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Scottish Government private finance schemes to build public projects are secretive, give too much power to companies outwith Scotland and may not deliver value for money, according to an expert critique.

Leading independent economists, Jim and Margaret Cuthbert, are calling for a major review of the Scottish Futures Trust (SFT), the government body that runs the schemes. There are “serious concerns” about how the whole system operates, they say.

The latest official data suggests that SFT now oversees £7.6 billion worth of investments covering the building of 42 hospitals, schools, roads and other projects across the country. Most of the secondary schools cost over £100 million each.

According to a detailed analysis by The Ferret, five large corporations dominate and profit from the investments made on behalf of taxpayers in one major SFT programme. Four of them – Galliford Try, Tetragon Financial Group, Morgan Sindal, and Amber Infrastructure Group – don’t have headquarters in Scotland.

SFT private finance projects are already being investigated by Audit Scotland and the Accounts Commission to see if they represent value for money.

In a joint investigation with The Guardian last December, The Ferret revealed that five projects had blasted a £932 million hole in the Scottish Government’s budget, after a change to accounting rules.

Now, the Cuthberts have written a 41-page report for the Scottish Labour Party criticising SFT projects for risking the kind of excessive profits that private finance initiative (PFI) schemes – previously used by Conservative and Labour governments – were condemned.

The report highlights evidence suggesting that some interest rates, and hence private profits, may be “unduly high”. Freedom of information requests have revealed that some lenders are charging interest rates of 10.75 per cent, about four times higher than the rate charged for public sector projects by the Treasury-owned Public Works Loan Board.

The companies involved in building, financing and maintaining the first phase of a major redevelopment of the Royal Edinburgh psychiatric hospital will earn £116m between 2016 and 2042, on a project which cost £38m to build. Its biggest partners are one of Germany’s largest commercial banks, Norddeutsche Landesbank, and the property company Galliford Try.

The Cuthberts warn that the dominance of corporations from outwith Scotland could restrict growth and deprive smaller Scottish companies of construction and maintenance work. “This potentially has adverse implications for innovation and growth in the Scottish economy,” they say.

The Scottish Government has “inadequate controls” over the operation and scrutiny of SFT activities, the report also argues. “The development of SFT has been accompanied by a hollowing out of procurement expertise in the public sector.”

Jim Cuthbert was chief statistician at the Scottish Office when he retired in 1997 and Margaret Cuthbert an economic consultant with Strathclyde and Heriot Watt universities. They have both worked with the 35-country Organisation for Economic Co-operation and Development and written more than 280 papers for academic journals, parliamentary reports and independence-supporting publications.

In a joint statement to The Ferret, they pointed out that “hub” companies set up to run schemes for SFT are not subject to freedom of information law. “This effectively puts the operation of the hub programme beyond adequate scrutiny,” they said.

“But the situation is even more unacceptable because the terms of the original contracts under which the hub companies are set up were designed so that aspects of their activity would, in effect, be within the operation of freedom of information.”

They added: “Secrecy makes it impossible to tell whether the financing costs of hub projects are unduly high, but circumstantial evidence suggests that this is indeed the case. Overall, concerns raise serious doubts about the extent to which the hub initiative is actually achieving value for money.”

In 2016, The Ferret sought a determination from the Scottish Information Commissioner on whether SFT hub companies were subject to freedom of information law. The commissioner ruled that they were not.

According to the Cuthberts, the high costs of paying for SFT schemes in the future would make heavy demands on the public sector. “It does not appear that the risks of over-committing against these income streams are being adequately managed by the Scottish Government, putting future levels of public services at risk,” they said.

“Overall, the SFT now is a very different animal from what was originally envisaged when this type of body was first being thought of. Given the concerns identified in our research, the time is now overdue for a general review of SFT’s purpose and operations.”

The Cuthberts were backed by Mark Hellowell, a senior lecturer in health policy at Edinburgh University who has studied private finance schemes. He pointed out that since the financial crisis in 2009, Scotland had become the main market for private finance schemes in the UK.

