Jersey International Finance Centre - Ministerial Response - 13 January 2016

STATES OF JERSEY

JERSEY INTERNATIONAL FINANCE CENTRE: FINANCIAL VIABILITY (INTERIM REPORT) (S.R.7/2015) – RESPONSE OF THE MINISTER FOR TREASURY AND RESOURCES

Presented to the States on 13th January 2016 by the Minister for Treasury and Resources

STATES GREFFE

2015  S.R.7 Res.

JERSEY INTERNATIONAL FINANCE CENTRE: FINANCIAL VIABILITY (INTERIM REPORT) (S.R.7/2015) – RESPONSE OF THE MINISTER FOR TREASURY AND RESOURCES

Ministerial Response to: Ministerial Response required by: Review title:

Scrutiny Panel: INTRODUCTION

S.R.7/2015

11th December 2015

Jersey International Finance Centre: Financial Viability (Interim Report)

Corporate Services

The Minister welcomes the report of the Panel's expert advisers, EY. Their findings confirm  the  basis  on  which  the  Jersey  International  Finance  Centre  (JIFC) development has been planned and undertaken to date.

The Minister has difficulty in reconciling the findings and recommendations of the Panel's report with those of their expert adviser. For that reason, he is unable to agree with a number of the Panel's findings, or to accept 2 of their 3 recommendations.

The Minister would welcome further explanation and provision of evidence by the Panel to substantiate the conclusions they have drawn from their adviser's work.

In particular the Minister wishes to make the following points in his response –

• The  Panel  makes  much  of  comparing  the  States  of  Jersey  Development Company's (SoJDC's) delivery of the JIFC development with how the private sector  would  have  approached  a  similar  project.  To  do  so  displays  a fundamental  misunderstanding  of  the  purpose  of  SoJDC. The  Company's purpose is to act as the delivery vehicle for property development for the States of Jersey, and in so doing, to deliver socio-economic benefits for the Public of Jersey, where land or existing developments are no longer required for States purposes. P.73/2010 clearly set out that the company would deliver regeneration projects within development plans approved by the Regeneration Steering Group. The purpose of SoJDC is not solely to deliver profit, in the same way as a private developer appraises and delivers projects. It lends consideration to the wider and longer-term economic benefits to the Island of its projects, in a way that a private developer would not be required to do. In order to safeguard the interests of the taxpayer, the company operates a risk mitigation process that requires the costs of construction for each building to be covered by legally binding pre-let agreements – that being the value of the completed building with the level of initial pre-let will exceed the value of the borrowing. This is the case with Building 4, and will continue to be the case for all buildings within the JIFC. The phased approach was recognised in the Minister Planning and Environment's revision to the Masterplan in 2011.

• It is interesting to note that the first item in the Panel's terms of reference for their review is "to consider whether the 2008 Masterplan for the Esplanade Quarter continues to represent the best socio-economic value to the States of Jersey on behalf of the Public of the Island." Paragraph 2(a) of those terms of reference requires an assessment of whether the Minister for Treasury and Resources has undertaken "an up to date assessment of the benefit to the Island of the proposed Jersey International Finance Centre". The Panel would appear to have lost sight of these socio-economic benefits when publishing its interim report. The Minister considers that the wider benefits of the JIFC, whilst difficult to quantify, far outweigh the simple profit calculations relating to Building 4. He considers that more weight could have been given to the evidence from, for example, Jersey Finance, of the need for Jersey to remain an attractive destination for the world's mobile financial services businesses and to invest in infrastructure. Ernst and Young, in the Executive Summary to their report, clearly agree with this view. They state –

• "we also consider that this weak profit performance is not a reason alone to not proceed with the development"; and
• "we believe it is appropriate to embark upon this first step, largely as a catalyst to the commencement of this regeneration project which is so important to Jersey".

