Supplementary memorandum by Railtrack
PASSENGER RAIL FRANCHISING AND THE FUTURE
OF RAILWAY INFRASTRUCTURE
Should Railtrack's successor emerge from administration
in the same form (albeit with different ownership) as the old
For pragmatic reasons, the successor should
emerge in broadly the same form. Indeed, major changes to the
core functions of the business could not be achieved without a
major, complicated and time-consuming restructuring of the entire
industry. It would not be possible to hold the key management
skills in place long enough to do this. Most of our activities
are inextricably interlinked with others in the industryfor
example the planning of trains, engineering work and the operation
of the network. This further increases the difficulty of undertaking
any restructuring of Railtrack, in isolation. The Government requirement
to limit the duration of administration also militates against
significant change to the form of Railtrack.
Effort therefore needs to be focused on ensuring
that the successor can succeed in this form; through continuing
the development of robust plans for maintaining a high quality
reliable infrastructure, along with associated estimates of the
costs and risk of achieving this. These need to be supported by
the comprehensive asset management information system and other
management tools that are currently being developed, and introduced
throughout all contractors, over a three-year time horizon. This
will give the control and intellectual ownership that Railtrack
has never had. A sustained period of high investment will be requiredwhatever
the form of successorto make good the legacy of Treasury-imposed
under-investment over several decades.
Some have commended vertical integration with
TOCs, or regional infrastructure companies. These may be longer-term
possibilitiesindeed, Railtrack wished to trial thesebut
not for now, to avoid distraction from the activities mentioned
above. Any proposals of this kind would need to be assessed against
EU rail legislation which requires the separate allocation of
certain responsibilities to "infrastructure managers",
and "railway undertakings" (train operators).
What are the key issues regarding the interaction
between train and infrastructure operation that should be addressed
in the new structure for Railtrack's successor?
As noted above, there is a need to maintain
the same industry structure at least for the time being. It is
clear that more focus should be brought to bear on the need to
manage railways from the perspective of being a whole system.
This focus might be achieved through a combination of integration
of businesses, improved regulatory and commercial relationships,
and better approaches to cross-industry working.
However, the current institutional structure
produces inconsistency in the manner in which the Government/SRA
funded requirements are set for train operators and the network
operator. In the case of train operators, the requirements are
set by the SRA in franchise agreements for periods ranging from
one year to 15 years. Outputs for the network operator are determined
by the Rail Regulator, together with their remuneration and incentives,
for a period of five years. Hence, the objectives and incentives
of train operators and the infrastructure operator are in permanent
overlap. It is this mismatch, and the failure to synchronise franchising
and periodic reviews, which has resulted in misaligned incentives.
What is the most appropriate basis for funding
Railtrack's successor? Should all of the money come from track
access charges or should some come directly from Government/SRA?
Following the periodic review we received payments
from the SRA via two routes: (i) direct grants, and (ii) access
payments underwritten by SRA. There is little apparent logic behind
this split of remuneration which had no significance for operators,
the travelling public or Railtrack. A simpler and more transparent
approach would be to put in place a long-term contract including
direct funding between the public sector and Railtrack's successor.
This would remunerate the same baseline scope, quality and costs
of the national network, which formed the focus of the periodic
review. The principal role of track access charges should be to
recover from operators the marginal costs associated with their
use of the network, including any costs arising from scarce capacity.
It is essential that a buffer, or financial
reserve, is created if the successor to Railtrack is to bear any
risks, and if every cost variation is not to be met by automatic
variations (or even worse, bureaucratically agreed variations)
to subsidy. This buffer, and the extent of risk transfer it brings,
will cost the taxpayer money to secure, whatever may be the details
of capital structures and interest and, if applicable, dividend
payment policies. The buffer could be a combination of retained
earnings (from higher levels of subsidy payments), subordinated
debt or equity. Government must determine which will deliver a
more efficient approach to managing the relevant industry risks,
and consequently providing longer-term benefits to the taxpayer
and travelling public. If not equity, the Treasury will, in practice,
always have to pick up the tab.
