Memorandum by Transport for London (LU
1. SETTING THE
London Underground Limited (LUL) is a vital
public asset both for the capital and the country. It is the single
most important part of London's public transport infrastructure,
carrying over three million passengers on a typical weekday. The
Underground now carries approximately the same number of passengers
as the entire National Rail network in the United Kingdom (UK)
and generates over £1 billion in revenue income annually.
Nearly three years and seven months ago, on
20 March 1998, the Deputy Prime Minister announced to Parliament
plans for a Public Private Partnership (PPP) to modernise the
He described the Government's solution as representing "an
entirely new approacha third way. It is not privatisationor
even partial privatisation; nor is it an old-style, publicly funded
nationalisation. It is a publicly owned, publicly accountable
model to get the best from both the public and private sector".
This paper sets out Transport for London's (TfL)
objections to the PPP and our alternative plan. We have consistently
maintained that the wholesale ceding of management control over
both Underground investment and day to day maintenance to private
interests is a risky experiment that is unsafe, unmanageable and
unnecessarily expensive. Recent experience with Railtrack supports
Regrettably, the complexity and incoherence
of the PPP has only increased as the process has developed. More
than ever the PPP is a dangerously bad idea.
An effective programme to modernise (and expand)
the Underground must be, in TfL's opinion, a strategic
UK transport priority, not least because of London's economic
importance to the country as a whole. We call on the Government
immediately to transfer the Underground to TfL, who have
an alternative management plan ready to implement.
2. WHY THE
THE PPP CONTRACTS
The Government should not sign the PPP contracts
PPP is unsafe and unmanageable.
PPP does not deliver value for money.
The proposed contract terms do not
properly protect the public interest.
Safety on the Underground under the PPP will
rely on the ability of LUL to adhere to its HSE approved Safety
Case when most relevant safety activities have been contracted
out to the Infracos who must in turn comply with LUL's Safety
and Engineering Standards. As we know from the Railtrack experience,
safety is by no means guaranteed by contract assurances.
A major criticism of the failed Railtrack experiment
was that safety was compromised by the fragmentation of the system
whereby train operations and right of way maintenance were separated.
This fundamental obfuscation of accountability was compounded
in most observer's views by Railtrack's further sub-contracting
of safety critical track maintenance to Balfour Beatty (who are
part of the Metronet consortium which is preferred bidder for
two of the three PPP contracts). Put simply, this is essentially
the model now proposed for the Underground. The right hand of
Government is correcting this elementary mistake while its left
hand is repeating it.
Under the PPP LUL will retain the statutory
responsibility to ensure safety. However, as in Railtrack, while
LUL will operate trains, it will lose control of the condition
of the infrastructure, including rolling stock, track, signals
and tunnels, all of which will be maintained by the Infracos.
In order to meet its safety obligations without control
of those key pieces of infrastructure, LUL must rely on the terms
of its PPP contracts with the Infracos (which require them to
have and comply with a contractual safety case and LUL's Engineering
Standards) and keep its fingers crossed that the Infracos and
any party to whom safety sensitive work is subcontracted by the
Infracos, will provide it in good time with sufficient information
to enable it to assess whether all safety critical activities
have been performed, whether the relevant Infraco has complied
with its safety case, and if not, whether the complex contract
provides any realistic remedy for the Infraco's failing.
As we have seen with Railtrack, this is a fragmented
system which clouds accountability and encourages "buck passing"
and in which the commercial disincentive to provide safety critical
information to the party with the statutory responsibility for
safety is strong. The PPP contractors will be penalised if they
fail to improve capability, reliability and ambience, and will
receive bonuses for improvement. In fact their financial models
require that they receive significant incentive payments to achieve
the profitability promised to investors. As Lord Cullen observed
in the Railtrack context "the magnitude of the penalties
that are likely to be imposed for poor performance and the gross
disparity which exists between performance and safety sanctions
respectively, may well have conveyed to the industry the message
that performance was the top priority". While there are differences
between the Underground PPP and the Railtrack structure, the PPP
incentive structure provides the same message and will lead to
the same priorities.
Neither can the public take comfort in LUL's
Engineering Standards to control Infraco behaviour. Parsons Brinckerhoff,
a leading international transport engineering firm, reviewed LUL's
Standards on behalf of TfL and concluded that they "are
inappropriate and inadequate to serve as an effective management
control mechanism to protect the public interest in performance
based PPP contracts with privately owned Infracos".
