Select Committee on Transport, Local Government and the Regions Appendices to the Minutes of Evidence

Further memorandum by Institute of Logistics and Transport (PRF 10A)


  The Secretary of State on 16 July 2001 instructed the SRA to concentrate on improving services within existing franchises, or by negotiating short two year extensions. This change to Government policy was seen essentially as the creation of a breathing space to permit resolution of the problems caused by Railtrack's then inability to progress and fund the enhancements which the SRA had previously linked to its long-term franchise replacement programme. The position is unchanged but, within that two year extension timescale, a new process must be found to resolve the impasse. Railtrack's successors must be properly organised and remunerated to allow and incentivise them (in the words of Railtrack's current Licence Condition 7) to secure the maintenance . . . renewal and replacement and . . . the improvement, enhancement and development of the network.

  A body or bodies, or perhaps an arms-length division, must be created to take forward major new projects and other enhancements to the network. If these changes have become effective by 2006, two years after the majority of the existing franchises are due to end, then the position will be effectively no worse than when the Secretary of State made his announcement in July. However a framework for the envisaged public private partnership between SRA and the private sector is urgently required to enable the preferred bidders for the South Central and SWT franchises to move forward with their plans for improving the network, stations and depots.

  Meanwhile, the SRA should bring forward and implement its programme of franchise extensions or (in some cases) replacement franchises. These should be progressed in parallel to the inevitable changes to Railtrack and should be designed to end the uncertainty about management of franchises and ensure that the expected benefits to the customer start to come through quickly. These include better performance, improved and new rolling stock, relatively simple enhancements to the network and attention to the industry's safety problems. The changes to safety reporting lines and institutions recommended by Lord Cullen could be brought forward to the same timescales. This programme requires new and invigorated leadership from both Government and the SRA to ensure rapid implementation. Hopefully, the programme will not require new primary legislation.


  The financial structure needs to be sufficiently robust for the successor to manage efficiently the risks which it is required to manage. There is a strong correlation between the structure and these risks—which we refer to in more detail below. The appropriate structure will recognise and should optimise the substantial cash flow derived from the taxpayer (currently approximately 60 per cent of Railtrack's revenue). The overall financial structure must itself be adequate and contractually robust for efficient private sector capital funding to be available. The structure should be capable of meeting the obligations of the successor, assuming that it is properly managed. The extent of those obligations will be determined within the existing legislative and contractual framework. Whether the successor will be required to fund and carry out enhancements to the network or to refinance them, or simply to operate, maintain and renew the network (as implied by the Mr Byers' statement to the House on 15 October) will need to be decided early on and will affect the choice of financing structure. We note that the SRA and the Department had formed the view some time ago that the balance sheet of Railtrack was inadequate for it to fund the considerable amount of enhancement needed but still minor enhancements were to remain with Railtrack.

  The question of financial structures is intimately linked with the question of ownership. The ILT is concerned that adequate consideration should be given to the range of possibilities. There are a number of models to be examined:

    (a)  public ownership. This, as has recently been discussed in the Institute for Public Policy Research (IPPR) publication, Building Better Partnerships, need not rule out the raising by the public corporation of private sector capital.

    (b)  continued private sector ownership. Given the apparent interest of the private sector in acquiring Railtrack's business from the Administrators, this route should not be ruled out.

    (c)  a public private partnership under which Government offers a concession through a competitive process (for perhaps 30 years) for the operation, maintenance and renewal of the infrastructure. The concession could be of the entire network or regional segments. The concession company or companies would be able to raise private finance from the capital markets and the cost of capital would reflect the government based revenues. The concept is not dissimilar to the London Underground PPPs and would enable Government to meet value for money criteria.

    (d)  a split of ownership from operation. The successor body could own the infrastructure and probably be responsible for capacity (path) allocation but contract the operation, maintenance and renewal functions to the dominant franchise group for each region or line of route. Those groups would raise capital from the capital and debt markets.

    (e)  not for profit organisation: as proposed by the Secretary of State the successor could be established as a "not for profit" organisation, such as a company limited by guarantee. If the membership were to be appointed and removed by the SRA, this organisation would have some characteristics of a publicly owned corporation although capable of becoming insolvent. The key difference from models (b)-(d) would be that the primary motivation of managers would be to provide efficient public infrastructure rather than to make returns for shareholders. There would be no shareholders' equity and therefore no requirement for revenue to fund a return on equity.

  ILT is cautious about the "not for profit" proposal because, unlike both public sector corporations and public limited companies:

    —  there is little experience of how well such organisations will attract high calibre management and run efficient operations;

    —  unlike Welsh Water, the successor body will effectively be at the beginning rather than at the end, of a very substantial investment cycle, a significant difference if the successor is to be responsible for part of the enhancements;

    —  again, unlike Welsh Water and indeed all the other regulated utilities, the successor will be substantially dependent upon government subsidy;

    —  the different stakeholder interests represented amongst the members are likely to lead to compromise rather than clear direction;

    —  the members would have no direct financial stake in the business.

  We wish to stress that whichever form of private sector entity is chosen the successor's cost of raising finance on the debt and capital markets will be affected by the degree of government support of its cash flows available (as has been made clear by Standard & Poors, the credit rating agency). What is more, the perception of the risk profile of the successor eg the state of the infrastructure and the safety obligations of its operator, will probably make it very difficult for the successor to raise private finance without a considerable element of government guarantee or alternatively government finance effectively equivalent to equity. Failure to provide such support, given the amount of taxpayers' money involved, would affect value for money.