There appears to be a misunderstanding in Government
on levels of risk over the next three or four years. It is not
the case that if new major commitments are given to SPVs, the
residual risks of Railtrack's successor are "low". They
are "high", partly due to the poor state of infrastructure,
and also because the predictive tools previously referred to will
take around three years to introduce. This has huge implications
for risk, whatever the transfer model adopted.
What should the division of responsibilities be
between the SRA and the Rail Regulator?
The current split of responsibilities has proved
confusing and unworkable.
The SRA should be the principal agency within
Government that sets the output requirements for the publicly
funded railway network. The focus of the SRA should be balanced
(eg safety, operation and maintenance) and not just related to
enhancement and upgrade priorities. Consistent with this, one
would expect the Regulator to have no role in determining the
level of the outputs that the SRA requires of the network operator
for the public funds it wishes to make available. Rather, it is
for the Regulator to determine an efficient price for delivering
Independent regulation of the industry is likely
to be necessary in most models of industry structure. Government
must be seen to rebuild confidence in the independence of Regulation.
The activities of regulation should be confined to two distinct
(i) economic regulation of the monopoly elements
in the industryprincipally to allow the network operator
and (where not covered in their franchise bids) train operators,
the right to seek an independent (periodic) assessment of the
level of efficient costs at which they should be expected to deliver
the outputs required of them; and
(ii) ensuring fair play between train operators
and the network operator in the ongoing provision of services.
The first should be conducted within a single
organisation responsible for regulation of both train operators
and the infrastructure managerunlike the current arrangements
with different bodies regulating train operators and Railtrack.
Combining the functions within an SRA also responsible for specifying
output requirements for the network would be feasibleproviding
there remains a right of appeal to an independent body such as
the Competition Commission.
The second role, involving approval of track
access agreements and adjudicating on disputes, could be performed
by a separate body. However, it would be worth considering whether
there remains a case for requiring individual regulatory approval
of track (and other) access agreements, which has been a distinguishing
characteristic of the domestic regulatory regime in rail. If,
instead, these agreements were merely regulated by the Competition
Act, the role of this regulatory body would be limited to the
adjudication of disputes (perhaps building on the current industry
disputes resolution mechanisms).
Uncontrolled and overbearing regulation by competing
bodiesand the lack of effective co-ordination between ORR
and SRAare among the problems which have led to the present
situation. For the successor to Railtrack to succeed requires
significant reform on the current structure of industry regulation.
Is it sensible to separate responsibility for
enhancement projects from that for the operation of the network
as is proposed with the use of Special Purpose Vehicles?
There are significant issues with the proposed
use of SPVs or major enhancement schemes. These are quite apart
from the untested nature of the SPV propositionunlikely
to happen in practice before 2003/04, despite being the main plank
of Government policy.
First, the SPV needs to undertake investment
when most projects involve integrated renewal and enhancement
programmes on the network. Such schemes would require the renegotiation
of the pre-existing maintenance and renewal contracts.
Secondly, where SPVs undertake upgrades, the
question of which party efficiently takes the associated risks
on safety and train performance on operational parts of the network
needs to be resolved.
Experience on the WCML demonstrates the contractual
complexities of upgrading an existing operational railway. SPVs
require a rigorous process of ensuring that the contractual interfaces
and risk allocations are well understood by all parties in developing
proposals or upgrading the network. Whether this additional complexity
is manageable will depend very much on the nature of the scheme.
SPV structures would be much more straightforward on green field
developmentssuch as on the Channel Tunnel Rail Link and
also on stations and depotswhich are not themselves part
of the core multi user network.
There is a direct link here to the earlier financing
question. It is likely that some important elements of risk associated
with big upgrades will be required to be borne by the network
operator, for SPVs to be financeable at acceptable value for money.
This implies the need for a further "risk cushion" in
Railtrack's successor, either in the form of hard Treasury funding
guarantees or equity.
In the event that SPVs cannot be proven to work
in the more complex cases, the logic for separating responsibility
for enhancement projects from the operation of the network is
John W Smith
Director of Regulation & Government
19 November 2001