 2007-March 2008 offers a neutral starting point for securing broad support, but as part of the business processes of SFT D&D a detailed, ongoing consultation and communication plan will require to be developed.

The following implementation steps are recommended:

1.16. Conclusion

This SBC sets out a case for an SFT initiative supported by the establishment of a dedicated SFT organisation. It has considered the early aspirations for SFT, as well as the considerable potential for SFT to drive efficiency and add value - potential created by the ambitious plans for infrastructure investment across the public sector over the next 10 years.

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