  The relationship between Railtrack's successor and the train operating companies is of critical importance in delivering rail services that are responsive to customer needs. The adversarial nature of the contractual relationships within the industry has been a significant factor in the perceived underdelivery of the industry against the objectives set by government and the expectations of the travelling public.

  We argue that the primary objective should be to simplify the contracts and to reduce the number of contractual interfaces. One of the problems caused by the current structure is the number of relationships each Railtrack Zone has with its train operating customers. Equally, an individual train operator may have to deal with several individual zones to secure the delivery of its services. Scotland is often held up as an example where relationships work well, due at least in part to, firstly, the close geographical matching of the infrastructure and service boundaries and secondly, to the close co-operation at a service delivery level between zone and operator. Similar benefits may be available in the South East and in the proposed Wales and Border franchise area.

  We consider that there are several key requirements that should be met with any new structure:

    —  All information on infrastructure condition, path allocation and performance should be shared with users to represent a confidence building measure and provide a basis for ensuring that, where train paths are scarce, they are used in the most efficient manner.

    —  The interests of freight users must be given proper recognition so that freight operators are able to play their full part in delivering government objectives for the transfer of freight from road to rail.

    —  There is a continuing need for performance regimes to govern the infrastructure user and operator performance under the access regimes, although we see considerable scope for simplification, particularly through focusing on aggregate performance, rather than at the detail level.

    —  We consider that there could be a role for regional boards with representation from all the operators plus the successor to Railtrack to foster a close relationship between the train operators and the infrastructure manager. We think that there are risks if the infrastructure operator was to be placed under the direct control of a train operator and there would need to be regulatory conditions to protect the interests of minority route users.

  We do not propose to cover in detail the issue of future regulatory bodies but the enhanced role of the SRA must be reinforced by Government support rather than detailed management by DTLR. The continued need for an independent rail regulator also needs consideration.


  The Government appears to be committed to maintain the new national rail infrastructure manager within the private sector as a not for profit company. The success or otherwise of such a policy will have a profound impact on the level of future investment within the rail industry. It is imperative that the allocation of rail business risk is adequately addressed in any future policy options. A key objective of rail privatisation was to lever in private sector investment into the rail industry, whether as debt finance (including bonds) or equity. Following unexpected growth since privatisation, massive private investment is now needed.

  For Railtrack, equity was to absorb the business risk (and by definition receive a larger share of any rewards) and debt finance was to provide the bulk of funds needed for rebuilding programme. The removal of the equity element in the financing of the national infrastructure while at the same time continuing to profess a reliance on debt secured through bonds, represents a policy dilemma for the Government. For such a policy to succeed, a radical examination of industry business risk distribution will be required.

  The removal of Railtrack as an infrastructure provider will not in itself change the level of risk faced by the industry. Trains will still run late and as the outgoing CEO of Railtrack commented "40 year old rails will still need replacing". In establishing a new organisation, the Government will have to decide both how the risks are to be allocated within a new railway order and who will take responsibility for those areas, which cannot be apportioned. A failure to adequately address this issue will ultimately plunge the entire railway industry into a crisis far greater than seen in the period post Hatfield.

  The Government could seek ways by which the industry can be de-risked. To do this will require removing many of the building blocks of the original privatisation philosophy. Whereas this may be politically attractive, it would be perverse if as a result the industry loses some of the successes of the industry restructuring undertaken during the mid 1990's. The removal of performance payments for train service disruption (having doubled them this year) and payment for engineering possessions of infrastructure are two such areas and the Secretary of State has already hinted at such a change. It would undoubtedly de-risk the industry in the narrow sense but at a cost. A strong force for player motivation would be lost and the link between the customer and the myriad of service providers would be broken. This would neither aid day-to-day train performance nor allow the State to adequately manage its public service standards for the railway.

  Separating out the process of infrastructure management into its constituent parts (operations, maintenance, renewals and enhancements) does offer the opportunity to identify individual risk elements and these can be managed separately by different organisations. Other parties within the industry will be prepared to undertake former Railtrack activities if this adds value to their existing activity. If such a policy were pursued, wholesale industry reform would be needed. Managing the residual business risk of any new infrastructure manager will be a critical piece of government policy. It is highly unlikely that any industry player would want to or be financially able to take on the totality of risk, which faced Railtrack over the last two years. The public outcry over gauge corner cracking and the impact of the West Coast Route Modernisation cost increases imply that either the infrastructure manager or the government will have to accept a significant amount of critical business failure risk.

  As we mention in our response on financing structures, the ability of any new infrastructure manager to absorb business risk will be dependent on its financial structure at conception and ultimately on its financial reserves. A company with adequate financial reserves or government support will be able to absorb risk and attract debt finance to undertake the necessary investment. A company that is not adequately endowed will end up possibly absorbing risk at the expense of investment. There is a very real concern that such an organisation will enter a spiral of decline prompting further State intervention.

  Government has a range of policy options in managing the risk relationship between itself and a future infrastructure manager. It is unlikely the Government will be able to fully disperse catastrophic business risk. It can however remove some risks from the industry, spread as much as possible of the remaining risk amongst the players and either accept the residual risk or allocate it to a suitably finance infrastructure company.

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