“The SNP has repackaged the old PFI schemes and made cosmetic changes but the projects run by SFT are basically the same, with some of the rougher edges smoothed off,” he said.

“The Cuthberts lifted the lid on PFI and showed that it was poor value for money, so it’s great that they are now turning their attention to SFT projects.”

The new report is being launched at a press conference today in Holyrood by Scottish Labour. “We need an independent, root and branch review of how the Scottish Futures Trust operates, given the scale of the problems uncovered by this report,” said the party’s economy spokesperson Jackie Baillie MSP.

“The current approach is cloaked in secrecy, but we know there are serious questions about future funding. As it stands it looks like the government has maxed out the credit card without knowing if it can afford the repayments.”

The SNP counter-attacked by calling on Labour to apologise for its “dreadful” PFI legacy. Schools and hospitals signed off by Labour with a total capital value of £4bn will cost the public sector £22bn in repayments, the party said.

SNP MSP Ivan McKee added: “In the relatively short time since SFT was established it has achieved a cumulative total of almost £1 billion in independently-verified savings and benefits.”

The Scottish Government pointed out that the cross-party finance committee concluded last year that the SFT had helped improve the efficiency and effectiveness of infrastructure investment in Scotland, leading to better value for money.

A government spokesperson stated: “SFT delivered £146 million of savings and benefits last year. Since being established, it has achieved a total of £923.7 million in savings and benefits.”

The SFT stressed that it used a wide range of financing approaches to enable local investment. “This has included using local authority borrowing to build 2,000 affordable homes, and to finance the growth accelerator in Edinburgh that has catalysed the £850m redevelopment of the St James Centre,” said an SFT spokesperson.

“Where project finance is used, it has been secured on significantly better terms than historic deals, thereby improving value for money. EU rules mean that public bodies cannot choose where companies they work with are headquartered, but we can seek to maximise local employment and this has been very successful in securing thousands of local jobs.”

How the money leaves Scotland

A exclusive analysis of the accounts of hundreds of companies in the SFT’s hub network shows that five large private firms influence – and benefit from – the investment local taxpayers make in new schools and health facilities throughout Scotland. Four of the firms are based outwith Scotland.

What are Scottish Futures Trust hubs?

The Scottish Futures Trust – an arms length agency of the Scottish Government – has divided the country into five territories. Each territory has a dedicated hub company, or “hubco”, that involves local public sector organisations working in partnership with each other and a private sector partner.

The hub company packages up groups of smaller capital projects – such as primary schools or heath centres – in a bid to attract better rates of corporate finance and achieve economies of scale.

New public facilities are built using a so-called non-profit distributing (NPD) model, which like their PFI predecessors, involves a single Design, Build, Finance and Maintain contract.

Despite the name of the model, private investors in NPD projects are able to profit from their involvement. As a Scottish Government briefing explains: “It is important to note that the NPD model is not a ‘not for profit’ model. Contractors and lenders are expected to earn a normal market rate of return as in any other form of privately-financed deal.”

There is evidence that the new model has worked to control some costs.

Private finance projects delivered under the previous PFI regime typically involved taxpayer payments equivalent to 5.4 times the initial capital value of the asset. Under the SFT’s hubco programme, average repayments fell to 2.6 times the initial capital value of the asset.

Since the hub structure was set up around 2010, Scottish Government data confirms that over £2 billion of investment, has either been undertaken or is in the pipeline.

The hubco websites often appear as equal partnerships, but in reality the private companies have control. The private partner companies are given exclusive rights to develop projects within their territories for 20 years. They have a 60 per cent equity share in their hubco.

At the same time, each public sector partner can have an equity stake as small as 1.7 per cent in their local hub.

The private control is important as it means that the borrowing that is undertaken to fund the capital costs of building new infrastructure is kept “off the public sector books.” But as the Cuthberts’ report notes, it also gives private investors influence over how hubcos operate.

Although each building project is tendered separately, our analysis shows that the corporate hubco partners often have a relationship with at least one of the primary contractors in their territory.

