Further memorandum by Institute of Logistics
and Transport (PRF 10A)
PLC BEING PLACED
The Secretary of State on 16 July 2001 instructed
the SRA to concentrate on improving services within existing franchises,
or by negotiating short two year extensions. This change to Government
policy was seen essentially as the creation of a breathing space
to permit resolution of the problems caused by Railtrack's then
inability to progress and fund the enhancements which the SRA
had previously linked to its long-term franchise replacement programme.
The position is unchanged but, within that two year extension
timescale, a new process must be found to resolve the impasse.
Railtrack's successors must be properly organised and remunerated
to allow and incentivise them (in the words of Railtrack's current
Licence Condition 7) to secure the maintenance . . . renewal and
replacement and . . . the improvement, enhancement and development
of the network.
A body or bodies, or perhaps an arms-length
division, must be created to take forward major new projects and
other enhancements to the network. If these changes have become
effective by 2006, two years after the majority of the existing
franchises are due to end, then the position will be effectively
no worse than when the Secretary of State made his announcement
in July. However a framework for the envisaged public private
partnership between SRA and the private sector is urgently required
to enable the preferred bidders for the South Central and SWT
franchises to move forward with their plans for improving the
network, stations and depots.
Meanwhile, the SRA should bring forward and
implement its programme of franchise extensions or (in some cases)
replacement franchises. These should be progressed in parallel
to the inevitable changes to Railtrack and should be designed
to end the uncertainty about management of franchises and ensure
that the expected benefits to the customer start to come through
quickly. These include better performance, improved and new rolling
stock, relatively simple enhancements to the network and attention
to the industry's safety problems. The changes to safety reporting
lines and institutions recommended by Lord Cullen could be brought
forward to the same timescales. This programme requires new and
invigorated leadership from both Government and the SRA to ensure
rapid implementation. Hopefully, the programme will not require
new primary legislation.
The financial structure needs to be sufficiently
robust for the successor to manage efficiently the risks which
it is required to manage. There is a strong correlation between
the structure and these riskswhich we refer to in more
detail below. The appropriate structure will recognise and should
optimise the substantial cash flow derived from the taxpayer (currently
approximately 60 per cent of Railtrack's revenue). The overall
financial structure must itself be adequate and contractually
robust for efficient private sector capital funding to be available.
The structure should be capable of meeting the obligations of
the successor, assuming that it is properly managed. The extent
of those obligations will be determined within the existing legislative
and contractual framework. Whether the successor will be required
to fund and carry out enhancements to the network or to refinance
them, or simply to operate, maintain and renew the network (as
implied by the Mr Byers' statement to the House on 15 October)
will need to be decided early on and will affect the choice of
financing structure. We note that the SRA and the Department had
formed the view some time ago that the balance sheet of Railtrack
was inadequate for it to fund the considerable amount of enhancement
needed but still minor enhancements were to remain with Railtrack.
The question of financial structures is intimately
linked with the question of ownership. The ILT is concerned that
adequate consideration should be given to the range of possibilities.
There are a number of models to be examined:
(a) public ownership. This, as has recently
been discussed in the Institute for Public Policy Research (IPPR)
publication, Building Better Partnerships, need not rule out the
raising by the public corporation of private sector capital.
(b) continued private sector ownership. Given
the apparent interest of the private sector in acquiring Railtrack's
business from the Administrators, this route should not be ruled
(c) a public private partnership under which
Government offers a concession through a competitive process (for
perhaps 30 years) for the operation, maintenance and renewal of
the infrastructure. The concession could be of the entire network
or regional segments. The concession company or companies would
be able to raise private finance from the capital markets and
the cost of capital would reflect the government based revenues.
The concept is not dissimilar to the London Underground PPPs and
would enable Government to meet value for money criteria.
(d) a split of ownership from operation.
The successor body could own the infrastructure and probably be
responsible for capacity (path) allocation but contract the operation,
maintenance and renewal functions to the dominant franchise group
for each region or line of route. Those groups would raise capital
from the capital and debt markets.
(e) not for profit organisation: as proposed
by the Secretary of State the successor could be established as
a "not for profit" organisation, such as a company limited
by guarantee. If the membership were to be appointed and removed
by the SRA, this organisation would have some characteristics
of a publicly owned corporation although capable of becoming insolvent.
The key difference from models (b)-(d) would be that the primary
motivation of managers would be to provide efficient public infrastructure
rather than to make returns for shareholders. There would be no
shareholders' equity and therefore no requirement for revenue
to fund a return on equity.
ILT is cautious about the "not for profit"
proposal because, unlike both public sector corporations and public
there is little experience of how
well such organisations will attract high calibre management and
run efficient operations;
unlike Welsh Water, the successor
body will effectively be at the beginning rather than at the end,
of a very substantial investment cycle, a significant difference
if the successor is to be responsible for part of the enhancements;
again, unlike Welsh Water and indeed
all the other regulated utilities, the successor will be substantially
dependent upon government subsidy;
the different stakeholder interests
represented amongst the members are likely to lead to compromise
rather than clear direction;
the members would have no direct
financial stake in the business.
We wish to stress that whichever form of private
sector entity is chosen the successor's cost of raising finance
on the debt and capital markets will be affected by the degree
of government support of its cash flows available (as has been
made clear by Standard & Poors, the credit rating agency).
What is more, the perception of the risk profile of the successor
eg the state of the infrastructure and the safety obligations
of its operator, will probably make it very difficult for the
successor to raise private finance without a considerable element
of government guarantee or alternatively government finance effectively
equivalent to equity. Failure to provide such support, given the
amount of taxpayers' money involved, would affect value for money.
