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


Examination of Witness (Questions 260-279)

WEDNESDAY 28 NOVEMBER 2001

MR BOB KILEY

  260. Is it your view then that the London Underground modernisation project, whether it is being done through PPP or being done through another financing route, risks the same kind of unexpected and substantial cost overruns that we have seen on the West Coast Mainline?
  (Mr Kiley) If you do not know where you are at the start of the project, if you are not aware of the condition of the road ahead, you are almost certain to blow it. It is in the nature of human beings to low-ball it, at the start, because we are all in a political environment, and then costs usually go in one direction; if you have been lax on that front and if you do not have good information, they rise, and the West Coast Mainline is a good example of that. It is just best to do it right at the start and to keep it right, yet stay with this development of knowledge within the asset register; the needs assessment is an ongoing process. As I said when I made my opening statement, we will do that, it will take some time, but some things can go forward. For instance, you can begin the process of ordering new rolling-stock and beginning a tender for refurbishing of existing rolling-stock, because that is more knowable; it will take some time to be actually clear about that, than much of the rest of the physical plant, so there will be early activity. But this assessment would have to be done on an urgent basis, you would have to be prepared to spend some real resources on it, and I cannot tell you for sure how long it will take, it will take as long as it takes to finish it; but, certainly, it should be able to be done within 18 months.

  Chairman: It sounds altogether too logical for British railways, Mr Kiley.

Mr Donohoe

  261. When is it that your organisation takes complete control of London Underground, if at all?
  (Mr Kiley) That is a subject for the National Lottery, because I do not think anyone can answer the question really, because we do not get control of it until this procurement is finished, one way or the other, and then there is a period of time where the transfer occurs. So it could be anywhere from, if you take Mr Byers' estimate of April, before the safety case was done, if you use that as a possible in-point, which I am not at all certain about, and you add to that three or four months to transfer the Underground, which was the estimate I heard last July, that takes you well into the summer. So it could be as late as the end of next year, if things go wrong.

  262. Do you think that is affecting the performance of London Underground today?
  (Mr Kiley) Yes, I do.

  263. What would you want to see happen, to avoid that?
  (Mr Kiley) I would like the London Underground to be transferred to us immediately and we will get on with it; it is exactly the same thing that I said to the Prime Minister in April when he asked me the same question.

  264. When you were in New York and Boston, did you use consultants?
  (Mr Kiley) We used contractors, consultants, we had a whole variety of private sector companies involved in the rebuilding process; in fact, we relied heavily on them, probably 90 per cent of all the activity was carried out by private contractors.

  265. But, specifically, here, in London Underground, in looking at the evidence that we are receiving and on the basis of a fairly sizeable amount of work being undertaken, we hear the costs of using consultants?
  (Mr Kiley) Oh, you mean the current costs of using consultants?

  266. Yes; and also the fact that they seem to use these consultants, when I would imagine it would be by far better, if you were moving into the future, to have expertise that you are looking for from the likes of consultants in-house?
  (Mr Kiley) If you do not have internal expertise and rely on it to the maximum extent possible, you are going to run into serious troubles down the road. And I know that an enormous amount of research has been expended on consultants and legal resources here; it is a procurement that has taken almost four years, but that is, what, £50 million a year, that is a large price tag. Because of the role that we have played, of trying to argue that there is another way to go than to keep PPP, we have spent close to £2 million ourselves on the total resources and trying to keep up with all of this; so that is money, all of this is money, that could usefully have been put into the physical plant, and that is unfortunate.

  267. But, in specific terms, if you take the Government's appointment of Ernst & Young to carry out a value for money case, to satisfy the request for an independent assessment of the PPP, was that money well spent?
  (Mr Kiley) Let me answer that in two ways. One is that this has been advertised as an independent review of the value for money exercise, and I do not really think that is the way to go. The National Audit Office was called into this, thanks in no small part to the concern of this Committee, just about a year ago; it reached the conclusion that the value for money case had not been made at that point, it made a series of recommendations, they have kept track of this. I think, if we were to scour the countryside in the UK for the one independent body left, it would be the National Audit Office, and I hope there will be the opportunity for them, before contracts are signed, to get into it, do its analysis, reach its conclusions, make them public, make them public before the contracts are signed. Ernst & Young, a fine accounting firm, is, I think, not as independent as the National Audit Office would be. After all, Ernst & Young has been brought into play by the Department, with respect to Railtrack, before it went into administration, and are still being paid by somebody a substantial amount for administering Railtrack. So I would not challenge the integrity of any of the people involved with Ernst & Young in these efforts, but we have to be mindful of the appearance, not just the actuality of independence, in a project that has been so contentious and controversial and time-consuming as this one. And I hope that the Government sees it this way; sometimes they sound that way, other times they do not.

  268. But is it not your experience of the use of consultants that on occasions they give you the information that you are looking for, or think that you are looking for, and are not as subjective as they might be?
  (Mr Kiley) I do think that consultants make an earnest effort to be professional, and I do not question the professionalism of any of the significant accounting firms and consulting firms that have been involved in the PPP effort, we have had some involved ourselves. But the fact that they have all been involved, they have all done important pieces of work, and that some of them continue to be involved, says that, strictly speaking, they are not independent, and we do need an independent evaluation of the value for money case.

  Mr Donohoe: Did the Government consult you before they agreed the terms of reference given to Ernst & Young?

Chairman

  269. Did the Government actually discuss with you the terms of reference given to Ernst & Young before they started on the project?
  (Mr Kiley) No, they did not.

