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


Further memorandum by the Department for Transport, Local Government and the Regions (PRF 35A)

INTRODUCTION

  1.  This Memorandum provides the further information requested by the Transport Sub-Committee in the light of the High Court's decision on 7 October to grant an order placing Railtrack PLC into Railway Administration. Several of the Sub-Committee's supplementary questions relate to the Government's proposal that a Company Limited by Guarantee (CLG) could take over Railtrack PLC's railway assets and its role as Network Operator. The responses below refer to this proposal. But the Sub-Committee will be aware that there may be more than one proposal before the Administrator, who is responsible for assessing and making recommendations on proposals for transferring Railtrack's railway assets out of administration as a going concern. Any such transfer must be approved by the Secretary of State.

THE IMPACT OF RAILTRACK PLC BEING PLACED IN RAILWAY ADMINISTRATION ON THE GOVERNMENT'S FRANCHISING POLICY

  2.  The fact that Railtrack PLC has been placed in Railway Administration will of itself have no significant effect on the Government's franchising policy. The Strategic Rail Authority will continue to exercise all of its functions, including its work on franchises and refranchising, until the implementation of the Government's proposed streamlining of the regulatory regime. Those functions would then be taken over by any successor body.

  3.  The SRA's "Strategic Agenda", published in March 2001, explained that it saw a role for Special Purpose Vehicles (SPVs) to finance major enhancement projects in the future. Subsequently, on 2 April the Government announced that it had agreed with Railtrack that it would now concentrate on the maintenance of the existing network, improving safety and the service for passengers—with other partners helping to expand the network. The impact of placing Railtrack PLC into administration does not affect this work and detailed proposals on the working of SPVs will appear in the SRA's Strategic Plan.

  4.  To date, heads of terms for three replacement franchises—Chiltern, South Central and South West Trains—have been signed. All of these now envisage the use of some form of SPV to finance significant infrastructure enhancements. A successor to Railtrack PLC will, however, be important to ensure delivery of these replacement franchises.

  5.  The SRA is currently negotiating a potential two year extension to GNER's East Coast franchise. It is also progressing, with Railtrack, the design and development of the East Coast Main Line infrastructure upgrade. The Government announced in April that this would be taken forward as an SPV, rather than by Railtrack alone, and this continues to be the case.

  6.  The SRA is reviewing the remainder of its franchising programme in the light of the draft Statement on Passenger Rail Franchising that the Government issued in July. The Government does not expect this to be significantly affected by Railtrack's situation.

FINANCIAL STRUCTURE OF THE GOVERNMENT'S PROPOSED SUCCESSOR TO RAILTRACK AND THE ALLOCATION OF RISK BETWEEN THE COMPANY AND THE GOVERNMENT

  7.  A CLG would be a private company run on purely commercial lines but without shareholders and consequently without the need to pay dividends in return for equity funding. Any operating surplus from the company would be re-invested in establishing reserves and in developing the network. The CLG would not be run by the Government or by the SRA. It would be run by a highly professional board, tightly focused on delivering a quality rail network, remunerated and incentivised accordingly and with corporate governance structures comparable to that of a traditional PLC. The Government is confident that incentive packages could be devised to ensure that the CLG recruited and retained the very best people. Incentives would be based initially on safety, meeting financial and efficiency targets, and providing a quality service to customers.

  8.  For funding purposes the CLG would have the same sources of income as Railtrack had: property income, track access charges and grant. Some 90 per cent of the company's income would therefore be covered by stable long-term contracts. Revisions to these contracts, for example to reflect any changes to the regulatory regime, would be subject to independent regulation in respect of the fair price to be paid for the outputs Government wished to purchase.

  9.  The CLG would not need equity to raise debt finance. The company would have the existing debt from Railtrack transferred to it and would be able to borrow further from the debt markets to the extent necessary. The cost of this borrowing would depend on the company's credit rating and under the proposals currently being developed the Government would expect the CLG to have an investment grade (ie at least BBB) credit rating. The Government anticipates that in practice lenders would view the company as a very low credit risk and a sound basis for their investment.

  10.  The CLG would operate with much lower risks than Railtrack, concentrating on operating and maintaining the infrastructure as well as undertaking small-scale renewals. It would not undertake major new projects with all their attendant risks of cost overrun. As described earlier, it is anticipated that such projects—like the East Coast Main Line upgrade—will henceforward be undertaken by Special Purpose Vehicles (SPVs). These are likely to be bespoke joint venture companies financed by a combination of Government grant and private sector debt and equity.

  11.  Neverthless, the CLG would need a "cushion" between the risk of poor financial performance and debt providers that equity would provide under the standard PLC model. This would come from two main sources, which combined would allow the CLG access to sufficient funds to cover foreseeable circumstances.

  12.  First, the Government would expect to put in place an arrangement by which the company could access a standby, subordinated loan facility. This facility would be enshrined in a contract, providing explicit support in specified circumstances up to a predetermined limit. It would be capped. It would not amount to a Government guarantee of debt, but the repayment of this facility would be "last in the queue" of creditors for repayment. The possible value of this facility would be determined once the Administrator has a better understanding of Railtrack PLC's true financial position.

  13.  Second, since the company would not be distributing profits in the form of dividends, it would earn a surplus over direct costs. These would be sufficient over time to build up a significant reserve.

RELATIONSHIP OF THE PROPOSED CLG TO OPERATING COMPANIES

  14.  The Government believes that a CLG would significantly enhance co-operation in the industry to the benefit of Train Operating Companies and rail passengers.

  15.  The CLG that the Government is proposing would be a private sector company with a fully professional board comprising some 12 to 15 directors. The Government would expect the executive positions on the board to include a CEO along with safety, engineering, finance and commercial directors. The non-executive directors would include a chairman, one director nominated by the SRA and one appointed after consultation with the Train and Freight Operating Companies. The board would be completely focused on delivering a quality rail network fit for the 21st Century, remunerated and incentivised accordingly, and with corporate governance structures comparable to that of a traditional PLC. The Government would expect to put in place incentive packages comparable with those for similar roles elsewhere in the private sector, which would ensure that the company recruited and retained the very best people.

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  16.  Instead of shareholders, the CLG would have members. The SRA would be the founder member of this CLG and the Government anticipates that the majority of the other members would come from the private sector. Individuals drawn from private sector companies with a direct stake in the railways, other interests including passenger groups and employees could all be possible members. The members would have a role equivalent to that of shareholders in ensuring the high performance and full accountability of the board. The Government anticipates that operator involvement along these lines would allow the CLG structure to promote a more collaborative and co-operative approach throughout the industry, the absence of which was one of the industry's weaknesses when the network was under Railtrack's stewardship.

RELATIONSHIP OF THE PROPOSED CLG TO THE RAILWAY REGULATORY BODIES

  17.  In other utility sectors, regulators have the dual role of balancing shareholder and consumer interests. As this would not be the case with a CLG model, it is the Government's intention to streamline the regulatory regime. We recognise the continued need for independent economic regulation and are considering the details of this. Precise powers and responsibilities would be set out in legislation.

  18.  In the meantime, the SRA and the Office of the Rail Regulator would retain their existing powers and carry out their respective functions. The proposed streamlining of regulatory functions would not affect the Health and Safety Executive, which would continue to oversee aspects such as the new company's safety case.


 
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