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

Memorandum by the Rail Regulator (PRF 53)



  1.  Since he assumed the appointment in July 1999, the Regulator has been pursuing a programme of reform of Railtrack's accountability. The programme comprises three main elements:

    (a)  a strengthened network licence, putting right the deficiencies of the original licence in areas such as Railtrack's asset knowledge, dealings with dependent customers and disposal of land;

    (b)  a reformed financial framework, providing Railtrack with a proper system of incentives to improve performance and grow the passenger and freight traffic on the network; and

    (c)  stronger and simpler contracts between Railtrack and its train operator companies in relation to the specification of what Railtrack has to do for the access charges it receives and what rights and remedies the parties are to have if things go wrong.

  2.  The aim of this programme has never been to impose a straitjacket on Railtrack managers, nor to allow the Regulator to micro-manage Railtrack's activities. Rather, it is designed to set in place the contractual and licence provisions, and financial incentives, that would focus managers' attention on those activities which are necessary in any competent and efficient network operator. It is widely recognised, for example, that Railtrack needs a comprehensive asset register, documenting the condition and performance of its assets, as the basis for its condition-based asset management policy. The fact that the work to establish such a register has been led through the Regulator seeking a licence modification is an indication of the degree of management failure on Railtrack's part.

  3.  The Regulator's reform programme is almost complete, and most of its elements only took effect from April, May and June 2001. It is therefore too early to judge its success.

  4.  This memorandum summarises both the Regulator's perspective on the position of Railtrack up to Friday 5 October 2001 and his position whilst Railtrack is in railway administration. Decisions on the appropriate structure of the railway industry, including the structure and role of Railtrack's successor coming out of administration, are primarily matters for Government and the railway administrators.


  5.  The Regulator's objective in the periodic review, set out initially in his consultation document in August 1999, was to provide Railtrack—and through it, the railway industry and those who fund, use and depend on it—with a sound and fair financial settlement which would enable and incentivise the company to operate the network safely and efficiently and to invest in enhancing its capacity. The Regulator's final conclusions, published on 23 October 2000 (a few days after the Hatfield derailment), established the revenue Railtrack is entitled to earn from franchised passenger train operators at £14.9 billion for the period 2001-06. Together with other income, this gave Railtrack a total of £17.5 billion[24] revenue over the five-year control period, an increase of nearly £5 billion over the first five years from privatisation (control period one). Railtrack formally accepted the periodic review on 15 January 2001.

  6.  The periodic review also contained interim review provisions to provide flexibility should circumstances materially change. On 15 January 2001, the Regulator made a statement acknowledging the significant impact at Hatfield and in which he indicated the criteria for triggering two types of interim review, to deal with cash flow concerns or other, more fundamental funding issues. It said:

    "The Regulator would consider sympathetically an application by Railtrack for an early interim review to examine the appropriate timing of Railtrack's revenue requirements . . . [He] would also consider sympathetically an application by Railtrack for a subsequent interim review during the second control period to consider the ongoing impact of Hatfield on its efficient expenditures and outputs in the second control period. In either case, however, Railtrack would need to demonstrate that:

    —  the effects in terms of additional expenditure requirements or financing costs were material; and

    —  the impact on Railtrack's financial position would, without further regulatory action in the second control period, make it unduly difficult for the company to finance its relevant activities."

  7.  In respect of the company's immediate financing pressures, instead of applying to the Regulator for an early review concerning the timing of receipt of revenues, the Regulator agreed that Railtrack might approach the Strategic Rail Authority (SRA) directly. He indicated that, if the SRA agreed, £1.5 billion, then allocated to control period three (2006-11), should be brought forward to control period two. On 1 April 2001, the SRA and Railtrack agreed. The Regulator subsequently issued a public statement adjusting the 2006 regulatory asset base to reflect the bringing forward of that amount.

  8.  The SRA and Railtrack also agreed at the same time to use their best endeavours to implement a funding structure (called the "RenewCo" structure) which would have created a £1.4 billion revolving credit facility secured on grants payable as part of the periodic review. On the basis of these arrangements, Railtrack announced on 2 April 2001:

    "The acceleration of this income . . . will provide a stable financial basis for the Company and will ensure that a credit rating within the A category is maintained. The satisfactory resolution of this issue means that Railtrack need not now approach the Regulator for an interim review of its financeability."

  9.  In respect of the period between January and October 2001, the Regulator consistently made clear his view that the immediate focus for Railtrack's senior management should be network recovery. Railtrack confirmed that the cost of the immediate consequences of Hatfield would be borne by its shareholders, and that it intended to approach the Regulator for an interim review to address the longer-term implications of Hatfield, once the picture was clearer and the company had assembled the appropriate evidence to support its case. In its announcement of 2 April 2001, Railtrack said that that application would be likely to be made in summer 2002.

  10.  Railtrack made no application to the Regulator up to 5 October 2001 and nor did it indicate that an urgent interim financing review was necessary. This is consistent with the company's Report and Accounts dated 23 May 2001, subsequent company announcements and its discussions with ORR.

  11.  Annexed to this memorandum is a diagram explaining the interaction of the periodic review and the SRA's contractual indemnity in relation to increases in access charges.


  12.  As the Department of Transport, Local Government and the Regions has stated in its evidence to the Committee, the statutory duties and functions of the Regulator (other than in relation to licence enforcement) are unaffected by Railtrack's administration. The Regulator considers that it is appropriate for him to exercise his regulatory functions in a way which will assist with achieving the purposes of the railway administration order, since securing an end to the administration, and the establishment of a stable structure for the industry, are consistent with his duties to:

    (a)  promote the use and development of the network;

    (b)  promote efficiency and economy on the part of persons providing railway services; and

    (c)  enable persons providing railway services to plan the future of their businesses with a reasonable degree of assurance.

  13.  To that end, the Regulator has been in discussion with the railway administrators about the ongoing need to secure adequate information about the condition, capacity and capability of Railtrack's assets (in effect, establishing an asset register) as well as ensuring that there are systematic and robust plans in place for network performance, and for the stewardship of the assets, in the future. The fundamental issue with this work is not who owns the assets, but that proper plans should be developed and implemented to ensure that those assets are operated and maintained in a way which promotes and protects its obligations to its customers and the public interest.


  14.  Any regulator needs to have the information that allows him to make an informed judgement on the performance and competence of the regulated company, together with access to the regulatory tools that allow him to act, through a mix of incentives, to influence the behaviour of that company. Thus, whilst the degree of regulatory involvement may vary, the principles of the regulatory framework remain the same, and need to be tailored as appropriate to fit the purpose and functions of the regulated business. Given this, and the fact that Government has given no indication that it is contemplating wholesale structural change to the industry, the Regulator will continue his work to establish a regulatory framework that is fit for purpose for a rail industry where the ownership of the infrastructure is in the hands of the company which also sells access to train operators on a contractual basis. Indeed, the Government has noted the importance of meeting licence obligations in its guidelines for evaluating any proposal for the purchase of Railtrack.

  15.  Annexed to this memorandum is a diagram illustrating the relationships between the infrastructure provider and infrastructure users on the one hand and infrastructure users and their ultimate customers on the other.

24   in 1998-99 prices. Back

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