• These statements indicate their understanding of the Minister for Treasury and Resources'  position  that  the  success  of  the  JIFC  development  cannot  be measured through profit alone. The wider benefits to the future of the Island are  incalculable;  the  potential  consequences  of  not  proceeding  are unthinkable. It is impossible to say whether a private developer would have proceeded with the development of Building 4 at this time, although other developments in the vicinity are visibly proceeding. Such a debate is of little benefit, given that SoJDC are, in any case, proceeding in accordance with their required risk mitigation measures, which mean that sufficient pre-lets have  been  secured  to  fund  construction  costs.  They  are  also  required  to proceed with the significant obligation to provide public realm and parking that a private developer would not have to consider. The development sends an important signal of the Government of the Island's commitment to the future of its most important industries, whilst minimising financial risk to Islanders. The Minister is disappointed that the Panel is not able to recognise and support the development as an investment in the future of all Islanders, not just those working within financial services. Scrutiny has a vital role to play in the Island's government and its views, quite rightly, influence the opinions of States Members, interested parties and the Public alike.
• The Minister welcomes properly researched and evidenced scrutiny of the exercise  of  his  powers  and  responsibilities,  and  is  hopeful  of  further constructive dialogue with the Panel to move towards a shared understanding of what an exciting and pivotal innovation the JIFC represents in the Island's history. Most jurisdictions would embrace and offer enthusiastic support for Government-led  intervention,  carried  out  with  minimal  financial  risk,  to safeguard future jobs and standards of living for all inhabitants. The Minister will always have regard to the work of the scrutiny function, but he and the Council of Ministers are absolutely committed to the importance of the JIFC.

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FINDINGS

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RECOMMENDATIONS

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CONCLUSION

The Minister is fully supportive of the Scrutiny function. It is therefore uncomfortable for  him  to  be  unable  to  agree  with  the  majority  of  the  Panel's  findings  and recommendations. This response should be contrasted with the appended response to the findings of the Panel's expert advisers, EY. Their findings are clearly evidenced and are accepted. It is the conclusions drawn by the Panel from that work that the Minister is unable to clearly understand.

The JIFC development has been subject to an unprecedented level of public scrutiny. The Minister would welcome the opportunity to work collaboratively with the Panel on an approach which would alleviate the concerns expressed by a section of States Members and the Public in general. The Minister is entirely satisfied that he has sufficient evidence that the JIFC development is of direct financial benefit to  the taxpayer and the Public. The wider economic benefits to the Island are incalculable, and  the  risks  to  the  Island's  most  productive  industries  of  not  proceeding  are unthinkable. If the Panel's remaining work on this subject serve to better inform the Assembly and the Public that the development is not only desirable but essential, then the Minister is pleased to contribute to that process.

APPENDIX

EY REPORT EXECUTIVE SUMMARY Findings  Comments

1  The masterplan for the  Agreed;  however,  it  should  be  noted  that

Esplanade Quarter was  Jersey's  economy  is  improving,  and  having adopted in 2008 at a time  cumulatively lost 19% on its GVA levels since when the commercial outlook  2007, last year (2014) saw a 5% increase.

and market expectations in  There  is  significant  pent-up  demand  for  new Jersey were very different  Grade A  office  accommodation  in   St. Helier , than they are today.  having  had  very  little  new  space  delivered

during  the  recession.  There  is  currently c. 300,000 sq. ft.  Net  Internal  Area  (NIA)  of new build office under construction. The level of pre-lets and construction which has occurred since April 2014 exceeds pre-recession activity.

Furthermore, the residential property market is also  showing  marked  improvement,  with  the number of property transactions  back to pre- recession  levels,  and  the  average  value  of property exceeding the 2008 high for the first time (reported in Q3 2015 House Price Index).

2  SoJDC are about to embark  Agreed.

upon a phased' development  The Esplanade Quarter Masterplan provides for of Phase 1 of the Quarter,  a mixed-use development of 1.1 million sq. ft. namely by the construction of  of  NIA.  The  primary  uses  include  office Building 4 providing  (620,000 sq. ft.),  residential  (290,000 sq. ft.), 68,173 sq. ft. of Grade A  and  visitor  accommodation  (130,000 sq. ft.). office accommodation.  Phase 1  will  deliver  up  to  470,000 sq. ft.  of

office accommodation in 6 standalone buildings on the site of the existing Esplanade Surface Car  Park  (in  accordance  with  the  revised Masterplan).

SoJDC is carrying out the development on a building-by-building basis in response to known demand,  and  is  only  commencing  the construction  of  a  building  once  a  significant level of pre-let is achieved.