Mr Stevenson

  270. Mr Kiley, three areas, please, of questioning. What is your assessment of the risk transfer elements, in the situation we have at the moment, to the private sector in the PPP?
  (Mr Kiley) There is some equity commitment, or rather wobbly equity commitment, by the bidders; so they have some money at stake themselves, but it is overrated. So I think that, given the contractual commitments that continue to pile up as we move along, the amount of risk that is really being transferred is barely perceptible. As I said, even the risk that securities purchasers, bond-holders, investors in Railtrack took was greater than that being asked of the contractors here in PPP, and I mentioned some of the reasons for this, almost impossible, in fact, literally impossible, to terminate the arrangements. If we take the cost overrun situation, for the first seven and a half years, which are the only ones that are likely to be financed under this arrangement, the exposure that any one Infraco will have for cost overruns over seven and a half years is limited by contract to £200 million, or roughly £30 million a year. When you exceed that, providing that a third party, if there is a dispute, says that it is economic and efficient, which could take years, I guess, to sort out, then it is the Government's responsibility for picking up any of the overruns, and I do not call that much of a risk.

  271. Can I then ask about the arbiter, because in all your documentation you are quite critical of that proposition, that there would be an arbiter after seven and a half years to adjudicate, in any dispute, between the Infraco and, presumably then, your organisation; why are you so critical of that proposal?
  (Mr Kiley) Between the arbiter and other third party dispute resolution mechanisms that are built into these contracts, and given the variety of opportunities that there are in 135 volumes, 3,000 pages and two million words for disagreement about what language means, essentially, we are likely to be turning the management over to people we do not even know now, the arbiter, the dispute resolution mechanisms, the nature of which probably no-one in this room could really explain. And that is one of the inanities of this contract regime, that in the end people we do not even know about, mystery people, will end up making the determinations about how the place will be managed; it is just intolerable.

  272. But, I think it is fair to say, you suggest perhaps even stronger than that in your evidence to us, that the fact that the Infraco will be a monopoly, basically, then any power that the arbiter may be able to exercise will be limited, to say the least. Is that a fair assessment of your position, and, if it is, why is that the case?
  (Mr Kiley) I think what you have just said is a commonsense assessment, you have just said it very well, that the drift in the power relationships will mean that it will be a rare arbiter who will be flying in the face of what the Infracos really wish to do.

  273. My last area of questioning is about value for money, very subjective, very difficult to tie down, as the National Audit Office, of course, said; but, nevertheless, assessments are being made. Have Transport for London been involved with PricewaterhouseCoopers in determining any of those factors, that could lead to assessments being made?
  (Mr Kiley) We have certainly had discussions at various points over the past year with PricewaterhouseCoopers about their work, but we have had no involvement in their determination of the model, or models that are being used and the assumptions that are being built into the models.

  274. May I offer one example, Mr Kiley, that bothers certainly myself, I raised this with PricewaterhouseCoopers at our last evidence session, and that is the Deloitte & Touche report, which you were kind enough to circulate, I think?
  (Mr Kiley) After some struggle to get it out.

  275. Well, nevertheless, you managed it. One of the findings in the Executive Summary, in this area of value for money, is the quote: "highly material adjustments to the public sector comparator are judgmental, volatile or statistically simplistic," and it gives, as an example, one of the largest adjustments, amounting to £1.17 billion, related to performance, and it represents an expected failure of London Underground Limited, under the public sector comparator, to meet the performance requirements of the projects; in other words, they are bowling in, well, it is bowling in, an assumption that the public sector would not perform. (A) is that your reading of that situation, and (b) have you, in the light of this report, made your feelings clear to PricewaterhouseCoopers, or London Underground, or the Government?
  (Mr Kiley) We have tried, steadfastly, often and frequently in purple prose, to make our views on these subjects as clear as possible. We thought that the Deloitte & Touche report was spot on, but we had done our own analysis before Deloitte & Touche had, back in April, and then in September, as I mentioned to you. So the variable that I most enjoyed reading about was the one entitled `reputational externalities', which, to this day, I have trouble really understanding and believing could really be taken as seriously as the makers of the model seemed to take it, and I hope and pray that `reputational externalities' will sort of disappear from the scene by the time they do the final analysis.

Dr Pugh

  276. Can I just take you back to the issue of consultants, very, very briefly. I think I understood you correctly as saying that you thought it unlikely that Ernst & Young would be in a position to provide a fully objective analysis of value for money; was that what you were saying?
  (Mr Kiley) I think it is difficult for them to do an analysis which will be viewed as independent by most of the people who are going to be party to this, including ourselves.

  277. But you believe an objective assessment is, in principle, possible, if not done by Ernst & Young?
  (Mr Kiley) I think that by far the best way to go in this environment that we are in, and we have to be aware where we are in this process, is to rely on the National Audit Office's good offices to do this independently and objectively.

  278. Is that because you prefer their methodology, or because it is an agreed methodology?
  (Mr Kiley) It really has nothing to do with their methodology, it has to do with the fact that they have maintained an independent air throughout this entire process, and that is the one thing that Ernst & Young cannot really claim, because they have been working for the Department which has a very vital interest in the outcome. Deloitte & Touche would not be viewed as independent by the London Underground, or the Department, and that would be fine.

  279. Specific to the PPP, the seven and a half year figure, have you seen a satisfactory business case as to why seven and a half years should be the only period where the contract is really firm, it is a fraction of 30, I can see that, but, so is three, so is five, so is ten, why seven and a half years?
  (Mr Kiley) I was not around, but actually I think that the people who were preparing the tender actually had this debate about whether it should be five, seven and a half, or ten.


 
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