These so-called “tier one” contractors hire the myriad of smaller firms that are involved in the design, construction and maintenance of public buildings built through the hub programme, taking a management fee in the process.

Importantly, the private sector hubco partners are also entitled to at least 60 per cent of the subordinate debt offered by each project it undertakes.

Although most of the debt finance for any particular project is funded through senior debt which the SFT says attracts a rate of interest of around four per cent, a proportion of each project is also funded through subordinate debt. This is the risk capital, and potentially the most profitable debt to hold.

Freedom of information requests by The Ferret have shown that subordinate debt in hubco projects attracts a much higher interest rate of about 10-11 per cent. This is a figure which the Cuthberts’ report suggests could be lucrative for companies.

There is even some evidence from SFT documentation that the subordinate debt can be sold on at a profit – even before the risky pre-construction phase of a project has been completed.

Our analysis also confirms another claim the Cuthberts make, as it shows that a small group of companies, the vast majority of them based outwith Scotland, stands to capture a large proportion of this profitable subordinate debt because of their close relationship to the hub projects.

The key companies

Middlesex-based Galliford Try has a controlling stake in the South East hub. It also has 50 per cent stake in the corporate partnership that controls the North Hub and a minority stake in the South West hub.

The firm own Morrison Construction, which is also a tier one contractor to the South East Hub, the North Hub and the South West Hub. It therefore has a significant influence over the South East hubs and interests in two others.

Tetragon Financial Group also has financial interests in more than one hub. Through a complex network of companies in its Equitix subsidiary, it has the largest corporate stake in the SouthWest Hub, and a minority stake in the North hub. A subsidiary firm is a tier one contractor in the North Hub.

Tetragon Financial Group is based in the low tax jurisdiction of Guernsey.

Morgan Sindal, based in London, has 90 per cent of the equity in the company that controls the West Hub. It is also a tier one contractor to the West Hub, and has a significant influence over projects in that area. It is a tier one contractor in the adjacent South West hub too.

The East Central Scotland Hub is the only one where a majority of the corporate partner equity is controlled by companies in Scotland. Nevertheless, London-based Amber Infrastructure Group has a 42 per cent stake in the private firm that leads the East Central Scotland Hub.

The same group also operates as the fund manager for another Scottish Government infrastructure fund – The Scottish Partnership for Regeneration in Urban Centres.

The Scottish Government argued that hub network enabled investment in public projects to be brought forward more quickly than would otherwise be available through capital allocation and borrowing. Future operational and maintenance risks were balanced between the public and private sector, the government said.

The programme was fully transparent and had been given “a clean bill of health” by Audit Scotland, it claimed. “We provide annual investment estimates as part of the draft budget process, and six-monthly updates to the Public Audit and Post Legislative Scrutiny Committee on the progress of projects,” said a government spokesperson.

“Projects worth around £2.4 billion have been progressed to date, creating and maintaining jobs and enhancing our infrastructure. Changes to the EU national accounts classification rules in 2014 resulted in changes to the budgeting treatment of projects but there were no additional costs to the taxpayer as a result.”

The Cuthberts’ report in full

After the report was published, the chief executive of the Scottish Futures Trust, Barry White, responded on 19 October 2017 with this email.

The Cuthberts replied on 23 October with this email.

This story was updated on 18 October 2017 to include comments from Scottish Labour and from the Scottish Futures Trust (SFT), and on 23 October to include a detailed response from SFT and a reply from the Cuthberts.

An initial version said that Tetragon Financial Ltd had a minority stake in the South West hub and the largest corporate stake in the North hub. In fact the reverse is true, and the story was amended on 18 October to reflect this. The story also originally said that senior debt on hubco projects typically attracted an interest rate of five per cent, based on an estimate in the Cuthberts’ report. This was changed on 22 October 2017 to reflect SFT’s view that the rate was four per cent.

Reporting by Rob Edwards. Additional research, interactive charts and photo by Ally Tibbitt. This story is part of a continuing investigation into the Scottish Futures Trust by The Ferret in partnership with the Guardian.