Memorandum by Royal Bank of Canada (PRF
The Royal Bank of Canada has advised on and
raised over £3 billion debt finance for not-for-profit ("NfP")
entities in the UK and Canada. RBC is financial adviser for the
first "Infrastructure SPV" being developed as part of
the SRA's refranchising programme. Given our experience in the
debt markets and the rail industry, we are interested in considering
the issues surrounding the financing of the proposed investment
programme for the rail network and the structures in the NfP sector
which can aid in this process.
The Royal Bank of Canada ("RBC") is
Canada's leading financial institution and has been represented
in the UK for almost 100 years. RBC has particular expertise in
the railway, utility and PPP sectors and in raising capital for
NfP businesses. RBC's international bond business is based in
London where it is a Gilt Edged Market Maker and a top ten sterling
The RBC team has been responsible for the arrangement
of over £2 billion of finance for the UK social housing and
higher education through NfP vehicles. In addition, RBC was the
architect of NAV Canada (presented to this Committee in the past),
the NfP trust which owns and operates the Canadian air traffic
control system funded by large issues of debt in the bank and
capital markets. Canada is soon to announce further use of the
NfP structure as the preferred method of recapitalising several
RBC is neither a shareholder nor a lender to
2. THE FINANCING
2.1 Use of NfP Structures
The UK has demonstrated that NfP borrowers can:
raise large amounts of funding in
the bank and bond markets on very competitive terms;
work within a regulated environment;
run cost efficient businesses with
manage major business risks such
as construction and life cycle risk;
build reserves to permit future investment
and further debt funded expansion; and
protect both public and private investment.
In our view the bank and bond market will fund
the proposed investment programme in full over time through a
properly structured and regulated NfP borrowing entity.
2.2 Lessons Learned from the NfP Sector
Despite the unique features of the railway industry
there are a number of lessons to be drawn from NfP models such
as used to finance Social Housing (government supported), NAV
Canada (monopolistic service to commercial users) and the Glas
Cymru structure (cost-plus service and incentivised management).
These solutions have each demonstrated robustness in the eyes
of the rating agents and acceptability to a wide universe of investors.
2.3 The key requirements for the financial
A strong and clearly defined regulatory
system with a robust and independent regulator such as the Housing
Corporation in the social housing sector. The regulator must be
able to expel failing management. In a report titled "UK
Housing Associations lead the way", S & P describes the
Housing Corporation's role as including "assessment of the
competency of management and adequacy of procedures to enable
the association to meet it social objectives without taking risks
that could lead to a loss of public funds".
Appropriate management and governance
arrangements. The housing sector has found and retained competent
management without the necessity for "private sector"
style management incentives. Dwyr Cymru on the other hand has
put in place a management incentive scheme related to service
provision and protection of creditors. The management must have
the ability to generate surpluses from its operations to reinvest
in the network after establishing agreed debt service reserves
and/or to return to users in the form of reduced charges. Equally,
it must be recognised that rail, unlike water, is a cyclical business
where consumer demand is price elastic. There must, therefore,
be flexibility for management to manage cyclical shortfalls as
well as surpluses.
A capital structure which provides
a "cushion" for debt in lieu of equity capital. This
cushion will initially be provided by the Public Sector. To gain
the trust of the funding markets, the public sector must be incentivised
to look after other creditors' interests along with their own:
as subordinated debt provider, Government is at risk of first
loss if the regulatory system fails. The Housing Corporation is
specifically enjoined to protect public sector funding via the
regulation it imposes on the management of RSLs. As a consequence,
it is also implicitly protecting private stakeholders.
We see this as the key to the funding of New
Railtrack and would encourage the Select Committee to look at
the NfP housing sector as an example of successful regulation.
3. FAILURES IN
3.1 Existing Lenders
The banks and bondholders who will be asked
to fund New Railtrack have just seen their investment materially
deteriorate in value. Those who are also shareholders are likely
to suffer large cash losses. Trust must be re-established. We
do not believe that the Administrator's current proposals are
satisfactory to do this.
Securitisaion is an overused term and has become
confused with the debate on whether a national or regional model
should be adopted for the network.
Securitisation of operating businesses is as
yet unproven. With Glas Cymru, it is still too early to judge.
The rail infrastructure sector differs from water in terms both
of a very uncertain cost base (and the absence of sufficiently
creditworthy third parties onto which the operating and maintenance
risk could be laid) and a more difficult linkage into the end
payer/user. Securitisation hives off the highest quality cash
flows to classes of creditors who have no other interest in the
borrowers' other activities.
On the other hand, the NfP model uses this quality
cash flow to enhance the position of all stakeholders, including
private and public sector creditors, and can achieve a comparable
weighted average cost of capital and more management flexibility.
Little has been said about the future role of
the Regulator. We see this as key to any solution.
3.4 Government Subordinated Debt
If the Government's ambitions for investment
in the Network are to be met, public sector support must be dynamic,
recognising that until New Railtrack has substantial reserves,
all new capital spend must be seeded with Government assistance.
The lower cost of capital rationale at the centre of the proposed
NfP model will be lost if the benefit of Government support through
subordinated facilities has been destroyed by too many caps and
To meet the HM Government's ambitions for a
modern, safe railway network, the public and private sector must
rebuild the partnership put in jeopardy by the failure of Railtrack.
The private sector has already shouldered a
considerable burden (financial and technical) required to work
up infrastructure enhancement proposals to a level necessary to
satisfy both private and public sector funders. If the Government
is serious in its intention to meet publicly stated investment
targets (in amount and time), it must now shoulder its share of
the burden of the public private partnership.
Government's part is to state clearly and quickly:
the objectives for New Railtrack,
what it is willing to spend, and
to promote a robust regulatory, financial
and contractual structure where the private sector can efficiently
assess and price risk.
We are confident that a NfP structure will provide
a suitable vehicle for this. With this in place, there is nothing
to prevent full participation of the private sector in the Government's
plans for the network.
Failure to deliver this commercial framework
will result in repercussions beyond the railway system as the
private sector increases the risk premium for participating in
public private partnerships and other regulated entities.