The relationship between Railtrack's successor
and the train operating companies is of critical importance in
delivering rail services that are responsive to customer needs.
The adversarial nature of the contractual relationships within
the industry has been a significant factor in the perceived underdelivery
of the industry against the objectives set by government and the
expectations of the travelling public.
We argue that the primary objective should be
to simplify the contracts and to reduce the number of contractual
interfaces. One of the problems caused by the current structure
is the number of relationships each Railtrack Zone has with its
train operating customers. Equally, an individual train operator
may have to deal with several individual zones to secure the delivery
of its services. Scotland is often held up as an example where
relationships work well, due at least in part to, firstly, the
close geographical matching of the infrastructure and service
boundaries and secondly, to the close co-operation at a service
delivery level between zone and operator. Similar benefits may
be available in the South East and in the proposed Wales and Border
We consider that there are several key requirements
that should be met with any new structure:
All information on infrastructure
condition, path allocation and performance should be shared with
users to represent a confidence building measure and provide a
basis for ensuring that, where train paths are scarce, they are
used in the most efficient manner.
The interests of freight users must
be given proper recognition so that freight operators are able
to play their full part in delivering government objectives for
the transfer of freight from road to rail.
There is a continuing need for performance
regimes to govern the infrastructure user and operator performance
under the access regimes, although we see considerable scope for
simplification, particularly through focusing on aggregate performance,
rather than at the detail level.
We consider that there could be a
role for regional boards with representation from all the operators
plus the successor to Railtrack to foster a close relationship
between the train operators and the infrastructure manager. We
think that there are risks if the infrastructure operator was
to be placed under the direct control of a train operator and
there would need to be regulatory conditions to protect the interests
of minority route users.
We do not propose to cover in detail the issue
of future regulatory bodies but the enhanced role of the SRA must
be reinforced by Government support rather than detailed management
by DTLR. The continued need for an independent rail regulator
also needs consideration.
The Government appears to be committed to maintain
the new national rail infrastructure manager within the private
sector as a not for profit company. The success or otherwise of
such a policy will have a profound impact on the level of future
investment within the rail industry. It is imperative that the
allocation of rail business risk is adequately addressed in any
future policy options. A key objective of rail privatisation was
to lever in private sector investment into the rail industry,
whether as debt finance (including bonds) or equity. Following
unexpected growth since privatisation, massive private investment
is now needed.
For Railtrack, equity was to absorb the business
risk (and by definition receive a larger share of any rewards)
and debt finance was to provide the bulk of funds needed for rebuilding
programme. The removal of the equity element in the financing
of the national infrastructure while at the same time continuing
to profess a reliance on debt secured through bonds, represents
a policy dilemma for the Government. For such a policy to succeed,
a radical examination of industry business risk distribution will
The removal of Railtrack as an infrastructure
provider will not in itself change the level of risk faced by
the industry. Trains will still run late and as the outgoing CEO
of Railtrack commented "40 year old rails will still need
replacing". In establishing a new organisation, the Government
will have to decide both how the risks are to be allocated within
a new railway order and who will take responsibility for those
areas, which cannot be apportioned. A failure to adequately address
this issue will ultimately plunge the entire railway industry
into a crisis far greater than seen in the period post Hatfield.
The Government could seek ways by which the
industry can be de-risked. To do this will require removing many
of the building blocks of the original privatisation philosophy.
Whereas this may be politically attractive, it would be perverse
if as a result the industry loses some of the successes of the
industry restructuring undertaken during the mid 1990's. The removal
of performance payments for train service disruption (having doubled
them this year) and payment for engineering possessions of infrastructure
are two such areas and the Secretary of State has already hinted
at such a change. It would undoubtedly de-risk the industry in
the narrow sense but at a cost. A strong force for player motivation
would be lost and the link between the customer and the myriad
of service providers would be broken. This would neither aid day-to-day
train performance nor allow the State to adequately manage its
public service standards for the railway.
Separating out the process of infrastructure
management into its constituent parts (operations, maintenance,
renewals and enhancements) does offer the opportunity to identify
individual risk elements and these can be managed separately by
different organisations. Other parties within the industry will
be prepared to undertake former Railtrack activities if this adds
value to their existing activity. If such a policy were pursued,
wholesale industry reform would be needed. Managing the residual
business risk of any new infrastructure manager will be a critical
piece of government policy. It is highly unlikely that any industry
player would want to or be financially able to take on the totality
of risk, which faced Railtrack over the last two years. The public
outcry over gauge corner cracking and the impact of the West Coast
Route Modernisation cost increases imply that either the infrastructure
manager or the government will have to accept a significant amount
of critical business failure risk.
As we mention in our response on financing structures,
the ability of any new infrastructure manager to absorb business
risk will be dependent on its financial structure at conception
and ultimately on its financial reserves. A company with adequate
financial reserves or government support will be able to absorb
risk and attract debt finance to undertake the necessary investment.
A company that is not adequately endowed will end up possibly
absorbing risk at the expense of investment. There is a very real
concern that such an organisation will enter a spiral of decline
prompting further State intervention.
Government has a range of policy options in
managing the risk relationship between itself and a future infrastructure
manager. It is unlikely the Government will be able to fully disperse
catastrophic business risk. It can however remove some risks from
the industry, spread as much as possible of the remaining risk
amongst the players and either accept the residual risk or allocate
it to a suitably finance infrastructure company.