3  We are instructed by the  Noted.

Scrutiny Panel to provide  [Please note my reading of EY's Statement of advice upon the viability of  Work (Appendix A of its report) did not limit Building 4 and to comment  the instruction to the viability of No. 4 JIFC and upon the implications which  this  may  have  evolved  during  their our conclusions may have for  appointment.]

the remainder of JIFC and

also for the Esplanade

Quarter proposals as a whole.

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4  As part of our work, we have  Agreed.

received information from

SoJDC which is

commercially sensitive and

necessarily confidential. The

Scrutiny Panel has agreed

that, in order that we may

receive this important

information, we may enter a Non-Disclosure Agreement

with SoJDC. This was

exchanged on 15 July 2015.

5  Consequently our analysis  Noted.

contained in this report,

whilst informed by this

confidential data, does not

disclose any of this

confidential information. It is important to note that this

confidential data alone has

not driven our conclusions

which are also based upon our

findings in relation to the

office market in Jersey.

6  For example, we refer in our  Noted.

analysis to tenant incentives  [We note that the report sets out, on pages 24 which could be agreed to  and  25,  that  the  rent-free  element  of  the secure tenants. In reality our  incentives  provided  on  37 Esplanade  ranged analysis only allows for rent  from 9 to 15 months. On page 47, EY details free periods which in our  that  Rent-Free  of  18  to  24 months  has  been view would be representative  allowed for within its valuation of No. 4 JIFC.] of the market.

SoJDC has publicly disclosed that it will hold Therefore, should it be  these  office  buildings  for  3 years  after  the

necessary to correlate our  completion of the build. This will ensure that all analysis with the actual  rent-free  periods  are  wound  out,  and  that situation, it will be necessary  SoJDC benefits from any uplifts at first review. to obtain this direct from  There  is  nothing  uncommon  about  this SoJDC.  strategy – Dandara has now held 37 Esplanade

for  at  least  24 months  since  first  occupation.

SoJDC will have to bear the interest costs of

holding the building for 3 years; however, the

rental stream that  will flow on expiry of the

rent-free  periods  will  exceed  the  cumulative

hold  cost  and  any  other  incentives  that  JDC

may have given.

7  For the avoidance of doubt,  Noted. However, EY has reflected its position

our analysis of viability does  in the full knowledge of this information which not represent the actual out- it received having signed a suitably enforceable turn as will be experienced by  Non-Disclosure Agreement.

SoJDC in terms of actual

profit. This can only be

achieved by a direct

correlation with the data held

by SoJDC which is

necessarily confidential from

the public domain.

8  We detail below and in the  Noted  (statement  of  fact –  no  further

body of our report the  comments).

outcome of our analysis

together with our

observations and conclusions.

It is important to appreciate

that we have not carried out

an audit of the actual costs,

both incurred and proposed,

for the scheme.

9  Given that there remain costs  Noted.  In  accordance  with  SoJDC's

which are material to the  Memorandum  of  Understanding  with  its viability of the scheme which  Shareholder,  the  Minister  for  Treasury  and are either unresolved or  Resources,  and  P.73/2010,  SoJDC  provides confidential in nature, we  quarterly updates to the Minister, and  covers would expect that SoJ, as sole  both progress and viability of the Company's shareholder of SoJDC, ensure  projects.

that they are fully briefed

upon the potential impact of

these matters through their

normal channels of

communication.

10  We assess the gross  Noted  (statement  of  fact –  no  further

development value of  comments).

Building 4, net of purchaser

costs (i.e. reflecting the

anticipated sale price),

assuming a stabilised rental

profile (i.e. all rent frees

washed' through) of

£32.65m. In other words this

is our view of the potential

price at which the building

could be sold once complete

and fully income producing.

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11  This assumes full rent  Noted. SoJDC's position is that the value of the

received of £2.428m per  building should be based on an investment yield annum, i.e. £34 per sq. ft.,  of  6.5%.  This  yield  is  supported  by  BNP and an investment yield of  Paribas Real Estate and DTZ.

7%.