4. VALUE FOR
Evaluation of London Transport's (LT) Value
for Money (VfM) analysis of the preferred bids in both the deep
Tube and sub-surface competitions demonstrates that the cost savings
originally promised to Parliament when it endorsed the PPP have
proven illusory. This is because:
An analysis prepared by LUL's financial
advisors, PricewaterhouseCoopers (PwC), submitted to Parliament
in 1999 promised savings of £4.5 billion over the first 15
years of the PPP. A review by Deloitte and Touche of the Public
Sector Comparator (PSC) and preferred bids finds that the Government's
plans do not demonstrate value for money. The savings are nowhere
to be found.
When Parliament examined the PPP
it did so on the basis of the PwC figures which anticipated that
it would require an estimated annual subsidy in the range of £103
million over the first seven and a half years. The current estimates
suggest that the actual annual subsidy will exceed £620 million
and could be as high as £1 billion. Private finance has proven
to be enormously expensive without compensating benefit.
The VfM analysis of the preferred bids has been
manipulated in favour of the PPP and against the public sector
PwC's VfM analysis penalises
the PSC using performance adjustments based on a number of questionable
judgmental factors, including the arbitrary assumption that the
public sector should be expected to fail to meet the performance
requirements required of the bidders.
The advantages of bond financing
as a basis for a PSC have been largely dismissed despite the significant
efficiency gains and interest rate advantages of public finance.
Bond financing is dismissed on the basis of its questionable impact
on the borrowing cost for other public sector projects, known
as "reputational externalities". Deloitte and Touche
concluded that the rationale for such an adjustment was largely
theoretical and the adjustment should be very small. However,
we are encouraged to note that the Government has now belatedly
embraced the idea of raising funds on the capital markets for
infrastructure improvements as part of its solution to the Railtrack
The Government promised the PPP would not go
ahead unless value for money is demonstrated but has assigned
the task of "proving" value for money to LT's financial
advisors who are the architects, sponsors and promoters of the
PPP. It is apparent that their findings lack credibility yet this
appears to be the basis upon which the Government proposes to
commit billions of pounds of taxpayers' money. Value for money
must be determined prior to contract award by an independent and
5. CONTRACT TERMS
TfL has recently submitted a detailed
consultation letter on contract terms. The following issues are
particularly chilling in the light of the Railtrack fiasco:
A new and remarkable provision has been added
to the PPP contract that insulates the Infraco from any meaningful
obligation to provide finance after the first seven and a half
This means that if the Infraco does
not obtain new finance commitments before the seven and a half
year review date, TfL must either rreduce the Infraco's
obligations to rehabilitate the Underground so that no financing
is required or provide the necessary financing itself. In this
situation the public will not have the benefit of Infraco finance
but will still have the extraordinary burdens and restrictions
imposed by the PPP for an additional 22 1/2 years.
The contract does not pass the risk of performing
to the bid price and for cost overruns to the private sector.
So long as the Infraco can justify
the manner in which it manages the work as "efficient and
economic" it bears less than £30 million in budget overruns
per year. Any overruns over £200 million over the full seven
and a half year period will be paid by the public purse through
LUL. Unlike Railtrack, where the Government had the option to
say no to additional subsidy, the Government (or TfL) will
have no choice under the PPP.
Infraco's bid "price" for
the last 22 1/2 years of the contract will bear no relation to
the price that LUL will actually pay for those years. Instead,
the parties must renegotiate or seek a third party view as to
what an "efficient" (at year seven and a half) Infraco
should be paid for the expected (but not binding) scope of work.
The risk assumed by the Infracos
is limited to their equity investment. Unlike the standard Private
Finance Initiative (PFI) model, the PPP contract does not require
the basic protections of either parent company guarantees or performance
If PPP fails the public has no realistic way
out of the contract.
TfL has asked for a "public
interest termination" clause to be included in the PPP contracts
to give it the option of buying out the contract (with Government
consent) if the PPP fails. Remarkably, despite apparent bidder
acceptance of this concept, this proposal has been rejected by
the Government because it might suggest a lack of confidence in
Even if the Infraco utterly fails
and defaults, LUL has no right of termination or reacquisition
but can only invoke a lengthy and complex process to force the
Infraco to sell to new owners, even if the structure of the entire
arrangement has proven to be unworkable.
With Railtrack the Government was
finally able to pull the subsidy plug so that a restructuring
could be attempted. In PPP, LUL might well find itself in breach
of its contractual obligations if it refuses to bow to ever-spiralling
subsidy demands. The only way out would be for LUL to default
on its obligations. If it did so under the PPP contract, payments
to shareholders could be five to 10 times the levels now being
discussed for Railtrack investors.
Once contracts have been signed, LUL's rights
will be severely constrained.
LUL will have no meaningful role
in the Infraco decision making or selection of investment priorities.
Infracos are free to depart from asset management plans supplied
to LUL and have no contract obligation to actually deliver the
specific investments suggested by their bids. LUL is also denied
conventional rights to vary the Infracos' scope of work. Contrary
to the Government's assertions that the PPP does not involve "privatisation
or part privatisation of the Tube", the Infracos' long term
control over the Underground infrastructure, coupled with their
long term economic interest in that infrastructure, indisputably
vests the Infracos with ownership of the infrastructure during
the 30 year term of the contract (even if technically title to
the assets remains in LUL). For all substantive purposes, the
Infracos' interest in the Underground infrastructure is indistinguishable
from the interest Railtrack had in the railways infrastructure,
and does represent privatisation.
LUL will have no opportunity to adjust
the contracts until the seven and a half year review. Given that
the Infracos will then effectively be in a monopoly position,
LUL's ability to negotiate meaningful adjustments will be limited.
The key role of the Arbitrator is
to determine contract pricing at the seven and a half year review.
The ability of the Arbiter to perform this function will depend
on both the quality of the information then available and reference
to comparable businesses. As there really are no comparable businesses
(except the other two Infracos) and all relevant commercial information
can be tightly controlled by the Infracos, LUL's ability to make
any informed submissions to the Arbitrator will be limited and
the Infracos will be free to exploit their monopoly positions.
TfL supports and endorses the Mayor's
commitment to transparency. The public has a right to see and
understand the extraordinary concessions which are being handed
to the private sector on its behalf. "Commercial confidentiality
must not be used as a cloak to deny the public's right to know".
Annexed to this memorandum is a copy of TfL's
Proposed Management Plan for the Underground.
It is significant that this document, published in April 2001,
addresses all of the key issues identified by this Inquiry as
important to maximise the service provided by the Underground.
It is even more significant that TfL's alternative bears
striking similarities to the evolving model proposed for Railtrack
involving, as it does, a not for profit trust to raise funds on
the capital markets with such funds to be supplemented by Government
grant. Of particular interest are:
TfL proposes a simple but
highly structured and tightly disciplined management structure
which has worked in other transport systems around the world.
The defining feature of TfL's proposed model is its clear
structure of accountability affording the public owner unified
control over the entire system. In TfL's professional judgement,
this is essential for passenger and staff safety. This sits in
stark contrast to the PPP model in which public control over the
Infracos' activities is limited and relies upon unwieldly contractual
mechanisms embedded in 135 separate contract documents, in excess
of 2,800 pages of contract terms with 2,000,000 words.
TfL's proposed financing programme
and management structure is designed to allow the public owner
to set and enforce clear and achievable performance targets on
the Underground, at the lowest borrowing cost. This would be achieved
in a coherent manner, prioritising the areas in most need of rehabilitation
to assure safety and deliver a tangible improvement for passengers
in the short term. TfL's model also provides sufficient
flexibility to allow the public owner to react appropriately to
PPP was misconceived at birth. The procurement
is now nearly four years old and has failed to elicit real support
from the public, transport experts or even PFI practitioners.
Despite the consumption of over £200 million pounds worth
of professional advice (and rising) PPP still:
fails to deliver the savings promised
to Parliament at the outset and will not provide value for money
when compared with a fair estimate of the public sector alternative;
fails to improve passenger safety;
fails to provide meaningful risk
transfer while at the same time ensuring enormous profit opportunities
to the private sector; and
will be unmanageable because of its
utterly convoluted contract regime.
The good news is that there is a way out. TfL
stands ready to implement its alternative plan which will deliver
the improvements to the Underground that are so desperately needed.
We call on the Government to transfer LUL to TfL so that
the job of rebuilding the Underground can commence.
Robert R Kiley
Commissioner of Transport for London
12 October 2001
8 Attached memorandum marked "A" details
the PPP timetable from May 1997 to date. Back
Cabinet Office-12 guiding principles in using Market Testing and
Contracting Out. Back
Not printed. Back