12  Assuming the fourth and fifth  Noted. SoJDC's position is that there will be no

floors are pre-let with the  letting void on Practical Completion.

equivalent of 24 months rent  Based  on  SoJDC's  projected  figures  for  rent free with the remaining floors  and  yield,  it  considers  that  No. 4  JIFC  will leasing up between  generate  a  net  return  (profit  and  land  value 6 to 18 months post practical  combined) of £7.5 million.

completion, all with 18 month

rent free agreements, we

calculate that the

development will return a

profit of £3.04m. This

represents a return of 12.04%

on costs incurred, and

specifically assumes that the

site is contributed at zero

cost.

13  Our analysis provides  Noted.

sensitivities to this outcome

varying the investment yield

and the leasing voids.

14  You will note that we have  Noted. These views on yield are not only those

also provided an analysis of  of SoJDC; BNP Paribas Real Estate (SoJDC's the potential profit based  letting agent) and DTZ (on behalf of HSBC) upon the views which have  also conclude that a yield of 6.5% should be been expressed by SoJDC,  achieved.

namely a lower yield of 6.5%

and assuming the building is

fully let on completion.

15  Although we do not agree  Noted.  The  most  significant  variable  in  the

with these assumptions, they  valuation of an office building is yield.

do demonstrate that if the  SoJDC and its letting agent, BNP Paribas Real building was fully let prior to  Estate, conclude that the standard of design and completion (with tenant  specification coupled with blue chip' tenants, incentives of 18 – 24 months)  these buildings should deliver a yield of 6.5%. and the investment is then

saleable at a yield of 6.5%, an  A yield of 6.5% has also been concluded by acceptable profit including  DTZ in its independent Red Book Valuation for site contribution would be  the Funder of No. 4 JIFC, HSBC.

delivered.  A half a percent shift in yield would have the

effect of adding around £3 million to the value of No. 4 JIFC.

16  This demonstrates the upside  It is the view of SoJDC and its letting agent

potential as suggested by  BNP Paribas Real Estate that this high-quality SoJDC although in our view  and unique development will be an attractive it does not fully reflect the  investment  proposition  and  that  the  Jersey likely outcome based upon  market is improving, with more inquiries from the evidence of current  investors.

market conditions.  The  same  level  of  yield  was  also  adopted

completely  independently  by  DTZ  in  its valuation for HSBC.

17  That said, we also consider  Noted and supported.

that this weak profit

performance is not a reason

alone to not proceed with the

development.

18  We believe it appropriate to  Noted and supported.

embark upon this first step,

largely as a catalyst to the

commencement of this

regeneration project which is

so important to Jersey.

19  This presupposes that SoJDC  Noted. SoJDC has publicly disclosed that it will can demonstrate that the  hold these office buildings for 3 years after the scheme will deliver at least a  completion of the build. This will ensure that all profit or no cost to SoJ.  rent-free periods are wound out and that SoJDC This will require their  benefits from any uplifts at first review. There disclosure to their shareholder  is  nothing  uncommon  about  this  strategy –

of an updated viability review  Dandara has now held 37 Esplanade for at least focused on Phase 1A –  24 months since first occupation. SoJDC will have to bear the interest costs of holding the

Building 4 above, taking  building for 3 years; however, the rental stream account of the effect upon  that will flow on expiry of the rent-free periods profit of any rent free or  will exceed the cumulative hold cost and any equivalent tenant incentives,  other incentives that JDC may have given. The both agreed and proposed  SoJDC projected £7.5 million return, therefore

together with due allowance  includes for all tenant incentives.

for all known and planned

costs of delivery.

20  In particular at the time of  The EY report included a contingency of 2.5%

this report being finalised  on  construction  costs.  The  EY  report  also SoJDC had begun site  included  a  greater  finance  cost  and  greater excavation works. It has  marketing  costs  than  incurred  by  SoJDC. become clear that additional  Following  cost  confirmation  to  date  on  the and unbudgeted costs are  excavation  works  and  decontamination being incurred to  processes, SoJDC's cost projections are that the decontaminate the site. Our  additional costs associated with dealing with the analysis makes no allowance  legacy  site  contamination  will  be  contained for environmental issues. It  within  the  EY  total  cost  allowances  with  no follows that, once established,  further impact on the EY profit level.

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this will further reduce the profit from the scheme below that which we have indicated above and detailed in our analysis which follows.

21  A contingency allowance of  SoJDC has entered into a lump sum JCT Design

2.5% is included in our  and  Build  construction  contract  on  a  fully appraisal but we believe that  designed  and  specified  scheme  with  <1% this should not be absorbed in  provisional sums.

its entirety for the purposes of  Any call on the residual contingency is likely to allowing for the cost of  be very minimal, and it is therefore absolutely decontamination given that  appropriate to allocate this contingency to the these costs, whilst  unknown  costs  of  dealing  with  the  legacy unbudgeted, are now partially  contamination.

known.

22  We also believe that it is  Noted and supported.

reasonable to plan for the

development of Building 5 to

follow as this will complete

the frontage to Castle Street.

23  However we would strongly  The JIFC is being undertaken on a building-by- advise that a review of both  building basis in response to known demand.

the JIFC proposals and the  This  significantly  reduces  delivery  risk  and wider Esplanade Quarter  ensures  the  construction  work  is  only

masterplan be undertaken.  progressed if a particular building is viable. This must not be at the cost of  There  is  significant  pent-up  demand  for  new the current phase but rather to  Grade A  office  accommodation  in   St. Helier , achieve a balanced and  having  had  very  little  new  space  delivered commercially based review of  during  the  recession.  JDC  is  in  contact  with the wider scheme.  20 prospective  tenants  with  a  total  space

requirement  of  325,000 sq. ft.  Indeed,  since

starting construction, JDC has received direct

enquiries from 6 new prospective tenants.

The Minister for Treasury and Resources would not  wish  for  a  review  of  the  Masterplan  to impact the delivery of Phase 1 of the Esplanade Quarter (namely the JIFC), and should a third or indeed a fourth office building be proven to be financially viable, the Minister would support SoJDC in its progression.

Whilst the Minister for Treasury and Resources does not disagree with the recommendation, any review of the Esplanade Quarter Masterplan is a matter  for  the  Minister  for  Environment  in conjunction with the Council of Ministers.

24  In addition, if the cost of site  The costs of remediating the site and dealing

decontamination proves to be  with  the  legacy  contamination  issue  will  be a disproportionate cost to  known shortly, and SoJDC has confirmed that developing the wider scheme,  based on known and projected figures to date, then the alternative of  these costs will be contained with the total cost capping the site and  figures used by EY in assessing the viability of developing ground and above  No. 4 JIFC.

should be explored as a more

realistic and cost effective

solution.

25  There are currently proposals  Masterplans are flexible, living documents and

to sink the road beneath the  will  no doubt  develop and change  over time development which we  (particularly  as  it  is  predicated  that  the consider to be commercially  Esplanade Quarter will take around 20 years to unrealistic and arguably a  deliver). The DTZ/C&W Red Book Valuation, burden upon the whole  combined with the costs forecasts provided by project. The associated public  SoJDC, suggests that the JIFC would provide realm, including the creation  the  financial  wherewithal  to  complete  the of landscaped amenity areas,  current masterplan proposals to lower La Route should also be considered in  de la Libération and carry out all of the public the context of a revised  infrastructure  associated  with  Phase 1  (the masterplan of the wider  JIFC),  should  this  continue  to  be  the  States scheme.  Assembly's desired outcome.

That is not to say that alternatives could not be assessed; however, this would be a matter for the  Minister  for  Environment  in  conjunction with the Council of Ministers.

26  An updated review of the  [Agreed/Noted].  A  review  of  the  Masterplan

masterplan with more  could  assess  the  alternative  approaches  to economically deliverable  achieving the linkage/connectivity which could objectives should achieve  be delivered in a more cost-effective manner, most of the original aims  thereby  enabling  States'  access  to  the whilst retaining the prospect  development receipts as early as 2020. These for the generation of  receipts  could  then  be  put  towards  other surpluses which the SoJ could  regeneration  projects  in   St. Helier  and  other apply to capital projects  States capital projects.

elsewhere on the Island. A  A review of the Masterplan is a matter for the key to this will be releasing  Minister for Environment in conjunction with land for residential  the Council of Ministers.

development, probably to the

south side of La Route de la

Liberation, much earlier than

will be currently possible and

to achieve the linkage of this

to the JIFC/car park site by

other means than the very

costly lowering of the road.

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